The Failure of supervisory stress testing: Fannie Mae, Freddie Mac, and OFHEO

W Frame, Kristopher Gerardi and Paul Willen

No 15-4, Working Papers from Federal Reserve Bank of Boston

Abstract: In the aftermath of the global financial crisis, policymakers in the United States and elsewhere have adopted stress testing as a central tool for supervising large, complex, financial institutions and promoting financial stability. Although supervisory stress testing may confer substantial benefits, such tests are vulnerable to model risk. This paper studies the risk-based capital stress test conducted by the Office of Federal Housing Enterprise Oversight (OFHEO) for Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) that are central to the U.S. housing finance system. This research aims to identify the sources of the stress test's spectacular failure to detect the growing risk and ultimate financial distress at these GSEs as mortgage market conditions deteriorated in 2007 and 2008. The analysis focuses on a key element of OFHEO's stress test, the models used to predict default and prepayment of 30-year fixed-rate mortgages.

Keywords: bank supervision; stress tests; model risk; residential mortgages; government-sponsored enterprises (search for similar items in EconPapers)
JEL-codes: G21 G23 G28 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2015-03-01
New Economics Papers: this item is included in nep-ban, nep-cba, nep-rmg and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Working Paper: The failure of supervisory stress testing: Fannie Mae, Freddie Mac, and OFHEO (2015)
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