Capital. Sufficient levels of capital, properly aligned with risk, serve to motivate managers to operate within acceptable risk tolerances and make financing costs commensurate with risk. The current capital regulation of the GSEs is inadequate in that it fails to adequately address their credit and the portfolio management risk. As a result of legislation and the OFHEO implementation of the risk-based capital rule the GSEs are unlikely to ever need more capital than their minimum capital requirement (2.5% for on-balance sheet assets, 0.45% for off balance sheet obligations).

New capital requirements can and should be structured to attract capital to the housing finance markets. As the GSEs have expanded beyond traditional prime mortgages, the charter requirement for credit enhancement for loans with LTVs above 80% is now too simplistic. New forms of mortgage insurance or other forms of credit enhancement should be encouraged as mechanisms for spreading the risk of the mortgage market beyond the federal housing finance entities.

Capital can also be used to control the expansion of the federal housing finance entities beyond their allowable scope. Significant capital surcharges can be added for those institutions that go beyond their limits. Added capital will reduce the risk of expansion to the housing finance system and prevent the use of the charter advantages for non-mission purposes. Even within a holding company structure, the chartered activities should be segregated and separate capital maintained to support those activities. In this way firms can gain diversification benefits, while retaining the transparency associated with the limited operations of the chartered entity.

Effective Regulation. Ensuring that federally sponsored enterprises utilize their advantages to meet their public purpose without taking on excessive risk requires effective regulation. Integrating the regulators of the housing finance system with other financial regulators is necessary for effective regulation. In addition, all housing finance regulation including that of the Federal Home Loan Banks should be integrated into a single entity.

The regulator must have clear and strong regulatory powers. This would include powers to determine whether the regulated entity is appropriately engaged in charter activities, cease and desist powers, and receivership powers.

SEC registration and disclosure should be required for all securities issued by the federally chartered entities. The public is not served by depriving GSE debt, equity and MBS investors the protections that they receive on all other securities. >>>