Fannie Mae and Freddie Mac are seeking significant revisions to a regulatory rule that forces them to submit all new products and activities for review, arguing it is too restrictive and goes against congressional intent.

In a rare joint comment letter sent this week to the Federal Housing Finance Agency (FHFA), the two government-sponsored enterprises objected to several parts of the July 2 interim rule, saying it was unnecessarily burdensome and ineffective, and could make it difficult for the GSEs to help during a crisis.

The letter marked one of the first times the two companies have publicly taken issue with their regulator, which seized them nearly a year ago and continues to run them in conservatorship.

No doubt because the companies are writing to their conservators, the letter is exceedingly polite, but it still makes clear that the GSEs think the current rule needs critical changes.

"The enterprises encourage FHFA to implement the statutory requirements in a manner that reflects the intention of Congress that this approach to new products should allow the enterprises to respond appropriately and in a timely manner to market needs and not unduly burden the enterprises at a time when innovation and flexibility are very important to borrowers and the secondary mortgage market," Timothy J. Mayopoulos, general counsel of Fannie, and Robert E. Bostrom, the general counsel of Freddie, wrote in a letter dated Aug. 31.

Observers said the pushback from the GSEs is a test of their relationship to the FHFA, which was formed a little over a year ago.

"This is an extremely important challenge to the nascent regulator," said Joseph Mason, an associate professor of finance at Louisiana State University.

At issue is an interim rule required by the Housing and Economic Recovery Act of 2008, which said that the FHFA's director must review any new product and submit it for public comment before it can be offered by the GSEs. The law also requires a GSE to provide a written notice to the FHFA for any new activity that the company does not consider a product. The agency has 15 days to determine whether the activity is a product subject to public comment and prior approval.

Under the rule, the FHFA does not define the difference between a new product and a new activity, leaving the agency's director to distinguish between the two. While that was cheered by some industry groups, Fannie and Freddie argued it could effectively treat products and activities the same way, which they say is not what lawmakers intended.

"Congress clearly intended that new products would be subject to a greater degree of pre-launch scrutiny than new activities, and that new activities would require a lower level of pre-launch review," the GSEs wrote. "In order to be workable and predictable, the final rule should provide clear definitions."

Some observers agreed the FHFA was blurring the line, and leaving too much uncertainty for the GSEs.

"It's kind of like saying the speed limit's going to be 55, but it doesn't say whether that's miles per hour or miles per day or kilometers per hour," Mason said. "It's saying, 'We'd like to limit risk from innovative products but we have no quantitative hard determination of what a new product is or what risk is.' "

The enterprises offered their own definitions for FHFA to consider, saying any new product should be an activity relating to conventional mortgages that poses a risk to the GSEs or the finance system and involves a significant change in terms, conditions or limitations from any existing product.

A new activity should be any new business line that is offered to the secondary mortgage market generally, the GSEs said. They said a new activity should not include any product that is de minimis in volume or scope, the automated loan underwriting system present before the final rule goes into effect, or any modification to the mortgage terms and conditions related to loans the enterprises purchase.

The GSEs also said the rule would require the same amount of information to be provided to the FHFA regardless of whether it is a new activity or a product, making the launch of any new activity overly burdensome.

They argued that the FHFA already has the power to review any new activity for safety and soundness purposes if it has concerns, and should allow a streamlined review.

"The interim rule creates unnecessary delay and inefficiency at the initiation of a new product and is duplicative of the ongoing safety and soundness review," the GSEs wrote.

The enterprises also criticize the rule for going beyond its scope. While the law said that any new product must be reviewed to be consistent with the safety and soundness of the mortgage finance system, the rule discusses the "financial system" as a whole.

"While the mortgage finance system undoubtedly is an important component of the 'financial system,' the latter term is clearly much broader and would require the enterprises to produce substantially more information that is contemplated by the statute," the letter said.

They also said the rule was going too far because it would require the FHFA to analyze the "degree to which the new product is being supplied or could be supplied by non-government-sponsored enterprise firms."

But the GSEs maintained that even if a non-GSE was offering the same product, they may not provide enough support for it during an economic downturn.

"While the enterprises' mission is to provide a constant and reliable source of liquidity, other types of entities are more likely to exit the mortgage market and reduce liquidity at a time when liquidity is needed," the GSEs wrote.

The GSEs are largely fighting to change the rule by themselves. While the rule attracted relatively few comments - only eight were on FHFA's Web site by Wednesday - most of the rest of them approved of the rules or wanted them to be even tougher.

The Consumer Mortgage Coalition said in its letter that if the GSEs were ever returned to their previous, semi-private status, the FHFA should monitor them even more strictly than the rule stipulates. The coalition also suggested changes to the interim rule to whittle down the exemptions it currently contains for some products the GSEs already offer.

It is not clear when - or even if - the GSEs will be returned to the private sector.

"The real question isn't about what new products Fannie and Freddie are going to offer, it's whether or not we're going to still have a Fannie and Freddie," said Jaret Seiberg, an analyst with Concept Capital's Washington research group. "This could become a legitimate fight five years from now, but first the administration needs to decide whether the enterprises should even continue to exist."

(c) 2009 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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