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OFHEO's Risk-Based Capital Stress Test: Incorporating New Business Is Not Advisable

GAO-02-521 Published: Jun 28, 2002. Publicly Released: Jun 28, 2002.
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GAO reviewed whether the Office of Federal Housing Enterprise Oversight (OFHEO) should incorporate new business assumptions into the stress test used to establish risk-based capital requirements. The stress test is designed to estimate, for a 10-year period, how much capital the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) would be required to hold to withstand potential economic shocks, such as sharp movements in interest rates or adverse credit conditions. Incorporating new business assumptions into the stress test would mean specifying details about the types and quality that would be acquired during the 10-year stress period, the types of funding that would be used to acquire such mortgages, and other operating and financial strategies that would be implemented by Fannie Mae's and Freddie Mac's managements. GAO found that data for the enterprises show that new business conducted over a 10-year period accounts for a large share of their on- and off-balance sheet holdings of assets and liabilities at the end of each 10-year period. Because new business represents such a large share of enterprise holdings over time, it would have a major impact on the enterprises' financial condition, risks, and capital adequacy in the face of stressful events. However, determining the appropriate new business assumptions to include in the model would be difficult and inherently speculative. with OFHEO having to develop plausible scenarios for how enterprise management and the market would respond in a stressful environment. OFHEO can use supervisory review, which includes examination of the enterprises' ongoing business activities and enforcement actions, and should work in conjunction with the capital requirement to help ensure the safety and soundness of the enterprises.

 

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