With the closing of the reply-comment period on the risk-based capital rule proposed by the Office of Federal Housing Enterprise Oversight, the safety and soundness regulator of Fannie Mae and Freddie Mac hopes to have a final rule ready by the close of 2000.

"We're sorting through and reviewing the thousands of pages of comments we've received so far," said OFHEO spokeswoman Stefanie Mullin. "The next step is to consider how to respond to each comment and then we'll begin rewriting the rule."

The risk-based capital rule, mandated by Congress after the creation of the regulator in 1992, is a stress-test approach that assures the government-sponsored enterprises will be adequately capitalized for 10 years during extreme economic conditions.

In consideration of the proposed rule, OFHEO will review all comments made during the two comment periods, as well as from the reply-comment period that ended April 14.

Among the numerous reply comments received, a majority of respondents cited the treatment of capital "haircuts," or reductions, to be given another look.

In comments by Fannie Mae, senior vice president, general counsel and secretary Thomas Donilon points out that haircuts on triple-B and unrated counterparties should be 100%, as opposed to the 80% that OFHEO proposed in its rule.

"OFHEO's proposed haircut of 80 percent for BBB-rated entities is extremely excessive, by several orders of magnitude, relative to past experience, including that of the Great Depression," the report states. "Fannie Mae believes that a careful and thorough analysis of counterparty risk exposure requires a detailed examination of the specific institution offering the credit enhancement and a review of the contractual agreements that define this exposure."

Freddie Mac also agrees that OFHEO's haircuts are excessive. "Freddie Mac believes that credit derivatives should receive the same counterparty credit risk or haircut treatment as interest-rate derivatives, except in cases where there is no counterparty," stated Maud Mater in Freddie Mac's comment. An example of this is proceeds of bond sales received up-front, in which no haircut should exist because there is no presence of counterparty credit risk.

Further adding to the haircut issue, the Mortgage Insurance Companies of America stated that all comments received regarding narrowing the haircut spreads between the double-A and triple-B/below investment grade counterparties should be ignored, and supports OFHEO's proposal. "OFHEO should ensure that its haircuts are large enough to prevent the GSEs from engaging in risk arbitrage," MICA's Suzanne Hutchinson stated.

As for GE Capital Mortgage Corporation, its comment stated that the haircut proposal should be uniformly applied based on external public ratings, noting that most GSEs have been given triple-A ratings because of implied government guarantee. GE further stated that the haircuts should not be based on the counterparty identity or transaction type.

James Zollo, GE's managing director for capital markets, cited in the comment that "many commentators criticized the haircuts proposed by OFHEO ... as too severe," but they did not offer any analytical support of their criticism.

OFHEO Director Armando Falcon has made instituting a "state-of-the-art" risk-based capital rule as one of his top priorities since becoming director last fall and hopes that the rule will be finalized by the end of the year.

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