OFHEO: Fannie, Freddie Still a Regulatory Concern

On the heels of a Standard & Poor’s report that managed to suggest that both Fannie Mae and Freddie Mac could endanger the rating agency’s view of U.S. sovereign debt, the Office of Federal Housing Enterprise Oversight on Tuesday issued a report to Congress that characterized the GSEs as “a significant supervisory concern.”

“Fannie Mae and Freddie Mac should be commended for the timely filing of their 2007 annual statements,” said Lockhart. “While they have made progress in fixing many of their systems, internal controls and risk management problems, they still have much work to do, especially with the continuing challenges of today’s mortgage market.”

As Congress and housing officials look to both GSEs to “do even more,” Lockhart argued that the need to put a stronger regulatory structure in place has become critical.

“As I noted in my transmittal letter, last month both GSEs agreed that a ‘world-class regulatory structure’ is needed and they renewed a shared commitment to work for comprehensive GSE reform legislation,” he said. “The time to act on the legislation is now.”

The House Financial Services Committee originally passed H.R. 1427, the Federal Housing Finance Reform Act of 2007, in March of last year, after its introduction by Congressman Barney Frank, along with Reps. Richard Baker (R-LA), Mel Watt (D-NC) and Gary Miller (R-CA). Industry pundits and pols alike have been calling for its approval by Congress ever since, to no avail.

The OFHEO Congressional report highlights the many risks both Fannie and Freddie face as the mortgage market continues to roil: deterioration in the market value of RMBS held in each GSE’s portfolio and increasing counterparty risk as seller-servicers, deritivative issuers, and mortgage insurers have seen their core ratings taking a hit.

It also warns on the uncharted territory both GSEs are now in, especially as it relates to model risk.

“[R]apidly changing market conditions significantly increased model risk, particularly for credit and
prepayment models,” the report warned. “Given the lack of historical precedent for current conditions and the fact that models are estimated based on historical experience, Enterprise models have become less reliable and require greater management judgment, increasing the potential for error in pricing and other metrics.”

Reuters reported late last week that Treasury Secretary Henry Paulson has scheduled a meeting with the heads of both Fannie Mae and Freddie Mac for this week, to discuss the proposed legislation.

Richard Syron and Daniel Mudd, the chiefs of Freddie Mac and Fannie Mae, respectively, will meet Paulson along with Sen. Christopher Dodd (D-CT) Sen. Richard Shelby (R-AL), according to the news agency.