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

W Frame, Kristopher Gerardi and Paul Willen

No 2015-3, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: Stress testing has recently become a critical risk management and capital planning tool for large financial institutions and their supervisors around the world. However, the one prior U.S. experience tying stress test results to capital requirements was a spectacular failure: the Office of Federal Housing Enterprise Oversight's (OFHEO) risk-based capital stress test for Fannie Mae and Freddie Mac. We study a key component of OFHEO's model?30-year fixed-rate mortgage performance?and find two key problems. First, OFHEO had left the model specification and associated parameters static for the entire time the rule was in force. Second, the house price stress scenario was insufficiently dire. We show how each problem resulted in a significant underprediction of mortgage credit losses and associated capital needs at Fannie Mae and Freddie Mac during the housing bust.

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: 57 pages
Date: 2015-03-01
New Economics Papers: this item is included in nep-ban, nep-rmg and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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