As the mortgage market continues to absorb the details of the accord recently reached by Representative Richard Baker (R.-La.) and the government-sponsored enterprises, questions are arising from observers regarding how some of the more nebulous nuances of the plan will be implemented and what role the Office of Federal Housing Enterprise Oversight will play as the plan goes forward.

"This is not a treaty. This is an agreement to draft a treaty," said Michael Youngblood, managing director of real estate at Bank of America. "Now who is going to draft it?"

Indeed, the consensus from market pundits last week was that the truce struck with the GSEs leaves many questions unanswered, especially regarding the role of Armando Falcon, the OFHEO director who was noticeably not in attendance when the deal was announced publicly on Oct. 19. It is not clear whether members of HUD, the entity that oversees the GSE's mission regulation, were present at the meeting.

"There is a missing fourth party here, maybe even a missing fifth party, if you include HUD," said another MBS participant.

While Baker's original intention had been to make OFHEO a tougher regulator of the GSEs, along with the Department of Housing and Urban Preservation, just how OFHEO would redefine its authority in the months ahead still remains somewhat of a mystery.

"Clearly Baker has indicated that he wanted to further strengthen the hands of GSE supervision, but whether that is done through OFHEO or HUD remains to be seen," said an MBS analyst. "If Baker had wanted to strengthen regulation, he could have involved OFHEO and left the enforcement of the accord to Mr. Falcon."

Baker's office would not return phone calls and a spokeswoman from OFHEO declined comment, saying that Falcon would address these issues in a speech this Tuesday.

"What can Baker do? All he can do is pass the law. [The GSEs] have no legal obligation to do what Baker says," Youngblood said. "They do have a legal obligation to follow the regulations promulgated by OFHEO."

"There seems to be this thought that we developed this with Baker, but that is not the case," said Sharon McHale, a spokeswoman for Freddie Mac. "We and Fannie Mae spent months working on the package of steps that we announced last week and ensuring that there was an important role for OFHEO in developing it. Throughout the whole development the interest of OFHEO was recognized and protected, but the measures were done between Freddie and Fannie - a voluntary series of steps that we were proposing to take.

"This was not negotiated between us and Baker or between us and OFHEO. And it all happened in a very quick time frame...There wasn't this meeting where these things were developed that didn't include outside groups. This was brought to Chairman Baker as a package - it wasn't like we negotiated with him."

McHale said that Baker thought that what he was presented with was a very credible model and far beyond what other financial institutions were doing.

"I think the general attitude right now is, We will take these steps, now let's go back and figure out how we'll implement them," McHale added. "There has to be a way to iron out the details with [OFHEO], to work with them so they understand how we're going about it and whether or not it makes sense to them."

Fannie Mae would not return phone calls regarding this topic.

It's All in the Details

Market observers have also been discussing a plethora of details that need to be clarified in the current plan - nuances which may call for completely different approaches from Freddie and Fannie, especially when the definition of "liquidity" is considered.

"A lot of ink needs to be spilt to specify what 90 days liquidity' means," said one MBS player. "Moreover, will Fannie and Freddie adopt separate interpretations of the agreement? The two GSEs each have different management styles with respect to the liquidity components of their overall assets."

The GSE accord with Baker and forthcoming risk-based capital rules were based on a paper discussing the management of liquidity put out by the Basel accord in 1998. That paper recommended that companies dependent on accessing the debt markets maintain one to three months worth of liquidity.

"That's where we came up with more than three months [of liquidity], because we want to say we exceed the best-practice recommendations of Basel," said Peter Mahoney, associate general counsel of Freddie Mac. "Each of Fannie and Freddie made a very specific pledge to maintain a portfolio of liquid non-mortgage marketable securities in a liquidity portfolio that will be at least 5% of on-balance-sheet assets."

Freddie's portfolio is usually composed of Fed funds and other short-term highly rated instruments, as well as other non-mortgage bonds. These bonds have a lot of variable rates, so they are puttable bonds that FHLMC can run off, but in the event that the GSE is holding something that is a fixed-rate instrument of five years, the agency will apply a haircut to it.

Additionally, the GSEs have to develop what-if contingencies, such as if related markets are disrupted, and Freddie Mac will apply haircuts as appropriate to assure that the three months liquidity requirement is really doable.

"We will be positioned such that if we are going to be cut off from the market for ten days or fifteen days or 25 days for rolling over our discount notes, the market will always know that we resort to a source of liquidity," Mahoney said. "Even under adverse scenarios we will not be relying on getting bailed out by the government or feel a need to get assurances from the government. Our independent financial strength provides investors with the ability to point to our balance sheets as opposed to the government."

However, within the parameters of the GSEs' announced commitments, it is possible to arrive at that commitment from a number of different strategies. This has led some observers to wonder whether Fannie and Freddie will arrive at separate agreements, given that the GSEs' approaches have differed in the past.

"[Fannie] may choose to hold different paper than we do," Mahoney said. "We're not turning into a government bureaucracy where all our steps will be dictated by a government agreement. Within the bounds of competitive considerations we are working with Fannie vs a vs the public parameters which we've been committed, to ensure we're on the same page. A lot of that will be checked and the math will be checked and the level of adherence to commitment, not by Fannie and Freddie, but by market investors on the two agencies.

"Investors are keenly interested in this entire package," he added.

Defining Liquidity

Still, many questions remain unanswered, according to market participants. For instance, do the GSEs allow offsets like prepayments of principal on loans and securities that Fannie and Freddie own? Do they allow offsets to the term of the GSE's float? Is that 90-days liquidity' relative to short-term debt or to long-term debt or to both?

"Defining liquidity is not as straightforward as it might seem," said one source who was trying to analyze the accord.

"In regard to the offsets, and planning for the what-if' scenario, will we assume the rollover? The answer is yes and no," Mahoney said. "Only to the extent reasonable under the scenarios we've proposed. We're not going to assume that if we have a bunch of instruments that could be disrupted that we're going to recover 100% principal on that... But almost everything we hold is either double-A or triple-A-rated, so a rating agency would assign the likelihood of recovering principal on that to a 1 in 30-year depression...so those haircuts will be appropriate in the bounds of the fact that we're getting a return that is pretty conservative and commensurate with the very high rating on all the securities we hold."

As to when all of these details will be hammered out, Mahoney said that the GSE is "aggressively moving to get these standards into place." Some preliminary work has already been done on the subordinated debt program, as well as the liquidity portfolio the GSE is developing.

"Though there is no fixed date, we will be looking to aggressively implement this in the first couple of quarters of next year," Mahoney said.

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