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M REPORT | 63 SECONDARY MARKET THE LATEST O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T A Contingency Plan for GSEs: Is it a Good Idea? A Former Freddie Mac CEO says, "no," but the FHFA calls it a necessary step prior to the enterprises' conservatorship exit. T he Federal Housing Finance Agency (FHFA)'s recently proposed "living will rule," according to the agency, is a necessary step toward Fannie Mae and Freddie Mac's fiscally responsible exit from government oversight. But a former Freddie executive is challenging the need for the rule, which he says would be a massive undertaking for the GSEs. The so-called "living will rule" essentially is a contingency plan for banks in the case of financial distress or failure. A "living will" or "resolution plan" would protect the broader financial market from harm that might accompany the failure of a significant financial institution. In December, the FHFA Director Mark Calabria explained the proposal and called for com- ment: "The rule proposed today is an important step toward a stronger housing finance system. Requiring the Enterprises to develop liv- ing wills, helps FHFA fulfill its responsibility to ensure that the failure of an Enterprise would harm neither taxpayers nor the mortgage market," Director Mark Calabria said. "The proposed rule gives FHFA a tool that supplements its existing statutory authorities to restructure a failed Enterprise so that government does not have to put the [GSEs] into conservatorship again." Former Freddie Mac CEO Don Layton, now a Senior Industry Fellow at Harvard's Joint Center for Housing Studies, makes a case in a paper entitled "The FHFA's Proposed GSE 'Living Will' Rule: Fatally Flawed and Unusually Vague" that a living-will rule applied to GSEs does not make good sense. Layton, in his writings, outlines his objections: "For the GSEs [as opposed to large banks] a living will has relatively little value versus what it does for systemically important banks" because: 1) The structure of a GSE, compared to that of a large bank, is ultra-simple: a GSE operates al- most entirely via one legal entity, in one country, and in one cur- rency, so the need for a detailed living will is substantially less; 2) Because about 90% of GSE as- sets are financed by pass-through mortgage-backed securities, a GSE in a living will situation faces li- quidity risks that are dramatically reduced compared to those faced by a bank; and 3) In some future GSE distress situation, when policymak- ers consider the health of the economy and homeownership, receivership will likely prove to be an unattractive policy alterna- tive compared to other options the government could deploy, so its likelihood of occurring is, in practice, minimal." Layton's paper goes on to pin- point what he sees as "fatal flaws" within the FHFA's proposal, and he recommends that the agency largely redesign the plan lest it be "replaced wholesale." "In my opinion, the living will rule proposal should undergo a major revamping through the comment-and-revision process. This process should eliminate the fatal flaws and clear up the vagueness that currently gives FHFA too much discretion to do whatever it wants," Layton said. "Furthermore, the rule should be scaled back so the implementation effort required matches its low regulatory value. The rule should also be revised into a technical document, as more typically re- quired of large banks, rather than the vehicle for policy implementa- tion that it is in its current form."