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The Federal Housing Finance Agency (FHFA), which oversees operations at Government-Sponsored Entities (GSEs) Fannie Mae (FNM: 0.00 N/A) and Freddie Mac (FRE: 0.00 N/A) as well as the Federal Home Loan Banks, is considering new ways in which to avoid the devastating knock-on effects often implicated in bringing the US economy to its knees.

In a white paper released today, titled 'Automatic Recapitalization Alternatives' (download here), co-author Robert Collender, a senior policy analyst at the FHFA, and colleagues write that "regulators are seeking ways to reduce the procyclical [where one hit in financials causes another and so on] effect of the current capital regulatory regime and the spillovers associated with financial firm distress."

The white paper is inviting discussion around the topic, especially in establishing capital buffers at financial firms so that, in the event of major economic downturn, the flow of credit will largely remain intact.

"A capital ratio requirement that increases with the rate of growth of the assets of a firm would result in a larger increase in capital during good times that could cushion financial firms and overall economy as losses are realized during downturns."

As part of the motivation for the white paper, the authors point to similar requirements established under the Basel II protocol which, the report claims, exacerbates downward spirals in financials by using credit ratings to establish risk-based capital requirements to apply to securitizations. Such a process is not for the GSEs or FHLBs, Collender said.

Capital risk measures under Basel II guidelines were implemented in the US on April 1, 2008. It is mandatory for large, internationally active banking organizations—those with $250bn in total assets or at least $10bn in foreign exposure—but optional for smaller firms. Basel II does not apply to Fannie Mae, Freddie Mac or the Federal Home Loan Banks.

Write to Jacob Gaffney.

The author holds no relevant investments.