BLOG VIEW: The U.S. Treasury Department and the Federal Housing Finance Agency (FHFA) have jointly issued new guidelines on releasing Fannie Mae and Freddie Mac from government supervision, restoring Treasury’s authority to approve any release plan.
That means protracted comment periods and approval from the Financial Oversight Council.
The GSEs were “free standing” at one point. Will the same financial structure prior to conservatorship work?
If not, what needs to be changed and what third parties – other than the GSEs and the government backstop – will need to be involved?
Whatever structure is designed it must retain the current GSE bond financing, secondary market execution and government “implicit” guarantee.
This implicit guarantee, never truly defined but more market assumed, affords rating agency comfort, government agency status, and deep pocket security (and hopefully capital) investors.
The guarantee is considered “explicit.”
GSE capital and credit structure(s) prior to conservatorship is an advanced CFA topic. What follows is a streamlined version of the former structure focused on the coverage of losses, with a potential pool insurance/reinsurance overlay addressing the residential loan loss claims the market never expected that led to receivership.
This simple model is a one-pool (with all identical loans) loss probability that is extrapolated into mortgage insurer, pool insurer, agency, and government loss expectancy and financials. Liberties have been taken with assumptions and calculations that would require extensive analysis. Examples include mixing loan-level and pool insurance math, life of loan income statements, and simultaneous losses and insurance premium collection.
Who are the players?
Borrower: Our mortgagor makes a 20% downpayment.
Private Mortgage Insurers (PMI): For borrowers who are unable to make a 20% home downpayment PMI protects lenders against losses due to default. The higher the loan-to-value ratio the higher the coverage required by the GSE’s. The PMI provides 12%
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