After several months of backlash from community banking groups and mortgage-backed securities players - and faced with the possibility of a legislative moratorium - Federal Housing Finance Board Chairman Bruce Morrison last week agreed to withdraw a controversial proposed rule that would have realigned the Federal Home Loan Bank's capital structure and, among other directives, would have called for the FHLBanks to divest their nearly $60 billion of MBS investments.

In a letter to the House and Senate chairmen of the congressional conference committee working on financial modernization legislation, Morrison assured that he would withdraw the FHFB's initiative, entitled the Financial Management and Mission Achievement (FMMA) proposal, pending final congressional enactment of a banking bill that is designed to modernize the FHLBank system.

According to Morrison, the FMMA - which would have phased out the arbitrage investments of the FHLBanks and divested them of MBS over a five-year period - was being taken off the table because, in response to an outcry from lobbying groups and others, Congress proposed a statutory moratorium on the FHFB's regulatory authority.

"Despite the best efforts of well-meaning advocates, such statutory language can only lead to serious ambiguity and potential litigation over the independent regulatory authority of the Finance Board," Morrison said. The FHFB first approved the proposal during late summer, to the chagrin of many market players.

Instead, the FHFB is now holding its FMMA plan in abeyance until the provisions set forth in the modernization bill take effect, a process which will take at least 18 months, sources say.

Modernization Bill Must Be Passed First

The FHFB will need at least that amount of time to address the regulatory issues involved in the bill, which encompass a complete overhaul of the FHLB system, including a shift to a risk-based capital structure and a uniform class of voluntary, rather than mandatory, members; an expansion of eligible collateral that can be borrowed against; and a change in the governance of the system.

"While the FMMA proposal was complex and multifaceted, in many senses, some of its major components were a bit of putting the cart before the horse'," said Robert Davis, director of government relations for America's Community Bankers, a group representing regional banks that spoke out vehemently against the FMMA proposal (MBSL 10/4/99). "We welcome this decision on the part of the Finance Board. Any rule that they put out needs to be developed to reflect the new capital structure and new form of membership that will exist after this bill becomes a law."

"The Finance Board needs to absorb the components of the legislative package and wait to see the responses from the banks before they resuscitate, reconsider or restart the FMMA regulation," added Brian Smith, the head of economic policy at ACB. "This gives a helpful pause while the FHFB works on other regulatory engineering tasks. Now they can see what tweaking has to be done to the FMMA before they relaunch that initiative."

Among other goals, the financial modernization bill will expand small business lending and community development initiatives, as well as make some adjustments to the capital base of the system. Moreover, it will clarify the roles of the federal regulator and each of the boards of directors for the individual Federal Home Loan Banks, Smith says.

According to Davis, the FMMA proposal would not resurface for a long time: Assuming passage of the banking bill, the Finance Board must first put out for comment their capital rules to implement the change in the capital structure system. After the comment period, there would have to be a final approval of the rule, followed by a period of at least 270 days wherein the member banks would submit their retooled capital plans.

"Even after the plans are submitted, there is a multi-year period for the banks to implement capital plans," Davis added. "This long period of transition won't end until at least March 2001."

Finance Board Stands By FMMA

Despite the fact that the FMMA proposal received criticism from member banks, Wall Street observers and lobbying groups, Finance Board officials insist that the withdrawal of the proposal was not a result of negative commentary.

"This was not based on any commentary we received, because the 90-day commentary period for the proposal ended on December 27, and very few people actually wrote anything to us yet," said Bill Glavin, spokesman for the Finance Board. "The reason that it was withdrawn is that so much of what it is based on is a change in the capital structure of the FHLBanks to a risk-based structure. If a bill were to be passed, it wouldn't make our proposal moot, but as a regulatory agency we would have to change our proposal anyway to make it based on the bill."

The FHFB had originally intended to make the FHLBanks shed their MBS portfolios because these investments were not considered to be consistent with the banks' core mission of promoting housing and community development. The FHLB system, which held $59.7 billion in MBS, had come under fire in the last several years for its investment tactics.

Despite Morrison's withdrawal of the proposal, the FHFB has made it clear that the restructuring of the FHLBanks' capital system and the issue of whether they should be allowed to arbitrage in the capital markets is still a legitimate and important issue for public policy debate.

"Any money the banks raised on Wall Street should still go to mission-related activities, and this is definitely still the position of the agency," Glavin added.

Still, market participants were generally happy to hear that, at least for the time being, the FHLB system would be able to maintain their MBS investments.

"I think that we would regard this as very favorable news for the mortgage securities market," said Michael Youngblood, director of mortgage research at Banc of America Securities. "It removes the overhang of divestiture that even if it had been undertaken over a five-year period, it would still have eliminated a significant permanent holder of MBS from the marketplace, and place incremental pressure on other participants to absorb the securities.

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