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Fannie Mae: What Happens When Governments Use Capital Rules For Political Ends

Karen Petrou memorand to Federal Financial Analytics clients Fannie Mae - what happens when governments use capital rules for political ends.

TO: Federal Financial Analytics Clients

FROM: Karen Shaw Petrou

DATE: October 2, 2015

Do governmental edicts erase risk? The U.S. thought so and supported residential mortgages by jiggering the risk-based capital rules, first for S&Ls and then even more disastrously for Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC). Now, the European Union will see if setting regulatory-capital standards for social purposes works any better for them. Although my hope is that fixing the EU’s capital books will spark lending, my forecast is that it won’t and my fear is that resulting distortions will have long-term, systemic impact akin to those in the U.S. If governments want spending for the public good, great – just do it directly or with express guarantees, not hidden subsidies to private financial-services firms.

Stuck in an economic rut, some in the fractured EU want to advance a Capital Markets Union that overrides national rules and create non-bank financing channels for corporate and infrastructure growth. Nice thought – the EU’s financial infrastructure resembles that of the Articles of Confederation. Not so nice in execution, though. Among other problematic provisions, the EU plan includes fixing the risk-based capital weightings for credit obligations based not on risk, but rather on social or, less charitably, political purpose.