Credit Risk Transfer Is Not a Panacea for Fannie and Freddie

Abstract

Fannie and Freddie’s credit risk transfer (CRT) programs are a set of highly promoted and useful tools to hedge unexpected losses. Financial institutions, such as banks and insurance companies, use credit protection and risk transfer products similar to CRT to enhance or supplement regulatory capital levels and to absorb mostly unexpected risk. Based on market conditions, there are both opportunities as well as limitations of using different CRT products. CRT is not a panacea for the GSEs as implied by some market commentators. CRT is procyclical and not a replacement for stable and permanent equity capital that supports expected risk.

TOPICS: Fixed income and structured finance, credit risk management, legal/regulatory/public policy