[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
                  OFHEO RISK-BASED CAPITAL STRESS TEST


                     FOR FANNIE MAE AND FREDDIE MAC
=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                    CAPITAL MARKETS, INSURANCE, AND 
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                              COMMITTEE ON
                           FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 23, 2002

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 107-79







                          U.S. GOVERNMENT PRINTING OFFICE
82-684                             WASHINGTON : 2002
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD, Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSELLA, New York               JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missiouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director
            Subcommittee on Capital Markets, Insurance, and 
                    Government Sponsored Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman   PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
CHRISTOPHER COX, California          NYDIA M. VELAZQUEZ, New York
PAUL E. GILLMOR, Ohio                KEN BENTSEN, Texas
RON PAUL, Texas                      MAX SANDLIN, Texas
SPENCER BACHUS, Alabama              JAMES H. MALONEY, Connecticut
MICHAEL N. CASTLE, Delaware          DARLENE HOOLEY, Oregon
EDWARD R. ROYCE, California          FRANK MASCARA, Pennsylvania
FRANK D. LUCAS, Oklahoma             STEPHANIE TUBBS JONES, Ohio
BOB BARR, Georgia                    MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, North Carolina      BRAD SHERMAN, California
STEVEN C. LaTOURETTE, Ohio           GREGORY W. MEEKS, New York
JOHN B. SHADEGG, Arizona             JAY INSLEE, Washington
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
JIM RYUN, Kansas                     CHARLES A. GONZALEZ, Texas
BOB RILEY, Alabama                   HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
GARY G. MILLER, California           RONNIE SHOWS, Mississippi
DOUG OSE, California                 JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      STEVE ISRAEL, New York
MIKE FERGUSON, New Jersey            MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
MIKE ROGERS, Michigan






                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 23, 2002................................................     1
Appendix:
    July 23, 2002................................................    35

                                WITNESS
                             July 23, 2002

Falcon, Armando Jr., Director, Office of Federal Housing 
  Enterprise Oversight (with attachment).........................     7

                                APPENDIX

Prepared statements:
    Barr, Hon. Bob...............................................    36
    Gillmor, Hon. Paul E.........................................    39
    Hinojosa, Hon. Ruben.........................................    40
    Israel, Hon. Steve...........................................    41
    Ney, Hon. Bob................................................    42
    Falcon, Armando Jr.,.........................................    43


                  OFHEO RISK-BASED CAPITAL STRESS TEST



                     FOR FANNIE MAE AND FREDDIE MAC

                              ----------                              


                         Tuesday, July 23, 2002

             U.S. House of Representatives,
     Subcommittee on Capital Markets, Insurance and
                   Government Sponsored Enterprises
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 2:15 p.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[chairman of the subcommittee] presiding.
    Present: Representatives Baker, Ney, Shays, Gillmor, Lucas 
of Oklahoma, Oxley, Rogers, Bentsen, Maloney, Ford, Lucas of 
Kentucky, and Israel.
    Mr. Baker. [Presiding.] I would like to call this meeting 
of the Capital Market Subcommittee to order.
    Today the Subcommittee meets to discuss the long-awaited 
results of OFHEO's risk-based capital rules for the housing 
government-sponsored enterprises Fannie Mae and Freddie Mac.
    The importance of this long-awaited test cannot be over 
emphasized because essentially what is at stake--giving both 
investors and taxpayers--is the clearest possible financial 
picture of the two government-backed companies with, today, 
having a combined debt of over $1 trillion, implicitly linked 
to taxpayer pockets.
    Because of this importance, and in the context of the 
current market environment, demanding unprecedented fullness, 
accuracy and integrity in financial disclosure, I feel it 
important to recount the history behind the risk-based capital 
test and how we have, at long last, arrived here today.
    In 1992, a legislative act directed OFHEO to issue a risk-
based capital rule within 18 months after the appointment of 
the director, in effect, by the end of 1994. OFHEO proposed 
rules for public comment, accordingly, in 1995, 1996 and 1999. 
In 1999, the proposed rule issued for comment actually included 
a table showing the required risk-based capital calculations 
for Fannie and Freddie as of September 30, 1996 and June 30, 
1997.
    Interestingly enough, on both occasions, Fannie Mae had a 
deficit, while Freddie had a surplus on both accounts. Saying 
it another way, one GSE failed the proposed test as early as 
1996 and 1997.
    On August 1st of 2001, Director Falcon testified that OFHEO 
would publish in early 2002 how the enterprises would fair 
under the rule then promulgated using fourth quarter, 2001 
data.
    Subsequently, on September 13, 2001, OFHEO finalized the 
risk-based capital rule. However, due to apparent 
complications, by December 11th of 2001, OFHEO announced in 
light of the proposed changes in the rule, the agency would, 
instead, use first quarter 2002 numbers to calculate how the 
enterprises were gauged.
    Finally, after a ten-year process, OFHEO announced the 
results of its amended rule for the first quarter 2002, using 
the amended test, showing that both Fannie and Freddie had 
easily passed.
    We can be pleased with that report, but it was as we all 
should have expected in light of this important statement made 
by Director Falcon prior to announcing the results. with the 
proposed rule in referencing June of 1999, the enterprises then 
began a program of managing their activities to ensure they 
would meet the requirements of the rule. I take that to mean in 
the middle of 1999 the enterprises were advised and prepared to 
initiate business strategies to comply with any rule 
subsequently issued by OFHEO.
    What is of importance to me today is to understand at least 
what changes were made in the rule initially promulgated that 
resulted in an additional delay in its implementation. Were the 
changes the result of the failure of either the GSEs to pass 
the test? Or was it an underlying failure in the adequacy of 
the test?
    Was the eight-and-three-quarter year period that developed 
the first test, subsequently modified in the 60 days following, 
was the result of running the test and determining that either 
GSE did not meet the minimal capital standards?
    Did either GSE request specific modifications?
    In my request of Director Falcon and OFHEO earlier this 
year, I specifically requested that the test be conducted in 
four different methodologies--prior to its modification in 
December; as promulgated after eight-and-a-half years of work 
on the last quarter of 2001; the first quarter of 2002; and, 
additionally, after the modification, as proposed by OFHEO on 
the same data set.
    It is my understanding in response to that request, the 
agency indicated that the data for the 2002 first quarter could 
be released publicly, but specific request was made of me in 
the committee not to release the information promulgated on the 
fourth quarter of 2001, specifically using the pre-amendment 
test.
    I am curious as to why that request was deemed to be 
confidential in the first place. I am understanding that the 
explanation was that the agencies were not managing to the 
standards of that test. I simply refer to the quote of the 
Director in 2002, which indicates, ``With the proposal of the 
rule in June 1999, the enterprises began a program of managing 
their activities to ensure they would meet the requirements of 
the rule.''
    Why is it so hard to get professional assessment of the 
enterprises that are so important to our economy without 
political manipulation? Taxpayers may or may not be at risk. We 
honestly just do not know. But in this environment of corporate 
questioning, where every accounting rule is studied and re-
studied, where every CEO is questioned and re-questioned, are 
there those who suggest that these two corporations, so vital 
to our economic success, are above questioning?
    I hope not.
    I would recognize Mr. Bentsen, now, for an opening 
statement.
    Mr. Bentsen. I thank the chairman for recognizing me. And I 
thank him for calling this hearing today.
    The subcommittee will hear from Director Armando Falcon, 
the director of the Office of Federal Housing Enterprise 
Oversight on the final risk-based capital rule for Fannie Mae 
and Freddie Mac. And we are pleased to welcome Mr. Falcon back 
to the committee, of which he is a graduate as a former counsel 
to this committee.
    As the chairman mentioned, OFHEO was created in 1990 to 
act. And I would note that Mr. Falcon and his predecessor have 
undertaken, in many respects, not without criticism, a 
Herculean task of creating this risk-based capital rule and the 
analysis to go along with it. And doing it with a number of 
congressionally-mandated strictures that would not, otherwise, 
be in place for other types of analysis that are done within 
the market.
    I think it is also important that we hear from Mr. Falcon 
today because over the last several years, as we have had 
debates over the issue of the GSEs, often OFHEO has been 
overlooked as they have been toiling away and trying to come up 
with this rule.
    And I would also just remind the chairman that while there 
may be concern among some that the GSEs are managing their 
activities in order to meet the requirements of the rule, in 
fact, that is the whole idea of having rules, whether they are 
risk-based capital rules for GSEs or for banks for thrifts or 
for any other institution is, in fact, you want them to manage 
their operations in order to meet the confines of the rule.
    So, Mr. Chairman, I am glad to hear from Mr. Falcon today, 
look forward to his testimony and the opportunity to question 
him on the issues that you have raised and others.
    And I yield back.
    Mr. Baker. Thank you, Mr. Bentsen.
    Mr. Ney?
    Mr. Ney. Thank you, Mr. Chairman.
    Thank you for holding this--
    Mr. Baker. Oh, I am sorry.
    Chairman Oxley, did you wish to be recognized at this time?
    Yield to Mr. Ney?
    Yes, sir?
    Mr. Ney. I am pleased that the committee has had a chance 
to review the final risk-based capital rule for Fannie Mae and 
Freddie Mac. This capital standard has been a long time coming 
and we are grateful that the process has now been concluded.
    We look forward to this rule being enforceable, hopefully, 
in the months ahead.
    The risk-based capital rule is designed to ensure that GSEs 
can survive the worst of housing downturns, with high credit 
losses and huge moves in interest rates over, basically, a ten-
year period.
    This risk-based capital is unique because it requires the 
GSEs to operate their businesses in a way that creates an 
incentive for risk reduction activities. And I think it should 
be, really, a model for all companies these days.
    It is important for this subcommittee to realize, and I 
know they do, that the risk-based capital standard is just one 
piece of an overall safety and soundness regime for these 
congressionally chartered companies. To be clear, after the 
1992 legislation, both of these companies were bound by minimum 
capital standards and continuous on-site examinations.
    Long before Enron and WorldCom, in October 2000, Fannie Mae 
and Freddie Mac announced six initiatives that the financial 
markets now rely upon to maximize financial transparency and 
market discipline. Unlike many other companies, these two 
companies have signed up for the annual credit rating; 
additional interest rate and credit risk disclosures; 
additional liquidity management; interim implementation of the 
risk-based capital standard; and the issuance of subordinated 
debt.
    Less than two weeks ago, I did join SEC Chairman Harvey 
Pitt and Fannie and Freddie for an announcement where the two 
companies agreed to register their common stock under the 1934 
SEC Act, which now binds these two companies to comply with SEC 
requirements for periodic corporate financial disclosures. In 
the press interviews after the announcement, Frank Raines 
committed on CNBC that Fannie Mae will--and I stress will--
certify 2001 financial statements by mid-August, just as SEC 
Chairman Harvey Pitt has asked of the top 1,000 publicly traded 
companies in this country to do.
    In addition, I was pleased to hear this morning new light 
about the fact that both companies have announced they are 
recommending to their boards of directors that they begin 
expensing all stock-based compensation. In the current economic 
environment, few other companies are stepping up to the plate 
to lead on financial disclosure and transparency in the way I 
think these two are, although I predict many companies will 
with what is going on now in the United States.
    And, Mr. Chairman, I just want to, again, congratulate you, 
Chairman Baker, for all your work and I look forward to hearing 
Director Falcon.
    Thank you.
    Mr. Baker. Thank you, Mr. Ney
    [The prepared statement of Hon. Bob W. Ney can be found on 
page XX in the appendix.]
    Mr. Ford, did you have an opening statement?
    Mr. Ford. Chairman, I will defer to the witness and have 
statements once he finishes.
    Mr. Baker. Thank you, Mr. Ford.
    Mr. Shays?
    Oh, excuse me, sir, Chairman Oxley?
    Mr. Oxley. Thank you, Mr. Chairman.
    And thank you for your leadership on this important issue.
    The Capital Market Subcommittee meets this afternoon to 
consider the new risk-based capital rule for Fannie Mae and 
Freddie Mac, which has been finalized by the regulator, the 
Office of Federal Housing Enterprise Oversight.
    OFHEO is responsible for ensuring that Fannie Mae and 
Freddie Mac are adequately capitalized and operating safely.
    The 1992 act which created OFHEO directed the agency to 
issue a risk-based capital rule tied to an enterprise's risk 
exposure, as well as the current leverage or capital rule is a 
minimum percentage of assets.
    I am pleased to welcome OFHEO's director, Armando Falcon, 
look forward to his presentation of the initial non-binding 
stress test results for the enterprises.
    And I encourage you to work, Mr. Falcon, with this 
committee as OFHEO moves ahead later this year to implement and 
enforce the risk-based capital rule. It is important that both 
the risk-based and leverage capital requirements are in place 
and being implemented in tandem so that Fannie and Freddie can 
continue to perform their housing mission in a safe and sound 
manner.
    In addition, I would like to hear from you about what 
actions OFHEO will take in conjunction with the SEC to 
facilitate implementation of the voluntary compliance by Fannie 
and Freddie with SEC disclosure requirements under the 
Securities and Exchange Act of 1934, and to review the adequacy 
of information disclosures related to mortgage-backed 
securities.
    Mr. Chairman, this will be an important next step in the 
series of hearings that you have conducted. And I look forward 
to the response from the director.
    I yield back.
    Mr. Baker. I thank you, Mr. Chairman.
    Mr. Israel, did you have an opening statement?
    Mr. Israel. Mr. Chairman, I will insert my statement for 
the record.
    [The prepared statement of Hon. Steve J. Israel can be 
found on page XX in the appendix.]
    Mr. Baker. Thank you, Mr. Israel.
    Mr. Shays?
    Mr. Shays. Thank you, Mr. Chairman.
    Mr. Chairman, thank you for holding these hearings. Mr. 
Oxley, for your fine work as chairman of this committee.
    I also welcome Mr. Falcon, director of OFHEO. I appreciate 
that he is here and I look forward to his testimony.
    I think with Mr. Falcon, we have, yet, another witness who 
recognizes that voluntary disclosure is not good enough, that 
disclosures need to be reviewed by the SEC for inadequacies. 
And, in other words, Fannie and Freddie will no longer act as 
their own securities regulator. And I emphasize that.
    The recent announcement that these two mortgage giants, 
Fannie Mae and Freddie Mac, will come under the SEC as it 
relates to the 1934 law is a huge turning point in the debate. 
And I congratulate them and the SEC and OFHEO for whatever 
involvement they had with this. But it does not relieve me of 
some of the questions that I still have and the committee still 
has.
    I think first and foremost, we need to know how these new 
disclosure requirements will be enforced and OFHEO's role in 
the rule making.
    Second, we need to know what are the policy reasons behind 
the continuing exclusion of Fannie Mae and Freddie Mac's 
mortgage-backed securities and debt securities from the full 
registration and disclosure requirements of the securities law.
    Third, I think we need to know how did the administration 
reach this agreement with Fannie Mae and Freddie Mac, since I 
know of no precedent in which the publicly traded companies 
dictate to government regulators what laws they will comply 
with.
    And finally, I look forward to discussing Fannie and 
Freddie's safety and soundness and the results of the risk-
based capital stress test with our director.
    Thanks.
    Mr. Baker. Thank you, Mr. Shays.
    Mr. Ford has reconsidered and would like to take advantage 
of his time.
    Mr. Ford?
    Mr. Ford. It is just for 30 seconds, Mr. Chairman.
    I, too, look forward--it was really Chairman Oxley's 
comments that spurred some thought on my part. So I appreciate 
his inspiration.
    Last week, as all of know, we held a hearing on both Fannie 
and Freddie's voluntary agreement to register their common 
stock with SEC. And I just wanted to point out--if someone 
already has not today--I know both of them have taken the bold 
voluntary step of announcing they will account stock option 
compensation as an expense against earnings. They are joining a 
growing number of companies in taking this step to enhance 
transparency and to inform shareholders.
    With these voluntary disclosures, Fannie and Freddie can 
focus, or continue to focus, on their primary mission, which is 
making home ownership available to all Americans. The home 
ownership rate is now 68 percent, at its highest level ever. 
And this is due, in no small part, to the liquidity that these 
two companies have provided to the primary mortgage market.
    I look forward to hearing from our witness today. And I 
look forward to doing all I can to ensure that Mr. Baker's 
concerns are addressed and that these two organizations can 
continue to provide home ownership opportunities for millions 
of Americans.
    Thank you.
    Mr. Baker. Thank you very much, Mr. Ford.
    Mr. Rogers?
    Mr. Rogers. Thank you, Mr. Chairman.
    I want to thank you for having these hearings.
    And I want to thank this committee, under the leadership of 
Mr. Oxley and Marge Roukema, for already taking a huge step in 
home ownership. And today we are going to talk about 
regulations. We are going to talk about stress tests and common 
stock registrations, maybe--I mean, we may touch on those 
issues.
    But more importantly, when you get done with all of the 
technical parts of providing home ownership, the bottom line is 
what are we doing to provide the opportunity, including access 
to capital, for those who are trying to get into homes?
    And if we cannot take this to the lowest common 
denominator, we will never be successful.
    And I appreciate Fannie Mae and Freddie Mac's work in what 
they do and try to penetrate communities, especially under-
served communities for having access to capital and getting 
into homes.
    And I look forward to your comments. And I suppose it is 
for us to wrestle over the details so that those individuals 
back home do not have to, that they can walk to that place, get 
access to that capital and have the joy of putting that key in 
the door and turning the key.
    And, again, under the leadership of this committee, as a 
whole, under Mr. Oxley, Mr. Baker, Mrs. Roukema, we have taken 
a huge step in improving the chances for most Americans to get 
into those homes.
    And I hope through the whole course of this we do not lose 
sight of that and the good work that both Fannie Mae and 
Freddie Mac have done and the better things that we can do to 
make sure that they are a stable force in the community to keep 
providing the access to that capital.
    And I would yield back the remainder of my time.
    Thank you, Mr. Chair.
    Mr. Baker. Thank you, Mr. Rogers.
    If there are no further opening statements, I wish to 
welcome back--no stranger to the committee--the Director of 
OFHEO, Mr. Armando Falcon.
    Welcome, Mr. Director.
    You will need to pull that microphone very close. We are 
having a hard time. Check the little button right down on the 
bottom; see if that does it.
    Mr. Falcon. How about this?
    Mr. Baker. Now, you are cooking.

 STATEMENT OF ARMANDO FALCON, JR., DIRECTOR, OFFICE OF FEDERAL 
                  HOUSING ENTERPRISE OVERSIGHT

    Mr. Falcon. All right.
    Mr. Chairman, Congressman Bentsen and members of the 
subcommittee, I am pleased to be here today to report to you on 
OFHEO's activities and the safety and soundness of Fannie Mae 
and Freddie Mac.
    This is an important time in the short history of the 
agency, as OFHEO has just entered its 10th year. OFHEO began 
operating when its first employee, the first director, took 
office on June 1, 1993.
    The agency was built from the ground up and had to acquire 
staff and address hundreds of administrative issues involved in 
establishing an agency infrastructure. OFHEO needed to procure 
office space, equipment, computers, telecommunications and 
other logistical support for the lawyers, economists, examiners 
and administrative personnel who would carry out the duties of 
the agency.
    In its early years, OFHEO's experienced staff worked to 
develop an in-depth understanding of the operations of the 
enterprises. OFHEO grew from a one-person agency into a strong 
and well-rounded regulator, fully capable of meeting its 
regulatory responsibilities.
    While the agency was being built, it was still obligated to 
fulfill its mission of regulating two extremely large and 
complex financial institutions. OFHEO's mandate is to ensure 
that the enterprises are safe and sound and adequately 
capitalized. In so doing, OFHEO helps ensure that the 
enterprises are able to provide liquidity to the mortgage 
markets and promote home ownership.
    I am pleased to report that OFHEO is meeting its mandates. 
We have found the enterprises to be safe and sound and 
adequately capitalized. The enterprises are providing 
unprecedented levels of liquidity and stability to the mortgage 
and housing markets.
    OFHEO looks forward to its second decade of pubic service.
    OFHEO's regulatory regime consists of three pillars. These 
are examination, capital standards and research. I will refer 
the subcommittee to my written testimony for a discussion of 
these topics and will use the remainder of my time to focus on 
the risk-based capital rule and disclosure.
    OFHEO's risk-based capital standard is unique among 
financial regulators. Unlike ratio-based capital standards, 
OFHEO's standard is based on a 10-year stress test. A stress 
test measures risk in the context of a company's overall 
portfolio, including the company's risk management activities. 
An enterprise can comply with OFHEO's risk-based capital 
standard by reducing risk or raising capital or a combination 
of both.
    The risk-based capital rule became effective last 
September. At that time, I appeared before this committee--the 
subcommittee--and was urged to consider whether refinements to 
the rule were necessary and, if so, to act quickly. I 
subsequently determined that modifications were appropriate and 
the rule was amended after a public rule making during the 
fourth quarter of last year.
    We will use the rule to classify the enterprises, beginning 
with the third quarter of this year.
    In the interest of public disclosure and regulatory 
transparency, last month, OFHEO released the results of the 
risk-based capital test using the first quarter 2002 enterprise 
financial data.
    Attached to my testimony is the press release announcing 
the results.
    Both enterprises passed the stress test, due to effective 
risk management, including extensive interest rate hedging and 
the first quarter's economic environment. Interest rates are 
low; home values are rising; and borrower defaults are minimal. 
An enterprises risk-based capital requirements will vary from 
quarter to quarter, depending on the enterprises risk 
management decisions and market conditions.
    I have taken a very open approach to the implementation of 
these stress tests. I decided to release the actual stress test 
computer model or source code to the public. In addition, I 
rejected an interpretation of the one-year implementation 
period, which would have precluded the release of any results 
during that time period.
    And when I announced the stress results for the first 
quarter of this year, I did not just issue a pass-fail notice. 
I released the full results for both upright and downright 
scenarios.
    However, that openness must be balanced with some caution 
to ensure that no misleading information enters the public 
domain. That is why OFHEO will not be releasing to the public 
any stress test results other than the official quarterly 
announcements. That, of course, does not override this 
subcommittee's right to information.
    And so, I have promptly, ahead of schedule, supplied the 
subcommittee with all of the information it has requested. My 
only request was that the subcommittee respect the 
confidentiality of the information.
    OFHEO considers this information confidential for a variety 
of legal reasons. But superior to all those considerations is 
concern about releasing misleading information about the 
enterprises financial condition that could disrupt the markets.
    We have developed a strong, rigorous risk-based capital 
standard. Now, the enterprises have one year to adapt and be in 
compliance before we enforce it.
    Congress wanted us to set up a new capital standard, not a 
trap. That is why it would be inappropriate to release results 
before the rule, as amended, was in place.
    I will now turn to corporate disclosure. OFHEO safety and 
soundness responsibility includes an obligation to ensure that 
the enterprise financial disclosures are adequate. Our agency 
began the comprehensive review of enterprise disclosure in 
April of 2002. In May, OMB requested that OFHEO specifically 
consider a rule that would ensure enterprise financial 
disclosures were comparable to those of other publicly held 
companies.
    In June, I responded to OMB's letter. I agreed that 
voluntary compliance was inadequate and that given the 
enterprises exemptions from the securities laws, OFHEO needed 
to promulgate enforceable rules in this area.
    I am pleased that OFHEO's objective will now be 
accomplished in a most efficient manner. The enterprises 
voluntarily agreed to subject themselves to mandatory 
regulation by the SEC under the Securities and Exchange Act of 
1934.
    I would like to highlight several key points about the 
agreement. The enterprises will become registered companies 
bound by the 1934 act. Absent the agreement, OFHEO would have 
adopted its own disclosure regime, based on the securities 
laws.
    Second, and most significant, the disclosures will be 
reviewed by the SEC and OFHEO. Currently, it is the enterprises 
that determine what corporate information is material and must 
be disclosed. Once registered, that will change and the 
ultimate arbitrator of what must be disclosed will be the SEC 
and OFHEO, acting in the public interest.
    Finally, the disclosure reports will be available from the 
SEC essential repository for corporate disclosure reports of 
all registered companies.
    In order to facilitate the application of the 1934 act to 
the enterprises, OFHEO will promulgate the rule concerning the 
filing of all required periodic reports. Registration with the 
SEC does not, in any way, limit OFHEO's ability to act in the 
interest of safety and soundness. In fact, as part of the rule 
I have mentioned, OFHEO is considering requiring supplemental 
disclosures beyond those required by the SEC.
    In addition, OFHEO, the SEC and Treasury will conduct a 
review of disclosures relating to the offering of mortgage-
backed securities by the enterprises and other issuers. The 
review will consider the appropriate manner for creating a more 
level playing field and greater comparability of disclosures 
that will enhance enterprise safety and soundness.
    I will note that OFHEO's goal is disclosure, not 
registration. After all, disclosure is the rationale underlying 
registration. Accordingly, OFHEO will not pursue a registration 
regime at this time. if our disclosures can be met without 
registration, and I am confident that they can be, then 
registration is unnecessary. However, until the review is 
completed, OFHEO, as the safety and soundness regulator, cannot 
and should not rule out registration in some form as a 
possibility.
    In response to the subcommittee's request last week, I have 
conferred with the SEC and Treasury and we have agreed to make 
every effort to complete the review by year end.
    Mr. Chairman, you have been a strong supporter of our 
budget requests in the past and have indicated support for 
permanent funding of OFHEO. OFHEO, as the agency responsible 
for the financial health of two companies with combined credit 
exposure of a little over $3 trillion, should be permanently 
funded, as are the other safety and soundness regulators. There 
is simply too much at stake not to take this prudent step.
    The administration supports this in its fiscal year 2003 
budget request for OFHEO. I urge the subcommittee to support 
legislation that would bring about this result.
    In conclusion, as I stated earlier, Fannie Mae and Freddie 
Mac are safe and sound and well capitalized. We all can see 
their financial health at the beginning of any discussion about 
them. We are able to have this discussion against such a 
healthy backdrop due, in part, to the hard work of OFHEO's 
employees. I do not mean to minimize the efforts of the 
enterprises' management, but through our regulatory program we 
constantly probe for weaknesses and vulnerabilities and assure 
that the enterprises maintain the highest standards of sound 
management.
    We have a state-of-the-art risk-based capital rule in 
place. We are expanding our examination program, building our 
regulatory infrastructure and conducting valuable research. The 
OFHEO of 2002, which I am proud to direct, gets the job done.
    Thank you, Mr. Chairman. And I look forward to answering 
any questions the subcommittee may have.
    [The prepared statement of Armando Falcon Jr. can be found 
on page XX in the appendix.]
    Mr. Baker. Thank you, Mr. Falcon.
    I do appreciate your willingness to appear here today and 
certainly understand the complexity and difficulty of 
establishing a test for what are very large and complex 
organizations.
    But I want to make it clear that my line of questioning 
today results from a great deal of frustration about the 
process and where I think we find ourselves, as of this moment.
    It took eight-and-a-half years and considerable 
encouragement from the committee and others, including defense 
of appropriations process, to make sure that OFHEO had the 
resources to ultimately prepare the most professional analysis 
possible for this committee and for the benefit of taxpayers.
    I find it troubling that at the end of that eight-and-a-
half year period, we then had an approximately 60-day period, 
of which I am told by the agency it was a result of my request 
asking you to be thorough and thoughtful in the process, that 
it took as long as it did to make the subsequent modification, 
resulting in the post-amendment stress test, as we have it 
today.
    As I understand it, the elements that were involved in that 
critical analysis related to the level of haircut, as opposed 
to AA rated--AAA rated mortgage insurance companies; funding 
costs; and certain multi-housing questions; and perhaps 
technical issues.
    Were there any other elements in the modification to the 
eight-and-a-half year test made by the 60-day test that I am 
not aware of, other than those four principle areas? And I will 
recite them again: AA, AAA haircut mortgage insurance 
companies; multi-housing issues; funding costs; and technical 
issues.
    Mr. Falcon. I believe that covers all of them, Mr. 
Chairman.
    The technical issues: I want to get into more detail later 
about what was in those technical details. Some might have 
risen to the level of more than just technical. Others may have 
been truly technical.
    Mr. Baker. So it is your testimony that those, in general--
and I am using ``technical'' as defined by the agency in my 
discussions with agency personnel.
    Three principles were as outlined and then dogs and cats 
were described as technical issues. And so I am saying in that 
context, those are the four areas in which the modifications 
were made resulting in the test that is finally to be 
promulgated?
    Mr. Falcon. Yes. I believe that is right.
    Mr. Baker. Did you have staff run the test prior to its 
final promulgation, prior to the modification? In other words, 
the September developed test, which was then subsequently 
modified December-January, was that test run by the agency and 
producing results before it was made public?
    Mr. Falcon. The version that was final pre-amendment, Mr. 
Chairman? Is that the one you are talking about?
    Mr. Baker. Pre-amendment.
    Mr. Falcon. We had a--yes--a working version of the 
computer code. We did.
    Mr. Baker. And what were the results, not in specific 
detail, but in generic terms? Were there difficulties with the 
way in which the test concluded its analysis? Were either of 
the GSEs or both GSEs found to have difficulties with that 
test? What is your remembrance of what happened with that pre-
amendment test?
    Mr. Falcon. There were many bugs that were being worked out 
at that time, Mr. Chairman.
    Mr. Baker. Was one of the bugs the result? Or be more 
specific.
    Mr. Falcon. You could not get an accurate result if you did 
not have the bugs worked out. The bugs were two times, 
primarily. The bugs were with the computer code, itself, as 
well as getting the data right so that it would plug into the 
computer code and then produce an accurate number.
    Mr. Baker. So once you got the bugs of the computer code 
behind you, let's assume we have a de-bugged test, built on the 
principles which you have enunciated, were there further 
modifications beyond the de-bugging?
    Mr. Falcon. We have been doing some de-bugging for the 
past--
    Mr. Baker. I understand, but what--
    Mr. Falcon. --beyond September.
    Mr. Baker. Let's put the bugs on the shelf. We found the 
major bugs and we might have had a small bug or two remaining 
that were later to be discovered.
    As of September 2001, bug issue principally resolved, were 
there other elements that were of concern to the agency that 
needed to be modified?
    Mr. Falcon. Well, I would not say that the bugs were 
resolved after September 1. We continued to resolve bugs after 
that point.
    Mr. Baker. Okay. Well, I give you bugs, too. Let's assume 
there are bugs and bugs B; were there other issues besides bugs 
and bugs B that were of concern?
    Mr. Falcon. As far as the computer model working?
    Mr. Baker. No.
    Mr. Falcon. No?
    Mr. Baker. Forget the computer. We are off of computer. We 
are off of bugs, bugs one, bugs two. We are now on to factual 
determinations beyond bugs, as in the case of the amount of 
haircut for AA versus AAA, as in multi-housing adjustments, as 
in funding cost adjustment, any other adjustment.
    Mr. Falcon. I mean, there are a variety of issues and they 
are referenced in the risk-based capital rule, both in the 
final rule where we indicate areas of further research--
    Mr. Baker. Well, let me ask it a different way. Did you 
consult or did the GSEs consult with you prior to the 
promulgation of the final rule and such consultation resulting 
in any modification to the final promulgated rule?
    Mr. Falcon. When we announced that we were going to amend 
this rule, we received comments from many interested parties 
about the rule. That is pursuant to notice and comment process.
    Mr. Baker. Sure. No. I am not suggesting anything 
inappropriate. I am trying to find out the facts.
    Did Freddie review the rule and its function and make 
recommendations to you for modification, on which you 
subsequently acted?
    Mr. Falcon. No.
    Mr. Baker. Okay. Thank you.
    Is it your view that the changes made in the post-amendment 
rule were primarily technical in nature and that did not have 
any substantive change that would either detract or enhance the 
GSE's capital adequacy?
    Mr. Falcon. It is a little difficult for me to track of the 
exact time period and version of the rule you are making 
reference to, Mr. Chairman.
    Mr. Baker. The final rule.
    Mr. Falcon. The final rule, the post-amendment?
    Mr. Baker. Correct.
    Mr. Falcon. And I am sorry, but the question regarding the 
post-amendment rule?
    Mr. Baker. Were there any modifications made to the post-
amendment rule that, in your judgment, would result in a 
significant capital adjustment in the conclusions the test 
would reach?
    Mr. Falcon. For which quarter?
    Mr. Baker. Any quarter, whatever makes you happy.
    Mr. Falcon. Okay. There were still various modeling issues 
that we were working out related to various activities of the 
enterprises. There were some issues with respect to remmicks 
and swaptions, I think was an area that we were working at, 
coming to the final conclusion and getting the final bugs 
worked out in a few areas like those.
    Mr. Baker. Okay. Well, let me go at it another way. When I 
wrote you in February, I suggested that the test be run four 
ways: pre-amendment; post-amendment; each test last quarter 
2001; first quarter 2002. You have achieved that; I got the 
results for fourth quarter pre-amendment test yesterday. And 
for that I thank you.
    In the letter responding to me on both instances, you 
indicated that we should treat or your request of the committee 
was to treat those calculations as confidential.
    I direct your attention to the 1999 test in which Fannie 
was found, under your promulgation, not to meet the minimum 
requirement. That is the 1999 data promulgated and published by 
your pre-amendment rule discussion.
    If you could print and publish that in 1999, showing there 
is a deficiency, what is the distinction between releasing the 
information you have given to the committee today and the 1999 
publication, which you issued?
    Mr. Falcon. Mr. Chairman, at that time, it was essential. 
In order to allow full notice and comment, it was essential to 
release to the public some information about the way the rule 
works, the release of not just results. In 1999 we released 
results based on 1997 data.
    In order to allow robust notice and comment, we needed to 
give the public some indication about not just results, but 
also sensitivity analysis.
    And so what we had in the proposed rule was not just 
results, but we broke it down for the public among various 
types of risk and showed what the sensitivity of the stress 
test was as allocated among different types of risk.
    Mr. Baker. One more question because I have exceeded my 
time.
    Have you, prior to the hearing today, released the data to 
any other third party, any members of Congress, anybody else 
besides my office and yours?
    Mr. Falcon. The enterprises have a working version of the 
code, Mr. Chairman--
    Mr. Baker. The specific question is, the answer to the 
letter I wrote in February, which you responded and said, ``We 
will provide you with the information,'' which you provided the 
last piece of which to the committee as of yesterday--
    Mr. Falcon. Yes.
    Mr. Baker. --has that information--four parts--been 
released to anyone else other than my office, as of this 
moment?
    Mr. Falcon. No. It has not even been released to the 
enterprises, Mr. Chairman.
    Mr. Baker. Well, I have been told other members of Congress 
have it.
    Mr. Bentsen?
    Mr. Falcon. Mr. Chairman, may I correct myself in the form 
that we did give the information to Congressman Kanjorski?
    Mr. Baker. Okay. And nobody else?
    Mr. Falcon. No, sir.
    Mr. Baker. Thank you.
    Mr. Bentsen. Thank you, Mr. Chairman.
    Mr. Falcon, the first quarter numbers that you released and 
the fourth quarter numbers that Mr. Baker and Mr. Kanjorski 
have, which I do not, under the post-amendment rules--well, the 
fourth quarter would be commensurate with the first quarter of 
2002, is that accurate?
    Mr. Falcon. Right. The chairman has numbers that he has 
requested and we have supplied to him which applies the stress 
test to the fourth quarter. And we released, publicly, results 
applying to the first quarter of this year.
    Mr. Bentsen. All right.
    The chairman seems to be raising a concern about what 
numbers pre-amendment versus post-amendment might look like 
with respect to Fannie or Freddie. I guess I would ask you from 
your interpretation of the law, the 1992 act and the 
administrative procedures act that governs your rule making 
process, I assume, the post-amendment rule is the rule.
    Mr. Falcon. Yes.
    Mr. Bentsen. And so for purposes of how OFHEO should 
conduct its stress test, under the law, it should use the post-
amendment rule. Is that right?
    Mr. Falcon. Yes, Congressman.
    Mr. Bentsen. And so the amendments that were made to the 
rule are what those, you know, the haircuts and the servicing 
ratings and issues that you and the chairman conversed on; 
those are the changes, some of which were brought up in an 
earlier hearing before this subcommittee. So nothing, just to 
reiterate what you--restate from what you responded to the 
chairman in the earlier line of questioning, there is nothing 
new here, in the amendments, that should be a surprise to 
anyone on this committee. Is that correct?
    Mr. Falcon. All the changes we made to the rule were done 
pursuant to notice and comment. We issued a proposed amendment 
to the rule as it stood in September. And, in fact, I was urged 
to make any changes only pursuant to notice and comment, and I 
fully agreed with that.
    We put out for public comment the changes that we were 
contemplating, received comment from many parties and then 
proceeded with what we thought was the right thing to do in 
crafting this risk-based capital rule.
    Mr. Bentsen. So to argue that numbers that are run using an 
unfinished rule are somehow indicative of the financial 
condition of one of the GSEs on their face would be inaccurate 
because that is not what the rule is, right? I mean, the rule 
is what the final published rule, after the amendments, is--I 
mean, that is what it is, right?
    Mr. Falcon. Right. That is what is currently in effect.
    Mr. Bentsen. And that is the rule that the GSEs will be 
required to manage their operations accordingly. And then the 
third quarter or after the third quarter when you begin to 
classify the GSEs, then they will be required if they are not 
already, will then be required to come into compliance at any 
time they are out of that.
    Mr. Falcon. Right.
    Some might argue that the one-year implementation period 
would mean that there should not be any results released until 
the one-year period ends. I have taken a more open approach to 
that and have said, in fact, and released numbers and that I 
would release numbers as soon as the rules were clearly in 
place.
    And since the rule was subject to amendment in the fourth 
quarter of last year, the rules were not clearly in place. We 
published the final rule in the fourth quarter of last year. so 
the rules were in place at that time. And that is why I said 
that we would release results for the first quarter of 2002.
    Mr. Bentsen. Upon issuance of the final rule, was there 
comment or much comment, subsequent to that, criticizing the 
standards that are being used? I mean, it is the accepted rule; 
it is under the APA. It is the law or it is the regulation. But 
I mean, is there still criticism of that, of the standards that 
are being used?
    Mr. Falcon. Every so often you might hear some criticism 
about the rules. Some think it is too lenient, some think it is 
too tough. What we have done is craft a rule which closely ties 
capital to risk. It is based on sound, historical analysis, 
historical data and our best judgment about the risk associated 
with all the different activities at the enterprises.
    I think it is a very strong, robust rule. And I am proud of 
the work the agency did to put this together. It has never been 
done before by any regulator.
    Mr. Bentsen. Thank you.
    Thank you, Mr. Chairman.
    Mr. Baker. Thank you, Mr. Bentsen.
    Mr. Ney?
    Mr. Ney. Thank you, Mr. Chairman.
    The question I had--I know you have had a lot of wrangling 
at yourself by others for a delay of a risk-based capital 
standard. But it was written in 1992. It was conceived on the 
heels of the savings and loan and really was constructed to 
look at a financial collapse of the like we have never seen. 
And I think that, you know, was part of it.
    The model measures depression-like credit risk fluctuations 
and then adds another I think it is 30 percent for operational 
risk.
    Are any other financial service companies subjected to a 
risk-based capital test comparable to what GSEs now face?
    Mr. Falcon. Thank you, Congressman. That is a good 
question. This is unique among capital standards for any 
regulator. It is one that was mandated by Congress.
    Other financial institutions like banks and thrifts have a 
risk-based capital standard, but that is more of a risk-
weighted leverage type standard. This is unique because it 
places the enterprises' balance sheets under severe economic 
stress and requires, through a financial simulation model, that 
they hold enough stress over that 10-year period, every quarter 
in that period such that they never become under-capitalized at 
any point during the 10-year period.
    This is unique. It has not been done by any other regulator 
up to now. I am proud of what the agency has accomplished.
    Mr. Ney. Well, like I said, I think you have done good. It 
is just I know you got a lot of heat getting there.
    Mr. Falcon. Yes.
    Mr. Ney. So--
    Thank you, Mr. Chairman.
    Mr. Falcon. Thank you.
    Mr. Baker. Thank you, Mr. Ney.
    Mr. Ford?
    Mr. Ford. Let me sort of walk back through just one or two 
things. They passed the test; is that what you are saying?
    Mr. Falcon. Yes, Congressman. For the first quarter of 
2002, the only numbers we have released, they do pass the test.
    Mr. Ford. And you will not release the fourth quarter 
numbers, again, for what reason?
    Mr. Falcon. The standard I have set is that I was going to 
release the results for the first quarter after which all the 
rules were in place. Since this rule was subject to an 
amendment in the fall of 2001, the first quarter for which the 
rules were in place would be that first quarter of 2002. That 
is why that is the first quarter that we have released.
    Mr. Ford. So, in other words, you did not release the 
fourth quarter because the rules have changed. And now that the 
rules--now everyone is playing under the same set of rules and 
you feel pretty confident this is the definite, that this is 
the set of rules that everyone would have to play under. And 
based on that, they passed.
    Mr. Falcon. Yes, Congressman.
    Mr. Ford. Let me ask you this, what more do you need to do 
your job better, do you think, if anything?
    Mr. Falcon. I appreciate that.
    Mr. Ford. Let's be honest, that is why we are here. I am 
just wondering what more do you think you need, if anything?
    Mr. Falcon. I appreciate that. Now that the agency has 
moved forward, we have got the risk-based capital rule done, I 
am moving to try to strengthen the agency for the long term. 
And we have got several items we would like to undertake.
    We would like to double the size of our examination staff. 
They are very talented and capable. But there are new 
challenges for them to meet. And to do so, they need to do 
their job with greater depth and with more resources.
    We need to continue to enhance our analytical resources so 
that we can utilize the stress test not just as a capital 
standard, but also as an analytical tool to help us do our 
probing for weaknesses and vulnerabilities. And then that work, 
in turn, goes towards our examination staff to our research 
staff to do their work.
    So I think all that comes down to additional resources for 
the agency. And the only sure way for us to do some long-term 
planning is for us to be permanently funded, as are every other 
safety and soundness regulator. And I think that is especially 
critical to the long-term success of the agency now that we 
have come this far in the first nine years.
    Mr. Ford. Let me ask you this just taking you back, do you 
believe you have been as--I know the chairman had some 
questions about documents and materials, the request that has 
been furnished in a timely way. Do you feel that you have 
complied with the law in terms of furnishing this committee 
with everything we have asked for--or members of this committee 
or, for that matter, the Congress--what they have asked for?
    Mr. Falcon. Yes, Congressman. We supplied the committee 
with all the information it has requested. In fact, our 
schedule was to try to get the information to the committee by 
the end of July. Given the fact that the hearing is taking 
place on the 23rd, we had to re-double our efforts and work 
evenings and weekends to make sure that we could meet the 
chairman's deadline, which we have.
    Mr. Ford. Do you feel like you will be able to meet that 
deadline now that we have got these new rules and everybody is 
fine?
    Mr. Falcon. Yes. We supplied the chairman with the 
information yesterday--the last part of it.
    Mr. Ford. My last question may be outside of your realm and 
you may not want to comment on it, but do you think it is a 
good thing that Fannie and Freddie decided to expense these 
stock options since, obviously, part of what we are feeling 
here, in the Congress, is the need to respond to the accounting 
scandals and the corporate fraud that--it is not as pervasive 
as the headlines suggest, but clearly has served to rock the 
markets in negative ways?
    Do you believe that their efforts to do these things are 
positives--if you can answer that question, if you feel 
comfortable in your capacity answering that question as a 
witness representing OFHEO this afternoon?
    Mr. Falcon. Sure. I think it is a very positive step by the 
enterprises. I think it represents their desire to maintain 
best-in-class standards of management at the enterprises. So I 
think it is a positive step. I certainly support the step they 
have taken today.
    Mr. Ford. The zeal with which we do some of these, Mr. 
Chairman, I do also hope that we--the Congress, here, will act 
to get this corporate accounting--this corporate governance 
bill real soon and we will also even ensure that the SEC has 
what it needs. I would imagine that would be helpful in some 
ways to our witness today.
    With that, I yield back the balance of my time, Mr. 
Chairman.
    Mr. Baker. Thank you, Mr. Ford.
    Mr. Lucas?
    Mr. Lucas of Oklahoma. Mr. Chairman, I do not have any 
questions, but I would gladly yield my time to the chair.
    Mr. Baker. Well, I thank you for that courtesy.
    Let me return to the point that a couple of members made. 
One, Mr. Bentsen talking about the construction of the rule, as 
modified, that there were no significant modifications of 
consequence, to which I certainly agree, from a material 
financial calculation to Mr. Ney's comment that the rule was 
built to withstand depression-like scenarios that no other 
financial institution must meet. I, perhaps, agree with that.
    And I think we have established in my first exchange that 
changes were made independent of GSE influence, pre-amendment, 
post-amendment; that the changes were minor; and that you do 
not feel it appropriate to release the fourth quarter 2001 pre-
amendment results because one, the GSEs were not managing to 
that rule and secondly, it is somehow unfair to make that 
information available.
    In your March 21 response to me, you went on at length, 
indicating that you would comply with my request for the four 
differing sets of standards, indicating a two date delivery 
promise, one early for the post-amendment test analysis, one 
later for the pre-amendment analysis, but in no manner or 
measure did you indicate to me in that letter of March 21 that 
that data should be treated as confidential.
    Secondly, in light of the 1999 data--why don't you move 
that? Nobody can see that. It is like being in the bleachers at 
Tiger Stadium. Move that thing over here somewhere.
    Watch yourself, now.
    [Laughter.]
    We are going to move it over here a little closer. But you 
can go ahead and put the other one up. But move the whole thing 
over.
    The 1999 data shows that Fannie Mae was not adequately 
capitalized for the purposes of the stress test. Now--
    That is fine. Just tell him to come on in closer. I still 
cannot see it. Come down over here, behind this row of chairs 
right in front and kind of turn it toward the director so he 
can see, as well as members.
    That is good right there.
    I do not know if that is close enough or not.
    Mr. Bentsen. Everybody on this panel, except Mr. Ford, is 
over 30 and so most of us cannot see that well.
    Mr. Baker. Yes. We are going to need binoculars. We may 
need interpreters to understand it, too.
    [Laughter.]
    Now, this is the long-awaited challenge, not-to-be-released 
data, which is historic in nature. And I want my two colleagues 
who remain to be comfortable with this.
    There is nothing in the data that pre-judges current 
operating condition or in any way impugns current management or 
in any way says that either Fannie and Freddie are not properly 
managed. But let's put this in its context.
    They were operating in the last quarter of 2001, which was 
a very volatile financial marketplace. And the eight-and-a-half 
year test was then applied to the two enterprises.
    What this says is that Fannie missed the mark by $600 
million, whereas if you use the post-amendment test, they were 
in excess of the requirement by $2.4 billion.
    Is that correct?
    Mr. Falcon. Billion.
    Mr. Baker. Billion.
    So it is a $3 billion swing from one test to the other.
    Now, we have all heard that it was--the modifications were 
made without GSE influence. The modifications were minor. They 
are of no market consequence.
    My view of the GSEs does not change as a result of this 
analysis. My evaluation is changing with regard to the agency. 
That is my point.
    And now whether or not the enterprise was in any financial 
duress or not is only something probably the GSE knows. But if 
the modifications to this test were made as a result of staff 
determination as to de-bugging--as to haircuts, as to multi-
housing, as to funding costs and it results in a $3 billion 
swing, you have got to ask one of two questions. Is the test 
valid? Or were the changes made as a result of some political 
involvement in the management of the structure of this test?
    And that is where I am.
    And now I am not going to ask the director any more 
questions on that point because you have made your case quite 
clear. You have established the test based on what you believe 
to be the most valid professional standards. You subsequently 
had staff modify the test, based on what you believe to be 
professional standards. And you stand by the test.
    Now let's go back to the fourth quarter of 2002 and Mr. 
Ney's comments. And I would certainly reserve time for Mr. Ney 
to come back and speak if he chose.
    But he said the rule was built to depression-like standards 
of conduct.
    Last quarter 2001 was a volatile financial quarter, but it 
was not depression-like in its nature. There was nothing that 
changes in the business structure of Fannie from the last 
quarter of 2001 to the first quarter of 2002 that makes any 
structural difference.
    I am just having a really difficult time in understanding 
how that test applied to Fannie Mae in the last quarter of 2001 
could result in the analysis we get and the new test applied to 
the same quarter results in a $2.4 billion capital surplus.
    It does not make sense.
    Jump in, Mr. Director.
    Mr. Falcon. Sure. I would like to, Mr. Chairman.
    First with respect to your point about me not asking in I 
think the March letter that the information be confidential, 
your letter to me requesting the information did not indicate 
that you intended to make the information public, so I did not 
feel any need at that point--
    Mr. Baker. Any time a member of Congress asks you anything, 
you have got to assume there is a press conference in the 
offing. I mean, you have been around here long enough.
    [Laughter.]
    Mr. Falcon. I know, Mr. Chairman, that--
    Mr. Baker. And let me say this, not to be frivolous, we 
debated this a long time. From your first announcement that you 
wanted us to keep this confidential, it caused me great angst. 
But we have gone through all the public records documents for 
you, everything we can come up with to determine whether it was 
or is not appropriate, and, basically, it was your request to 
me and that was it.
    It is a public document, as a result of a government agency 
work product, provided to a member of Congress that has been 
shared with another member of Congress. So there is no question 
about it.
    So let's move on beyond the debate of whether we should or 
we should not. The more important thing is about the facts.
    Mr. Falcon. Right. And to that point, my request is 
certainly not binding on the subcommittee, Mr. Chairman, all I 
can do is make the request. And certainly it is--
    Mr. Baker. But historical analysis is not going to make any 
difference to the market.
    Mr. Falcon. Let me address the issue of this chart here, 
please, Mr. Chairman.
    First off, this does not--this is not all the information. 
If we are going to put this information out in the public, I 
think, so that this is not taken out of context, this should be 
put in place with everything else that I sent you.
    Now, what the stress test shows for Freddie Mac, I am not 
sure if that is going to be released by the subcommittee, as 
well, but there is essentially little change in the numbers for 
Freddie Mac.
    Mr. Baker. I would be happy to discuss that and I want to 
know why the discrepancy.
    Mr. Falcon. Well, Mr. Chairman, with respect to this data, 
itself, if you are suggesting that we made any changes to the 
risk-based capital to try to effect the outcome for the 
enterprise in the fourth quarter, I think that is just 
incorrect.
    First, we did not have any fourth quarter information 
before us when we made decisions about how to modify the stress 
test. So there is no way that we could have tried to gauge the 
stress test to try to make them pass.
    And secondly, we had no idea of knowing which scenario 
would be binding--the up or the down scenario--
    Mr. Baker. Well, let me ask you on that point, if you did 
not have fourth quarter, that does not really matter. You could 
run the test on any quarter and I suspect--
    Mr. Falcon. You cannot run the test on any quarter, Mr. 
Chairman, each--that requires an extensive amount of data for 
each quarter. The enterprises have to assemble vast amounts of 
data, millions of points of data, parts of information are 
collected and are aggregated to create what we call a risk-
based capital report--
    Mr. Baker. That would lead me to ask this question, are you 
then telling me that you did not run the test at all before you 
released it to the GSEs? You just said, ``Here is the test, 
figure it out.''
    Mr. Falcon. We had some idea, based on our understanding of 
how the risk-based capital worked, about what might be some 
general--how the capital standard might be impacted by 
modification of the risk-based capital rule. And at the time 
that we published the final rule on this risk-based capital 
amendment, we said in the amendment that our anticipation is 
that the effects of this will be minimal and, in essence, a 
wash.
    Now what you do not have up here is the up rate for Fannie 
Mae.
    Mr. Baker. I am sorry, the what for Fannie Mae?
    Mr. Falcon. The up rate; this is just the down rate 
scenario for Fannie Mae. You do not have the up rate here, 
which shows that we actually increased our capital requirement 
by $5 billion.
    Now, here you are saying that we decreased it by $3 
billion, well we did not know which scenario would be binding. 
We did not even have this information in front of us. so we 
could just as easily have increased our capital requirement by 
$5 billion.
    Now you are suggesting we intentionally decreased it by $3 
billion; that is not true.
    Mr. Baker. So you are telling me if you took the fourth 
quarter of 2001 and ran the post-amendment test and took the 
same data and ran the pre-amendment test, that the differences 
between the two conclusions are what--minimal, not important, 
not clear?
    Mr. Falcon. I am not sure how they are relevant.
    Mr. Baker. The same data, the same quarter, two different 
tests, one gives one result, the other gives another. They are 
relevant. There were modifications made to the test that caused 
the results to be different.
    Mr. Falcon. Oh, absolutely. I agree with that.
    Now, did we know what the results of the modifications 
would be? As I said, the fourth quarter was not even closed yet 
when I made these decisions on what modifications to make to 
the stress tests. So to suggest that we were results-oriented 
in making these changes, it is just not correct.
    Mr. Baker. Mr. Lucas has expired his time.
    Mr. Bentsen, we come back to your side.
    Mr. Shays?
    Mr. Shays. I am happy to listen to questions or ask them. 
Which do you want me to do?
    Mr. Baker. Take off.
    Mr. Shays. Okay.
    I have already welcomed you, so I will not do that again. 
But it is good to have you here.
    And I would like to ask, you know, on April 8, OFHEO 
announced it would conduct a comprehensive review of the 
financial disclosure policies and practices of Fannie Mae and 
Freddie Mac. Can you advise this committee whether OFHEO was 
still pursuing this review? And when can we expect its release?
    Mr. Falcon. Yes. Thank you, Congressman.
    We are still pursuing the review with the SEC and the 
Treasury. And we are expecting to try to complete it by the end 
of the year.
    Now, that is our goal. We are going to use our best efforts 
to see if we can meet that goal. But we will see; maybe we will 
try to give you a mid-term report about how it is going.
    Mr. Shays. When you say join it with the SEC and Treasury, 
who is doing the bulk of the work?
    Mr. Falcon. That has not been established yet, Congressman. 
I imagine--
    Mr. Shays. Is the work being done now? Or is it still not--
    Mr. Falcon. Oh, yes, the work is currently being done. We 
are--
    Mr. Shays. Okay. So who is doing most of the work so far?
    Mr. Falcon. Well, we are doing a lot of research on the 
various types of mortgage-backed securities that are out there, 
the differential types of information that is released, along 
with each type of mortgage-backed security. And that will form 
the basis for us to undertake a comparison of the type of 
disclosures by issuer.
    Mr. Shays. Can you explain to me why OFHEO has been charged 
with promulgating a rule that will facilitate the 
implementation of Fannie Mae and Freddie Mac's agreement to 
register and disclose to another agency the SEC?
    Mr. Falcon. As part of this arrangement where the 
enterprises will voluntarily register under the 1934 act, OFHEO 
still maintains its safety and soundness authority. And it is 
not in any way limited by this functional regulation, you could 
call it, of Fannie Mae's and Freddie Mac's security 
disclosures.
    In so doing, we will promulgate a rule to require that 
these disclosures that are filed with the SEC also get filed 
concurrently with OFHEO. And there are two sections in the 1934 
act, Sections 14 and 16, dealing with insider trades and 
proxies which, because of the operation of some of the language 
in those sections, it is necessary for OFHEO to promulgate a 
rule requiring the application of those sections to Fannie and 
Freddie. And then, in order to comply with our rule on those 
two sections, all they have to do is submit the reports to the 
SEC.
    Mr. Shays. Is it unusual for one agency to basically, in 
essence, write the rule for another agency?
    Mr. Falcon. That is not what we will be doing, Congressman. 
They would be required to submit, well, for the balance, for 
every part of the 1934 act, except these two sections, they are 
voluntarily submitting themselves to the jurisdiction of the 
SEC for purposes of the 1934 act. And so we are not going to 
facilitate that implementation.
    But there are two sections for which require a little bit 
of a special treatment. And we are not going to promulgate a 
rule that in any way delegates OFHEO's safety and soundness 
authority. In fact, we will require compliance with Sections 14 
and 16 and compliance would be through OFHEO. However, they 
would be able to satisfy our regulatory requirement by 
submitting reports to the SEC.
    Mr. Shays. When do you expect the rule making to be 
completed?
    Mr. Falcon. I am hoping we can get that done in just a 
couple of months, Congressman.
    Mr. Shays. So by October 1 do you expect to have it done?
    Mr. Falcon. We will try--October 1.
    Mr. Shays. Do you expect it to be open for public comment?
    Mr. Falcon. Absolutely, Congressman.
    Mr. Shays. And when is the latest it would likely to take 
effect?
    Mr. Falcon. I think, depending on what else is in there, we 
may--that will affect length of the comment period. As I said 
in my testimony, we may include in this rule additional 
disclosures, supplements of those that would be required in the 
1934 act. And if we do so, we will want to be sure to allow 
sufficient time for notice and comment.
    It could be anywhere from 30 to 60 or 90 days.
    Mr. Shays. What role did OFHEO play in arranging the 
agreement between the SEC and the two GSEs?
    Mr. Falcon. We worked with the SEC and the Treasury to make 
sure that this could and would work. Once we were all satisfied 
that this would work, we then went about just making sure that 
we had a meeting of minds between the three of us about how 
this would work.
    Mr. Shays. And what role will OFHEO continue to play to 
ensure the agreement has teeth?
    Mr. Falcon. We will require that the reports they file with 
the SEC also get filed with OFHEO. Our safety and soundness 
authority and responsibility is not, in any way, limited by the 
enterprises voluntary registration under the 1934 act.
    So we will continue to review them pursuant to our safety 
and soundness authority and review those reports, as well. And 
should we ever see any shortcomings, we would consult with the 
SEC about that.
    Mr. Shays. Last week, Fannie Mae's quarterly analyst, Tim 
Howard, the company's CFO stated, ``We sought and obtained 
written concurrence from the SEC that voluntary registration 
under the 1934 act would not change the fact that, among other 
things, securities issued or guaranteed by Fannie Mae are 
exempt securities under the Securities Act of 1933 and may be 
sold without registration under that act.''
    Is Fannie Mae trying to have it both ways by assuring the 
administration and Congress that it will submit to the 
government regulation and assuring Wall Street that it will 
remain exempt from government regulation?
    And let me just ask this, is this an attempt by the company 
to perpetuate its implicit government guarantee? What is your 
opinion?
    Mr. Falcon. Well, what I think the statement is in 
reference to is, it is a statement that the waiver of their 
exempt status under the 1934 act does not mean that they are 
waiving their exemption under the 1933 act. I think that is 
what the statement was going towards.
    Mr. Shays. Have you seen this written concurrence? If so, 
will it be released to the public?
    Mr. Falcon. I am not sure what the written concurrence is, 
Mr. Chairman. And I am not sure I have seen it.
    Mr. Shays. Okay.
    Mr. Chairman, are we aware of what if there is anything in 
writing?
    Mr. Baker. I am not.
    Mr. Shays. Okay.
    You know, I would just make a request that we get access to 
that.
    I know my red light is on and so I will come back for a 
second round. But I do want to acknowledge that in the 
questions that we had asked before--and maybe this was pointed 
out--it was basically--maybe in your statement as well--I am 
happy that Fannie Mae and Freddie Mac will have to restate 
earnings. And they wanted our office to know that they were 
going to do that on August 14. And when we asked the Treasury, 
they did not know, but evidently that is going to happen. And I 
think that is a positive thing.
    Mr. Baker. Thank you, Mr. Shays.
    Mr. Bentsen?
    Mr. Bentsen. Thank you, Mr. Chairman.
    And Mr. Shays, I might recommend to you that in the 
testimony, Mr. Falcon's testimony on page six in the--I do not 
know if it is the carryover--you know, it is the first 
paragraph--in the fourth line it states that the ultimate 
arbiter of what must be disclosed will be the SEC and OFHEO.
    The testimony goes into great detail about what OFHEO is 
doing. I think they are to be commended for that because they 
are the congressionally mandated regulator for safety and 
soundness over the GSEs. And, in fact, they seem to be working 
arm-in-arm with the SEC on trying to figure out how to merge 
the financials for purposes of disclosure--
    [Laughter.]
    Mr. Bentsen. Our witness, I think, is very capable. So it 
is--but he was on this side of the aisle before. And he is a 
Texan, also, Mr. Shays, which is probably the main reason.
    I want to go back to the line of questioning that the 
chairman had on the comparison of enterprise capital 
requirements, pre and post final rule amendment.
    Let me restate, again, the rule went through the normal 
procedure. It went through the comment period. In fact, maybe 
even more so than normal procedure. You came and testified 
before this panel. You may have testified before a panel of the 
other body, I do not know. And had all the hoops you have to 
jump through with which to promulgate a rule under the laws of 
the United States, right?
    And so the rule is the final rule and that is what you are 
required by law, to calculate the risk-based capital and 
minimum capital standards of the GSEs, right?
    Mr. Falcon. Absolutely--that is right, Congressman.
    Mr. Bentsen. Now, Mr. Baker raises the concern--the broad 
variation in the fourth quarter Fannie Mae and first quarter--
fourth quarter 2001 and first quarter 2002 Fannie Mae numbers 
as opposed to Freddie Mac. And I appreciate your concern of 
laying out unfinished work in a volatile marketplace and 
saying, ``Well, gee, if you looked at it this way, even though 
that is not what the rule says, but if you made these 
assumptions for whatever reason, things might look worse than 
they really are--''
    Mr. Baker. Would the gentleman yield just a minute?
    Mr. Bentsen. I may have to yield.
    Mr. Baker. Just to clarify, the pre-amendment test was also 
promulgated. It was not a hip-pocket version that was short-
circuited and then later saved by 60-day amendment process. It 
was an eight-and-a-half year product which was subsequently 
amended by a 60-day process. Just for the sake of 
understanding.
    Mr. Bentsen. Fair enough. But nonetheless, all following 
the APA and the enacting legislation. But nonetheless, back to 
my point, I understand your concern about saying, you know, 
putting out supplemental data, which, at least legally, and 
perhaps mathematically maybe has minimal value, but in a 
volatile marketplace could have substantial effect.
    The changes in the amendment were primarily the haircut 
rules for derivative products and which would have affected the 
amount of capital or the amount of derivatives that the amount 
of capital set aside for purposes of the haircuts or the amount 
of derivatives that might be used for hedging purposes, and 
thus, the amount of capital that could be put at risk.
    And I guess it affected the service, the ratings of the 
servicers and the amount of capital that might have to be set 
aside to account for those ratings.
    And I assume there were some other technical changes.
    Are you able to tell us, you know, since we have now delved 
into these numbers, perhaps more than we should, are you able 
to tell us what were the main reasons for the changes in the 
final numbers? Was it the haircut rule? Was it the servicing 
rating rules?
    Mr. Falcon. It was based on additional information. We 
ground this rule very much in data and research and analysis 
and try to assess the risk of the various activities of the 
enterprises, based on our knowledge of how mortgages perform 
historically, based on differing loan characteristics, for 
instance. And as we get additional information to better 
understand various risks of the enterprises, we will undertake 
to make modifications to the stress tests.
    And so this will be a dynamic stress test.
    If a year or two from now we have more information which 
allows us to fine tune this even better, we may come out with 
an additional amendment. The idea is to continue to refine 
this.
    We put out version 1.0 of this stress test. We will work 
towards version 2.0 and 3.0 over time.
    I think part of the difficulty for the agency in trying to 
get this stress test done was trying to come out with version 
5.0 at the beginning. So what we have got is a very robust, 
strong stress test.
    Mr. Bentsen. If I might, with the chairman's indulgence, 
the new information, is that information applied uniformly to 
both GSEs? Or is it information that is specific to one 
portfolio or another?
    Mr. Falcon. It is information that is general information; 
it might be data, combined enterprise data. It might be 
research produced by either OFHEO or by some other third party 
about the performance of mortgages as a better estimation of 
counter parties.
    It does not necessarily have to be enterprise specific data 
or analysis. In fact, it usually is not.
    Mr. Bentsen. I yield back.
    Mr. Baker. Thank you, Mr. Bentsen.
    Mr. Bentsen. Thank you.
    Mr. Baker. I am going to go to Mr. Shays. He has schedule 
constraints.
    Mr. Shays?
    Mr. Shays. Thank you very much.
    Thank you, Mr. Chairman, for yielding to me.
    And I would like to turn our attention to mortgage-backed 
securities and have you share with us whether Fannie Mae and 
Freddie Mac should continue to enjoy an exemption from 
disclosure in what is their mortgage pools. You know these two 
companies better than just about anyone. So I am particularly 
interested in your views on this issue. And are you comfortable 
with the continued exemption?
    Mr. Falcon. Mr. Chairman, I think rather than give any 
opinions at this point, that is, I want to have the best 
possible information in front of me before I form judgments 
like that. That is why we are undertaking this study with the 
SEC and the Treasury.
    Mr. Shays. Do you have a lean one way or the other?
    Mr. Falcon. I cannot say right now, Congressman, because I 
have not reviewed the information that is put out by non-GSE 
issuers of mortgage-backed securities. So I would want to first 
compare what they put out versus what the enterprises put out.
    Mr. Shays. But it is true that Wells Fargo, for instance, 
would have to disclose when they put together a pool. So I 
mean, it is just not some kind of strange activity for the 
business to have to do, correct? I mean, we have certain 
parallels that we can look at, correct?
    Mr. Falcon. Right. Any issuer of debt, just by virtue of 
what the market will demand, will put out some level of 
disclosure that a companies that debt. That is your--
    Mr. Shays. Last week, Treasury Undersecretary Peter Fisher 
testified, quote, ``The time has come for Fannie and Freddie's 
investors to be assured that the level and quality of the 
corporate disclosure they receive are the same as those that 
are made by any other company that actively participates in our 
capital markets.''
    In your own testimony, you stated that OFHEO is, quote, 
``prepared to issue a rule requiring disclosure that would be, 
at a minimum, comparable to those of other trading companies'', 
end of quote.
    I do not quite understand this. How can we profess to want 
to treat Fannie and Freddie like any other publicly traded 
company and then qualify these statements by talking of 
continuing their exemptions from one of the two major security 
disclosure laws?
    Mr. Falcon. I think that is--what is important here is the 
disclosure. The benefit you get with registration is the 
disclosure. And what we are trying to do with this study is 
ensure that there is a level playing field and adequate 
information that accompanies the issuance of mortgage-backed 
securities.
    If we can, as I said in my testimony, if we can accomplish 
that, and I am very confident that we can establish adequate 
information, as well as the level playing field, through the 
cooperation and the joint study by ourselves and the SEC and 
Treasury, then registration is unnecessary. I am confident that 
we can get there with the right disclosure rules.
    Mr. Shays. Isn't basically registration and disclosure 
somewhat parallel?
    Mr. Falcon. I think that is right.
    Mr. Shays. Yes. So the question is do you stand by your 
statement that OFHEO is prepared to issue a rule requiring 
disclosures that will be, at a minimum, comparable to those of 
other trading companies?
    Mr. Falcon. Which--are you reading from my testimony, Mr. 
Chairman?
    Mr. Shays. Yes.
    Mr. Falcon. I think what I said--that at--prior to the 
enterprises' voluntary registration under the 1934 Act, we were 
prepared to issue a rule which would place them under 
requirements similar to the securities laws.
    But since they have voluntarily submitted themselves under 
the 1934 act, we are not going to pursue a registration regime 
at this time. And the issue, with respect to the application of 
the 1933 Act and disclosures on their mortgage-backed 
securities--focus there will be on the adequacy of disclosures 
and the level playing field.
    Mr. Shays. Mr. Fisher made it very clear to us that he 
certainly encouraged Fannie and Freddie to be under the 1934 
Act. And I am interested to know, did you play that same kind 
of role? Or were you passive on this?
    Mr. Falcon. We were certainly supportive of the enterprises 
coming under a mandatory disclosure regime. And if it was not 
going to be under 1934 Act, then OFHEO was prepared to issue 
such a regulation. And I said so in response to an OMB prompt 
letter on the subject, as well.
    Mr. Shays. Okay.
    Can you explain--and I am pursuing this a little more 
deeply--can you explain why Fannie and Freddie will continue to 
enjoy an exemption from registering their MBSs? I would like 
for you to answer this question keeping in mind that companies 
in the jumbo market, in which Fannie and Freddie do not 
participate, are required to register their mortgage-backed 
securities. What makes Fannie and Freddie's mortgage-backed 
securities different, for instance, than the mortgage-backed 
securities, again, of Wells Fargo?
    Mr. Falcon. I am not sure I can answer, Congressman, that 
is a judgment that Congress has made. And I would just defer to 
Congress' rationale for doing that when it granted the 
enterprises that exemption.
    Mr. Shays. You that--you are on a little bit dangerous 
ground only because that would imply that you do not have 
opinions that you would present to Congress. Do you not ever 
have an opinion or a suggestion that you would make to 
Congress?
    Mr. Falcon. No, Congressman. It is just in this area where 
we are studying the adequacy and the comparability of mortgage-
backed security disclosures--it is just in this area where I am 
trying to approach this with an open mind and not pre-judging 
the issues as we go forward with that study.
    Mr. Shays. Just one other, may I, Mr. Chairman, just pursue 
one other short line of questions?
    Regarding the interagency review of mortgage-backed 
securities that will be conducted by SEC and OFHEO and the 
Treasury, can you tell me whether this study will examine both 
disclosure and registration of mortgage-backed securities? If 
not, why not?
    And I will put this question out on the floor, too, just 
so--will the study investigate allegations that Fannie and 
Freddie cherry-picked the mortgage-backed securities, leaving 
lower quality mortgage pools for investors?
    By the way, I want to say that Fannie Mae and Freddie Mac 
say this does not happen. And I am just suggesting that there 
is a question of whether it does or not and want to know if 
cherry-picking will be one of the issues you look at in your 
review.
    Mr. Falcon. I think that is certainly an issue we will give 
some review, Congressman.
    Mr. Shays. Okay.
    Thank you, Mr. Chairman, for your patience and for yielding 
to me.
    Mr. Baker. Thank you, Mr. Shays.
    Mr. Ford, please?
    Mr. Ford. Thank you, Mr. Chairman.
    This has become somewhat humorous, Director. We are glad 
you are here, but we are debating something up here and you are 
just caught in the middle of this thing. so we apologize for 
you having to answer things that sometimes you feel 
uncomfortable and maybe even inappropriate.
    But I am going to try to ask you something that I think is 
appropriate. And, obviously, I am a little biased about it.
    But if you would not mind, forgive me, to compare and 
contrast the regulatory regime for Fannie Mae and Freddie Mac 
as it relates to safety and soundness. I imagine that you do 
not necessarily--at least not in this life you are not crafting 
things for these private enterprises, but if you would not mind 
giving us a sense, if you have a knowledge of that--if you 
could speak to that, I would appreciate that.
    Mr. Falcon. Sure. Our regulatory program, Congressman, is 
very much identical to the type of regulatory program that 
banks have. We have very talented and skilled examination 
program, much like the bank regulators. We have a regulatory 
infrastructure which sets standards and expectations that we 
have for the enterprises, along with other informal types of 
standards, guidances, agency interpretations.
    We have an active research group which helps us understand 
developments in the marketplace and the changing risk profiles 
of the enterprises. You know, we have talented financial 
analysts that can look at the enterprises balance sheets and 
results from the stress tests and try to help us better 
understand their vulnerabilities.
    So our program is very comparable to that of any other bank 
regulator.
    Mr. Ford. As it relates to--and this is a similar question, 
I am just trying to get it all on the record here, but how 
would--under this risk-based capital standard, how would other 
companies, primarily private banks, fair under this thing? I am 
not asking you to grade my bank, or for that matter, any other 
bank, but just a sense, because, again, we are--Chris Shays is 
my good buddy and he is writing a lot of things, particularly 
campaign reform. Richard Baker and I are good friends. He 's 
writing is lot of things, too.
    And I do hope the kinds of questions that we are asking 
Fannie and Freddie--I hope at some point we can also bring in 
these doggoned credit reporting agencies and ask them--put up 
some charts like that and explain how they misreport peoples' 
stuff and how they go about fixing it.
    But since they are not here, in terms of risk-based capital 
centers, how do you--how would they fair, some of these other 
companies fair in comparison to how Fannie and Freddie fair?
    Mr. Falcon. I could not say without having, you know, a 
broad range of financial information about those companies. We 
get very deeply into Fannie and Freddie's activities beyond 
just what they might release in--
    Mr. Ford. Forgive me for asking you to go beyond, but just, 
even if you do not feel like answering it, do not answer it, I 
just thought I would just put it out there because I think it--
    Mr. Falcon. It is a very rigorous stress test. It imposes 
very stressful economic conditions on their balance sheets. You 
know, it is not the type of stress test that any other 
financial company has to be able to withstand, as a capital 
standard.
    It would, I think, pose a challenge to many institutions to 
try to survive this.
    Mr. Ford. I would if it would be appropriate, the chairman 
knows a lot more about these issues than I do, but I would 
hope--and I will yield back my time--I would hope that maybe we 
can even add and not to put any of these institutions on the 
spot, including my own financial institutions.
    But at the same time, if we are going to be as demanding on 
these two organizations as we are--for good reason--and 
hopefully what will come out of this hearing is a safer and 
sounder system, then we should probably ask some of these other 
companies to provide or furnish us with this same kind of data.
    I do not know if you want to, necessarily, do it, Director, 
but if, indeed these tests are conducted. But I would ask the 
chairman if we could take a look or if he would consider doing 
it. I know I would support an effort to do that.
    And with that, I yield back the balance of my time.
    Mr. Baker. Thank you, Mr. Ford.
    I guess I can best express my situation this way, Mr. 
Falcon, after eight-and-a-half years, we had a test. We gave 
the test; one GSE passed; one GSE failed. Ninety days later, we 
have another test. Amazingly enough, both GSEs passed.
    Imagine what our public school system would look like if we 
gave everybody in the class a test. And then 30 days later, we 
came back and gave them exactly the same test with prior 
announcement. I bet our test scores would go up.
    Or if, before our children could go out to play in the 
afternoon, we asked them, ``Did you clean up your room?'' ``Oh, 
yes, dad, sure. But could you come back about seven and check 
it out?''
    That is my problem here. We have a test that was developed 
after eight-and-a-half years of very intense, very hard work 
with congressional oversight, people fighting to protect your 
budget, get you the staff you needed. And I feel, frankly, very 
let down. At the end of the day, we have got a process, by 
virtue of haircuts on mortgage insurance companies, multi-
family housing treatment, funding costs and some technical 
stuff I do not understand that we find such an erratic swing in 
the financial adequacy in relation to the stress test of one 
GSE.
    I have just got to tell you that I am not comforted either 
by the written or oral explanations of how we are where we are. 
Something has to be done about this.
    Now, I am not faulting you, individually. I may be faulting 
the process. I may be faulting the structure of OFHEO. It is, 
after all, the only regulatory body in the financial world that 
is funded by congressional appropriation instead of fees on the 
regulated enterprises.
    There may be other regulatory powers you need you do not 
have.
    But I have just got to tell you, this is unacceptable 
that--I do not know where we go from here. But there has got to 
be another place to land that can give the taxpayer of this 
country an accurate honest assessment of the true risk exposure 
they face in the indirect support of two enterprises which have 
over $3 trillion of exposure to this economy. That is enormous.
    And in light of the financial conditions of the market we 
face today, giving all the allegations that are floating--thank 
goodness we are not hearing any of that about Fannie or 
Freddie. I can only imagine the consequences if one of these 
two corporations were to report a financial irregularity.
    I am not alleging today that either of the enterprises are 
mismanaged--that they are taking on risk that they should not 
take. But I do not know what the road holds ahead. I do not 
know if the current management is going to be there 10 years 
from now. I do not know that the tools OFHEO has are going to 
be adequate as the enterprises continue to grow and expand.
    If we look back a decade and see what they looked like then 
and look at them today, there is a dramatic change in the risk 
profile of the two enterprises. One has a fairly significant 
amount of hedges in relation to the debt issued. The other one 
does not. Does that mean the other one is not appropriately 
managed? I do not think so.
    But we need to have a better, clearer insight which leads 
to less debate.
    I have not heard any explanation as to why the changes that 
were made--one, were made; two, as to how they could result in 
a $3 billion shift in the calculation resulting on the last 
quarter's calculations of 2001; and why I should be comforted 
in the manner in which the discussions have resulted in this 
foster.
    And, again, I say this having been in the trenches with you 
and fought the appropriators for a long time to get you into 
the place where I felt like we had the resources to at least 
stand toe-to-toe with them.
    I really do not have anything else to add. I just, over the 
August recess, I am going to give this a lot of thought--try to 
come back with something that is constructive. And I hope we 
can find a way to, once and for all, answer the questions that 
I know every taxpayer has got to want to know--am I safe? Given 
the volatility in the markets we face, we do not need this 
additional concern added into the financial calculus.
    And I, please, want to afford you the opportunity to make 
any comments you wish.
    Mr. Falcon. I appreciate that, Mr. Chairman. And you have 
always been the--supportive of OFHEO when we have needed it in 
our budgets. It often feels like a form of tough love that you 
have for the agency.
    But it is, I think, you are well intentioned about trying 
to support the agency.
    I would just suggest to you that the information that you 
put up here on the chart--I do not think it is an accurate 
demonstration of what we have done with this risk-based capital 
rule.
    In addition, the reason I think this information is also 
somewhat misleading about the enterprises' financial condition 
and what we have done is that I announced early in the fourth 
quarter that we were not going to release fourth quarter data. 
Now, had the enterprises understood that I was going to release 
fourth quarter data, would they have done something 
differently? Well, I do not know.
    Mr. Baker. But on that point--let's take the issue--they 
did not know, so they were not managing to it. They were taking 
risks we did not understand? Are you telling me we should not 
give pop quizzes? That we should drop in as a regulator--as an 
unannounced inspector of the credit files and see what is going 
on in the inner-enterprise? Are you telling me we have to give 
them a certified notice, ``We have coming June 14, 2003. Get 
your lipstick and your hair done''? I mean, come on.
    Mr. Falcon. It depends on what you want out of the capital 
standards. I do not use them as a game of ``Gotcha.''
    Mr. Baker. No, I do not either, but I want to know what 
real risk is involved in the real world and what we are taking 
on. And apparently--
    Mr. Falcon. And I think this rule does that. You know, I 
would like to have an opportunity, going forward, to try to 
persuade you that we have promulgated a very robust and strong 
risk-based capital rule. And we will be glad to give you a more 
in-depth explanation about the changes we have made.
    They are certainly well explained in the final rule that 
implemented the modifications--
    Mr. Baker. Well, the only--last point is that let's assume 
for the moment I am wrong on every point and that there is no 
merit to any of the criticisms I have leveled here today--why 
are we waiting until the first quarter of 2003 to implement the 
rule--to make it enforceable?
    Mr. Falcon. That is what the statute provides, Mr. 
Chairman. The statute says that this shall not be enforceable 
until one year after it is effective. That is what the statute 
says.
    Mr. Baker. One year from September 2002 or--
    Mr. Falcon. One year from September 2001.
    Mr. Baker. So that would be September 2002?
    Mr. Falcon. Yes.
    Mr. Baker. So why are we waiting until the first quarter of 
2003?
    Mr. Falcon. We are not. this rule will be--
    Mr. Baker. Well, that is good news. I was under the 
impression you were not going to have it enforceable in 2003.
    Regardless, I am saying to you that there is significant 
problems with the structure we now have. We need to make some 
modifications. We have got the August recess to see if we can 
figure out some solutions.
    I look forward to talking to you.
    Unless Mr. Bentsen--yes--well, please, Mr. Bentsen?
    Mr. Bentsen. Thank you, Mr. Chairman.
    And, again, let me thank you for calling this hearing. And 
even when we do not agree, I appreciate the amount of time and 
effort you put into this.
    I think, though, we need to make clear that there may be 
two issues here. One may be a process issue, although I would 
argue that we followed the--you know, we have been going 
through this with the APA. We had a hearing before this 
committee. Members of this committee on both sides of the aisle 
raised concerns about the proposed final rule. Amendments were 
made under the APA. And that is the final rule.
    And so on the one hand, we can raise concerns about the 
process. And they are legitimate. But on the other hand--and on 
any rule-making procedure. On the other hand, the question 
really has to be are you satisfied with the formula for the 
risk-base analysis and the minimum capital analysis? And if you 
are satisfied, then it is what it is. And if you are not 
satisfied, then that is another matter to look at.
    Perhaps the committee ought to take a look at whether or 
not we think, after all this work and the eight--10 years that 
the staff and analysts have been looking at this--whether or 
not the math is right or not, but the math is what it is.
    And we have to live with that and then in September they 
will begin to classify. And you have to pick markers in time 
with which they meet.
    I agree with you that--I mean, as I understand the laws and 
the way it works, OFHEO is in the GSEs. They are, as in many 
respects, the same way that bank examiners are in the bank. But 
they have to look at quarterly mileposts as they go through 
this to determine where they are in terms of capital.
    But, again, it is gone through the APA and maybe our debate 
has to come down to we do not like what you finally came up 
with. But you put a lot of time into it and we have not heard a 
lot of people come back and say, ``We think your formulas are 
wrong.''
    And maybe that is what they need to do, but they have not 
done it yet.
    Mr. Baker. And I would suspect that there are not a lot of 
people in the world who sit around their breakfast table in the 
morning discussing the stress test adequacy of the government-
sponsored enterprises.
    Mr. Bentsen. Only in Baton Rouge, I think.
    Mr. Baker. I can assure you when I get home I turn into a 
real person.
    Let me express this perspective, just to keep it in its 
proper context. When I wrote the letter to Mr. Falcon asking 
for the four permutations of the test, I really had no 
anticipation--nobody could have--as to exactly what the 
consequences. Because Mr. Falcon has testified that he did not 
know what the results of the test would be. It took 
considerable effort and time to run the test.
    I was kind of hoping that they would all come out within 
margin of error of each other and we could go on about our 
business. But I thought it would be a great thing for this 
committee to have, as a platform for future analysis, the four 
tests on two quarters run and we could then judge future test 
results by that platform.
    And I had a hint, when it took so long to get number four, 
that there was something up. But I had no substantive knowledge 
that the end result of that last test would be to show a GSE 
insufficient in relation to the test standard.
    That really was it.
    But now that it has occurred and I am trying to understand 
why and how, I am not at all happy with the consequences or the 
explanation as to how we got where we are. Because a $3 billion 
swing, even in GSE light world, is a significant swing.
    So for the record, I appreciate the long-standing effort.
    I appreciate, certainly, the gentleman's work from Texas in 
sitting through these hearings. You have been one of the few 
who has been able to make it through all of these.
    I am sincere in my concerns. I do not feel I know today any 
more about the true financial picture of the GSEs than I did 
five years ago. And after time, money and effort spent in this 
effort, that is, I think, rather disappointing.
    So I thank the gentleman for his testimony, his willingness 
to be here today. I am confident the release of this data has 
no consequence to the market performance whatsoever.
    And I look forward to working with the members of the 
committee on resolution of these matters in the coming months.
    Meeting adjourned.
    [Whereupon, at 3:53 p.m., the subcommittee was adjourned.]





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