An obscure banking rule in the works may squash the housing recovery, warns Clifford Rossi, executive-in-residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland.

The rule involves new liquidity coverage ratio (LCR) calculations for Fannie Mae and Freddie Mac put forth by the Basel Committee on Banking Supervision.

The calculation may restrict the amount mortgage securities from Fannie and Freddie, known as government-sponsored enterprises (GSEs), banks can hold, Rossi says.

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In an effort to prevent another financial crisis, the Basel Committee’s new ratio mandates that banks keep highly liquid assets of at least 100 percent of cash outflows over a stressed 30-day period.

The problem, he writes in an article for the American Banker, is that the rule classifies GSE securities as lesser-quality assets, which are subject to haircuts and caps.

“And it is in this differential treatment of liquid assets where the problem for agency securities arises,” Rossi states.

GSE securities now represent about 40 percent of bank liquidity portfolios. Under the new rule, they’ll be counted as lesser-quality, or Level 2a, assets, and subject to a 15 percent haircut and a 40 percent cap net of haircuts of total liquid assets used to calculate the ratio.

That means banks might have to reduce the Fannie and Freddie securities in their portfolios and turn to more low-yield securities like Treasurys, he predicts, warning that that will hurt banks’ ability to manage risk.

The Basel Committee is making a mistake, Ross charges. “GSE securities are one of the most liquid fixed-income markets in the world with almost $$4 trillion outstanding and an average trading volume of $250 billion daily,” he says. Plus, the Basel Committee’s rule may contradict the Dodd-Frank Act that classifies GSE securities as high-quality liquid assets. With a deep market, GSE securities feature low price volatility and transparency.

As banks reduce their holdings of the mortgage-backed securities, mortgage rates will rise, he warns. The securities are a major part of the Federal Reserve’s quantitative easing program. When the Fed unwinds QE, the rule could hurt housing markets if banks cannot replace the Fed’s purchases.

“Basel’s treatment of GSE securities in the LCR, if left unchanged, poses risk to the fragile housing recovery,” Rossi asserts, saying the requirement shows “how simple categorizations by asset risk-weighting can lead to unintended consequences for markets.”

The liquidity ratio has drawn little attention from others.

At a recent House Financial Services Committee hearing, Congressmen expressed about how the Basel rules would impact lending by community banks, according to the National Law Review. Representatives said they’re worried about how regulations and costs of implement them will impact community banks’ viability.

Editor's Note: The Truth About the Economy — Government Documents Lead to Eerie Conclusion