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Federal Register / Vol. 86, No. 5 / Friday, January 8, 2021 / Proposed Rules B. Process for Supervisory Determination of Temporarily Increased Liquidity Requirements V. Paperwork Reduction Act VI. Regulatory Flexibility Act
I. Introduction
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A. Background Liquidity risk management is a part of any safety and soundness regulatory framework for financial institutions.
The 2008 financial crisis demonstrated substantial weaknesses in the liquidity positions of the Enterprises, and liquidity and funding challenges were a significant contributing factor to establishment of the conservatorships in September 2008. The Enterprises had more than five trillion dollars in agency MBS and agency unsecured debt outstanding, held by various types of investors. Certain investors expressed significant concern about the credit worthiness of the Enterprises in the absence of an explicit guarantee from the U.S. government given the possible Enterprise losses arising from the 2008
housing crisis.
On September 6, 2008, the Enterprises were placed into conservatorship by FHFA. In connection with this action, the U.S. Department of the Treasury U.S. Treasury agreed to backstop losses by the Enterprises based on the terms of Senior Preferred Stock Purchase Agreements PSPAs entered into with each Enterprise in conservatorship. Even after receiving this public support from the U.S.
government, the Enterprises had significant difficulty issuing longer term debt in late 2008. Their primary source of funding was through the issuance of short-term discount notes, most of which had maturities significantly less than one year. The Enterprises eventually increased their ability to issue longer-term debt in 2009 and 2010
as the U.S. Treasury amended the PSPAs and increased its support to the Enterprises.
Banks in the United States and globally also experienced difficulty meeting their obligations during the crisis due to a breakdown of funding markets. As a result, many governments and central banks across the world provided unprecedented levels of liquidity support to companies in the financial sector in an effort to sustain the global financial system. In the United States, the Board of Governors of the Federal Reserve System Federal Reserve Board and the Federal Deposit Insurance Corporation FDIC
established various temporary liquidity facilities to provide sources of funding for a range of asset classes.

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These severe market stress events came in the wake of a period characterized by ample liquidity in the U.S. financial system. The rapid reversal in market conditions and the declining availability of liquidity during the financial crisis illustrated both the speed with which liquidity can evaporate and the potential for protracted illiquidity during and following these types of market events.
In addition, the recent COVID19related financial crisis reminded market participants of the speed at which the detrimental effects of a liquidity and funding crisis can manifest, as the majority of funding markets locked up in mid-March 2020. For example, the Enterprises had significant difficulty issuing longer-term fixed rate unsecured term debt in mid-March 2020, and that lack of investor demand lasted into June 2020. Market participants noted stress even in the U.S. Treasury markets.
In 2008, the Enterprises failure to adequately address these challenges was in part due to lapses in basic liquidity risk management practices, such as establishing an adequate portfolio of highly liquid assets to serve as a buffer in a crisis. During the 2008 financial crisis, the Enterprises maintained a liquidity portfolio largely composed of credit card asset backed securities, auto asset backed securities and other corporate unsecured debt, with minimal amounts of U.S. Treasury securities.
Recognizing the need for the Enterprises to improve their liquidity risk management and to control their liquidity risk exposures, in 2009 FHFA
convened an interagency task force composed of examiners from the New York Federal Reserve Bank, the Federal Reserve Board, U.S. Treasury staff, Enterprise staff, and FHFA examiners.
The discussions included draft standards being developed by U.S.
banking and foreign jurisdictions to establish international liquidity standards. These standards included the principles based on supervisory expectations for liquidity risk management in the Principles for Sound Liquidity Management and Supervision Basel Liquidity Principles. In addition to these principles, quantitative standards for liquidity were introduced to the U.S.
banking supervision framework in the form of a liquidity coverage ratio LCR
in 2013 and subsequently approved in 2014 and a net stable funding ratio NSFR in 2016 1 and subsequently approved in 2020.
1 Following the 2008 financial crisis, the Basel Committee on Banking Supervision established two international liquidity standards as a part of the
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After consultation with the U.S.
banking regulators about these developing liquidity risk quantitative standards and how they might apply to the Enterprises, FHFA issued a supervisory letter in December 2009 that established minimum 30-day and 365day liquidity requirements for Fannie Mae. FHFA issued similar supervisory guidance to Freddie Mac and added a requirement that Freddie Mac build out the capability to measure the cumulative net daily cash needs out to 365 days. FHFAs supervisory letters also required that 50 percent of the Enterprises 30-day cumulative net cash need requirement be held in cash at the Federal Reserve or in U.S. Treasury securities, with the balance of the liquidity portfolio limited to other defined highly liquid assets. These FHFA supervisory requirements were adopted by the Enterprises as board liquidity risk limits and serve as the foundation for the currently proposed 30-day and 365-day liquidity requirements.
The most significant change made by the proposed rule to the Enterprises liquidity management regimes would be the addition of certain assumptions involving stressed cash inflows and outflows. Maintaining a sufficient portfolio of high quality liquid assets to meet these stressed cash outflow and limited cash inflow assumptions would position the Enterprises to provide mortgage market liquidity in times of market stress even if they cannot issue debt. In effect, FHFA proposes to require that certain contingencies, like additional cash outflows from buying loans through the cash window also known as the whole loan conduit at Fannie Mae, and buying delinquent loans out of pools assuming a distressed mortgage market, be prefunded and backed by an appropriately-sized portfolio of U.S. Treasury securities and other high quality liquid assets.
FHFA standards for safe and sound operations for the Enterprises include those set forth in the Prudential Management and Operations Standards PMOS 2 at 12 CFR part 1236
Appendix. Standard 5 Adequacy and Basel III reform package: A short-term liquidity metric, the Basel LCR standard, to address the risk that banking organizations may face significantly increased net cash outflows in a short-term period of stress, and the Basel NSFR standard, to address structural funding risks at banking organizations over a longer-term horizon. See Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools available at https www.bis.org/
publ/bcbs238.htm; Basel III: the net stable funding ratio available at https www.bis.org/bcbs/publ/
d295.htm.
2 See 12 CFR part 1236 Prudential Management and Operations Standards.

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