Lessons in Risk Management to be Learned from Fannie/Freddie Takeover

Now that the federal government has announced its takeover of government-sponsored entities (GSEs) Fannie Mae and Freddie Mac, some questions remain as to the broader implications of the move. Sure, the Dow rallied, as did other market indices around the world. But what does the takeover say about the direction the lending space must take to help avoid similar instances in the future?

David Hamermesh, research director, consumer lending, with TowerGroup, says that short-term, the government's conservatorship of the GSEs will help restore "stability and confidence" to the market.

According to Ed Grau, senior executive, financial services risk management practice with Accenture, Americans shouldn't see the takeover as a handout. "Taxpayers may feel the federal government's decision to take over as a conservator of Fannie and Freddie was a handout," Grau comments. "However, injecting $1 billion in each of the companies in exchange for senior preferred stock yielding 10 percent and receiving warrants entitling a purchase of up to 79.9 percent ownership is akin to a leveraged finance buyout rather than a handout.

TowerGroup's Hamermesh was somewhat surprised by the speed with which the government made its move, thinking that such a decision would be put to rest until after the elections. "At this point, the focus is on putting in place a mechanism for how Fannie and Freddie will operate," he explains. However, the long-term policy decisions may be left to the new administration to hash out, he notes. For example, will it be decided that Fannie and Freddie need to be split into several smaller entities? "What fascinates me here is that if they do split them up, there will be a huge opportunity for financial institutions and technology vendors to creatively think about the pieces that were once relegated to Fannie and Freddie that they can potentially take over," he comments.

Although the fate of the two GSEs is still up in the air, decisions must be made more immediately with regard to better managing their risk. As with the financial institutions that ran afoul of subprime lending, risk was a key component to the breakdowns at Fannie and Freddie. Hamermesh notes that their recovery will be dependent in part on implementing technology around better risk management.

"Long-term, this is an illustration of the difficulty of justifying strategic long-term projects that cross lines of business," he explains. "The technology was there. It was putting the risk models in place, pulling the data together from disparate systems and staying on top of risk at the enterprise level that caused Fannie, Freddie and [other lenders] to fall."

Accenture's Grau also sees some lessons in the GSE situation for the rest of the financial services industry to note, especially around coverage, valuation and standardization. "Many banks are revisiting their risk and finance architecture, focusing on shared data sourcing and/or shared data storage across finance and risk to enable an end-to-end coverage of all transactions, better valuation and standardized reporting," he explains. "Integrating finance and risk operating models reduces redundancy and inconsistency as information needs converge to single sourcing and is reflected in outputs."

TowerGroup's Hamermesh maintains that had the Basel II framework for credit, operational and market risk been followed, the GSEs (along with the rest of the market) probably would have fared better. Whether the government takeover of the two entities will serve as a wakeup call to the rest of the industry with regard to the lack of speed with which Basel II is being implemented in the U.S. is anybody's guess. However, Hamermesh does think that the industry is starting to recognize its value. "There's a growing recognition that the precepts of Basel II are valuable, not just because we have to implement them, but because they are good ideas," he says. "While the technology existed in the past, the advances in those technologies that help gather all the data from different systems should also help when implementing [Basel] enterprisewide. It's not a simple data collection exercise."