Implications for the Performance of Fannie Mae and Freddie Mac
In its report from last Thursday, the regulator and conservator of the enterprises updated its projections of Fannie Mae’s and Freddie Mac’s financial draws from the Treasury Department. As of this month, the enterprises have drawn $169 billion under the terms of the Senior Preferred Stock Purchase Agreements, including funds drawn to meet the program’s dividend obligations. In part as a reflection of the updated housing-market outlook and better-than-expected delinquency trends over the past year, the F.H.F.A. now projects that total draws will range between $220 billion and $311 billion by the end of 2014. Given the size of the draws, it is widely understood that the agencies cannot return to profitability as long as the dividend payments are enforced.
While expectations of smaller agency losses are welcome news, the broadsheets’ coverage of the F.H.F.A. update belies the need for scrutiny of the methodologies supporting the conclusions. In particular, the estimates are the result of modeling exercises undertaken by the agencies themselves, incorporating scenarios provided by the F.H.F.A. but using internal models. In light of the failure of the agencies’ risk-management processes during the housing boom, it is altogether unclear that the results of this exercise should be treated as valid. Given the broad implications for public policy and the U.S. taxpayer, the F.H.F.A.’s statement, that credit-related expenses were calculated using “a statistical loan transition model [that] projects the unpaid principal balance (U.P.B.) of loans expected to default over the projection period” as well as other modeling processes, may not pass the litmus test of model transparency. The F.H.F.A. is correct in pointing out that “the projections reported here are not expected outcomes.”
The issue is exacerbated by the F.H.F.A.’s use of house-price scenarios and other inputs from Moody’s. While the scenarios may be valid, the F.H.F.A. does not substantiate the criteria used to evaluate the efficacy or reliability of these projections or the sensitivity of results to alternative projections. Absent a more rigorous disclosure of modeling approaches and assumptions, it is impossible to determine if the tests employed by the agencies 1) capture the risks of individual mortgages or mortgage pools with any degree of accuracy or 2) are unbiased in their assessments of each enterprise’s whole residential mortgage portfolio.
