[Senate Hearing 107-]
[From the U.S. Government Publishing Office]
S. Hrg. 107- 303
THE HOUSING MISSION OF THE OFFICE OF
FEDERAL HOUSING ENTERPRISE OVERSIGHT AND
THE FINANCIAL SAFETY AND SOUNDNESS
OF FANNIE MAE AND FREDDIE MAC
SUBCOMMITTEE ON HOUSING AND TRANSPORTATION
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
THE RESOURCES AND EFFECTIVENESS OF OFHEO AS A REGULATOR, THE CAPITAL
STANDARDS REQUIRED OF HOUSING GOVERNMENT SPONSORED ENTERPRISES, AND THE
STATUS OF RISK-BASED CAPITAL STANDARDS REQUIRED BY CONGRESS IN 1992
MAY 8, 2001
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PHIL GRAMM, Texas, Chairman
RICHARD C. SHELBY, Alabama PAUL S. SARBANES, Maryland
ROBERT F. BENNETT, Utah CHRISTOPHER J. DODD, Connecticut
WAYNE ALLARD, Colorado TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming JACK REED, Rhode Island
CHUCK HAGEL, Nebraska CHARLES E. SCHUMER, New York
RICK SANTORUM, Pennsylvania EVAN BAYH, Indiana
JIM BUNNING, Kentucky ZELL MILLER, Georgia
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN ENSIGN, Nevada DEBBIE STABENOW, Michigan
JON S. CORZINE, New Jersey
Wayne A. Abernathy, Staff Director
Steven B. Harris, Democratic Staff Director and Chief Counsel
Geoffrey P. Gray, Senior Professional Staff Member
Jonathan Miller, Democratic Professional Staff Member
George E. Whittle, Editor
Subcommittee on Housing and Transportation
WAYNE ALLARD, Colorado, Chairman
JACK REED, Rhode Island, Ranking Member
RICK SANTORUM, Pennsylvania THOMAS R. CARPER, Delaware
JOHN ENSIGN, Nevada DEBBIE STABENOW, Michigan
RICHARD C. SHELBY, Alabama JON S. CORZINE, New Jersey
MICHAEL B. ENZI, Wyoming CHRISTOPHER J. DODD, Connecticut
CHUCK HAGEL, Nebraska CHARLES E. SCHUMER, New York
John Carson, Staff Director
Tewana Wilkerson, Deputy Legislative Assistant
C O N T E N T S
TUESDAY, MAY 8, 2001
Opening statement of Senator Allard.............................. 1
Opening statements, comments, or prepared statements of:
Senator Reed................................................. 2
Senator Corzine.............................................. 3
Prepared statement....................................... 34
Senator Stabenow............................................. 3
Prepared statement....................................... 34
Senator Sarbanes............................................. 23
Senator Carper............................................... 26
Senator Santorum............................................. 35
Armando Falcon, Jr., Director, Office of Federal Housing
Enterprise Oversight........................................... 4
Prepared statement........................................... 35
Franklin D. Raines, Chairman and Chief Executive Officer, Fannie
Prepared statement........................................... 38
Leland C. Brendsel, Chairman and Chief Executive Officer, Freddie
Prepared statement........................................... 55
THE HOUSING MISSION OF THE OFFICE OF
FEDERAL HOUSING ENTERPRISE OVERSIGHT
AND THE FINANCIAL SAFETY AND SOUNDNESS
OF FANNIE MAE AND FREDDIE MAC
TUESDAY, MAY 8, 2001
Committee on Banking, Housing, and Urban Affairs,
Subcommittee on Housing and Transportation,
The Subcommittee met at 9:30 a.m., in room SD-538 of the
Dirksen Senate Office Building, Senator Wayne Allard (Chairman
of the Subcommittee) presiding.
OPENING STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Let me call the Committee to order.
I like to start my Committee hearings on time. I know many
of our witnesses that we call on our panels have very busy
schedules. I think out of courtesy to them and, actually, out
of courtesy to the other Members on the Committee, that we
should get started on time. I always make a point of trying to
do that. We are scheduled to start at 9:30 and it is now 9:30
in the morning.
I want to welcome everyone to the Housing and
Transportation Subcommittee of the Banking Committee. Today, we
will conduct a hearing on oversight of the mission of the
Office of Federal Housing Enterprise Oversight-- otherwise
known as OFHEO--and the financial safety and soundness of
Fannie Mae and Freddie Mac.
We have three witnesses. On the first panel we will hear
from Mr. Armando Falcon, Director of OFHEO. On the second panel
we will hear from Mr. Franklin Raines, Chairman and CEO of
Fannie Mae; and also from Mr. Leland Brendsel, Chairman and CEO
of Freddie Mac.
The American mortgage finance system is the envy of the
world. Fannie Mae and Freddie Mac are a vital part of this
system. They are among the largest financial institutions in
While both Fannie Mae and Freddie Mac are New York Stock
Exchange-listed companies owned by shareholders, they are also
Government Sponsored Enterprises--commonly referred to as
GSE's--with the specific mission to increase homeownership. Due
to their GSE status, the Congress of the United States has a
significant oversight responsibility for Fannie Mae and Freddie
In 1992, Congress created the OFHEO, an independent
regulator within the Department of Housing and Urban
Development, to regulate the financial safety and the soundness
of Fannie Mae and Freddie Mac. It has been 5 years since the
Senate Banking Committee has conducted oversight of the OFHEO.
This is our purpose here today. We will focus on the central
question of the effectiveness of the OFHEO as a regulator.
This is a very important question, for together, the
housing GSE's hold mortgages and issue mortgage-backed
securities that total over $2 trillion. They also have
outstanding debt in excess of $1 trillion, much of this held by
the U.S. commercial and savings banks. These numbers make it
clear how important it is that there be a strong and effective
safety and soundness regulator for Fannie Mae and Freddie Mac.
Today, we have asked the OFHEO to submit testimony on the
adequacy of its resources, the status of its risk-based capital
regulations, and the safety and soundness of the housing GSE's.
We will then ask the Chairmen of Fannie Mae and of Freddie Mac
to testify to the effectiveness of OFHEO as a regulator, to
discuss the financial safety and soundness of their
institutions, and to provide an overview of the voluntary
commitments made last year to provide greater public disclosure
of their own risk assessments, implement a stress test system,
increase liquidity, issue subordinate debt, and submit
themselves to review by debt-rating agencies.
I look forward to the testimony of our witnesses as we
conduct oversight in this important area.
Before I call on Mr. Falcon, I would like to recognize the
Members of the Committee that we have here with us this
morning. First, I would like to recognize the Ranking Member,
Senator Reed from Rhode Island.
I would also mention to the Committee Members, as well as
the panel, that we have a vote scheduled at 10:15 this morning.
My intention is to go through the first panel by 10:15 a.m.,
and then we have a series of three votes. We will return as
soon as possible after those three votes to hear from the last
panel, which will be Fannie Mae and Freddie Mac, if that sounds
okay with the Members of the Committee.
I want to recognize Senator Reed and I would ask if we can
keep our statements relatively brief so we don't get into
trouble with the business outline that I have put forth this
OPENING COMMENTS OF SENATOR JACK REED
Senator Reed. Thank you, Mr. Chairman. And thank you for
holding this hearing on a very important topic. I am pleased
that Mr. Falcon, Mr. Raines, and Mr. Brendsel will be here
testifying this morning.
We are in the process of a very important review of the
Office of Federal Housing Enterprise Oversight and also of the
two Government Sponsored Enterprises that it regulates--the
Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation. These are important institutions for our
economy. They are institutions that we need to be concerned
about in terms of both their safety and soundness and their
interaction with the capital markets of our country.
I hope that this hearing will provide perspective as we
consider these important issues. I do believe these issues
require study. This is the beginning of that study. It might
require additional hearings and if that is appropriate, I know,
Mr. Chairman, you would invoke such hearings.
But I look forward to having an opportunity to begin today
to look carefully at the operation of these institutions and to
hear the testimony of our distinguished witnesses.
Thank you, Mr. Chairman.
Senator Allard. Senator Reed, we will work closely on
follow-up after this hearing with you.
The Senator from New Jersey.
OPENING COMMENTS OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Chairman Allard.
I want to personally welcome the witnesses and thank them
for taking the time to testify here today. I know a number of
them personally and have a very, very high regard for them. I
also compliment you, Senator Allard, and Senator Reed for
holding this hearing.
I think few would dispute that the mission of the GSE's in
seeking to make housing more affordable and accessible is truly
one of the important objectives and a very important one for
The results are terrific-- 68 percent homeownership rate in
our country, rising African-American and Latino family
ownership. It is really, I think, a terrific result.
Today's hearing about this supervision and oversight by
OFHEO I think is an important one which there has been
questions and criticism that has arisen mainly from lengthy
delays in getting to end results. I understand that Mr. Falcon
inherited much of this problem. And so, I just look forward to
hearing his comments on the credibility and performance of the
But I want to make very clear that my own experience with
both Fannie Mae and Freddie Mac is that they are outstanding
institutions performing their roles exceptionally well.
Senator Allard. Thank you.
The Senator from Michigan.
OPENING COMMENTS OF SENATOR DEBBIE STABENOW
Senator Stabenow. Thank you, Mr. Chairman.
Mr. Falcon, it is good to see you again and to see Mr.
Raines out in the audience in his new and different capacity.
It is a pleasure to see both of you here today.
This is a very important topic, Mr. Chairman. I am pleased
that you are holding this hearing today. This is an opportunity
to discuss the vitally important function that Fannie Mae and
Freddie Mac play in our housing market, and it is a chance to
review their safety and soundness regulations.
There is no doubt that the role Fannie Mae and Freddie Mac
have played in creating a secondary mortgage market--
consequently promoting liquidity and mitigating risk--is key to
much of the success in the housing market. These two
corporations should be proud of the role that they have been
playing in promoting homeownership.
Although there is a strong record of achievement, much more
needs to be done. There are still too many people for whom the
dream of homeownership is out of reach. Good intentions are not
enough. We must follow with concrete action, and there is
obviously a vital role for the GSE's in achieving our common
One thing I would challenge the GSE's to do is to continue
to increase their involvement in the subprime market. As the
lending market has grown for consumers whose credit or income
currently may prevent them from qualifying for a conventional
loan, it has become all the more clear that we need the
benefits of reputable actors like Fannie Mae and Freddie Mac.
Aggressive GSE involvement in markets would surely help combat
some of the outrageous predatory loans that are occurring in
too many neighborhoods in Michigan, as well as around the
country--by standardizing these loans and promoting
competition--they would play a significant role. Indeed,
failure to become involved in these markets could almost be
considered counter to the GSE's mission for it would deprive
too many working families the clear benefits that the GSE's
bring to our housing system.
I would submit my full testimony for the record, Mr.
Chairman. But I am certainly pleased that you are doing the
hearing today. I would simply add that on the issue of
regulation of the GSE's, that I don't believe that now is the
time to do anything that would disrupt or radically change the
I certainly look forward to ways in which we can strengthen
the system and work together.
Senator Allard. Thank you.
We will proceed to the first panel. Mr. Falcon, welcome.
OPENING STATEMENT OF ARMANDO FALCON, JR.
OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT
Mr. Falcon. Thank you, Mr. Chairman.
Chairman Allard, Ranking Member Reed, and Members of the
Subcommittee, my name is Armando Falcon and I am the Director
of the Office of Federal Housing Enterprise Oversight or OFHEO.
Thank you for the opportunity to testify this morning. I
commend the Subcommittee for conducting this oversight hearing
on the safety and soundness of Fannie Mae and Freddie Mac.
The OFHEO was established as an independent entity within
the Department of Housing and Urban Development. The OFHEO was
charged with ensuring the safety and soundness and capital
adequacy of the Enterprises, while HUD was given the
responsibility for regulating the Enterprises' activities--the
so-called ``mission'' regulation.
As the Director of OFHEO, I am pleased to report that
Fannie Mae and Freddie Mac are currently in very good financial
health. They are well-managed and have exceeded the minimum
capital requirements every quarter since 1993, when the capital
requirement was first imposed. These conclusions are based on
the findings of our broad regulatory system, which includes a
highly regarded examination, capital analysis, and research
programs. While the current situation is good, I want to assure
you that OFHEO remains vigilant. The OFHEO works every day to
ensure that this financial strength and well-being will not be
jeopardized by the changes in the economy, the markets in which
the Enterprises operate, or even the Enterprises themselves.
It may be useful to compare OFHEO's program with
contemporary global thinking regarding large financial
institution risk management and regulation. The Basel Committee
on Banking Supervision is an obvious point of reference. The
Basel Committee, which is a group of central bankers and
international financial regulators, has endorsed ``three
pillars'' of banking supervision. They consist of supervisory
review, capital requirements, and market discipline. Our
regulatory structure is consistent with those pillars.
Specifically, OFHEO conducts comprehensive annual risk-
based examinations of both Enterprises, ensures compliance with
minimum capital requirements and will soon impose a risk-based
capital standard, conducts financial research on the
Enterprises and the markets in which they operate, and has
developed a formal regulatory infrastructure to ensure
transparency and enforceability of its rules and regulations.
Allow me to expand on our regulatory program.
The 1992 Act establishing OFHEO directs the Office to
conduct annual on-site examinations to determine the
Enterprises' financial condition. OFHEO reports the results and
conclusions of these annual examinations in our annual ``Report
to Congress.'' This is unique among financial regulators and is
a powerful tool in influencing the behavior of the companies we
regulate. While that report is not due until June 15, I am
pleased to tell you today that both Enterprises have met or
exceeded safety and soundness standards in all examination
OFHEO's examiners maintain a physical presence at the
Enterprises and have unlimited access to all levels of
management and to highly sensitive corporate records.
Each quarter, the OFHEO examination staff updates
conclusions relating to more than 150 separate components of
financial safety and soundness, thereby providing me with a
comprehensive picture of the Enterprises' financial condition.
Our examiners identify the opportunities for improvements in
Enterprise risk-management practices and work directly with
management to enhance financial safety and soundness.
Quite simply, our examination group provides me with an
accurate and timely understanding of the Enterprises' financial
condition and provides the Congress with an annual report card
on how well the Enterprises are managing their risk.
While examinations are an important part of oversight, it
is by no means the only area in which Congress provided OFHEO
with significant regulatory responsibility. The 1992 Act also
directed OFHEO to establish and to enforce two major capital
tests for the Enterprises--a minimum capital test and the risk-
based capital stress test.
OFHEO implements and enforces a statutory minimum capital
requirement. This requirement is a leverage-based test similar
to the existing capital requirements for banks and thrifts. If
the Enterprise's core capital exceeds the requirement, the
Enterprise is considered adequately capitalized. As I stated
earlier, both Enterprises continue to exceed their minimum
The 1992 Act also called for a second capital test to be
applied to both Enterprises--a sophisticated risk-based capital
requirement using a stress test. The stress test simulates
dramatic changes in interest rates and the highest historical
declines in property values to determine capital requirements.
This approach is consistent with the Basel proposal, which
is designed to increase the risk-sensitivity of capital
requirements. Our risk-based capital regulation will more
accurately tie capital to risk than any other current or
I recognize that OFHEO is overdue on this rule. So when I
took office in October 1999, I made finalizing the rule my top
priority. Last fall, we finished the rule. And I took the extra
step of having the stress test independently tested and
verified by an accounting firm. In addition, we continue to
assist Fannie Mae and Freddie Mac in meeting their
responsibility to process a vast amount of data in the form
needed to run the stress test.
Early last month, we formally submitted the rule to the
Office of Management and Budget for review. Once the rule is
cleared by OMB and the rule is published in the Federal
Register, Fannie Mae and Freddie Mac will be subject to the
most sophisticated regulatory capital standard of any financial
institution in the world.
As with all financial regulators, research is an area of
great importance to the OFHEO's ability to fulfill its mission.
Upon taking office, I set out to ensure that the Office had
sufficient research capacity to provide me with an independent
analysis of regulatory issues.
Our independent research is critical to the fulfillment of
our core mission. We must fully understand the industry, the
marketplace in which the Enterprises operate, and the stresses
of economic events on the Enterprises.
Finally, OFHEO is undertaking a regulatory infrastructure
project designed to fully implement the statutory mandates of
OFHEO, to provide greater certainty for the regulated entities,
and to produce greater transparency for the public in
understanding OFHEO's administration of its responsibilities.
To date, this project has resulted in the issuance of
policy guidances on minimum safety and soundness requirements
and the management of the Enterprises' nonmortgage liquidity
investments, as well as final regulations on enforcement
procedures and the OFHEO's annual funding assessments. Still
pending are rules dealing with prompt supervisory response and
corrective action, executive compensation, and updating the
Enterprises' minimum capital requirements.
In conclusion, OFHEO is aggressively fulfilling its
Congressional mandate. The Enterprises are subject to an
ongoing oversight through our examination program, must meet
quarterly minimum capital requirements, will soon be subject to
a state-of-the-art risk-based capital stress test, and can be
held accountable through our enforcement powers if found
lacking in any of these areas. I assure you, Mr. Chairman and
Members of this Committee, that OFHEO will remain vigilant in
continuing to fulfill its mission.
Let me again thank Chairman Allard, Ranking Member Reed,
and the other Members of the Subcommittee for the opportunity
to be here and testify on this important issue.
Senator Allard. Thank you, Mr. Falcon.
In 1996, the Senate Banking Committee held a similar
hearing to that which we are having here today. At that time,
there was much discussion about OFHEO's progress in the
development of risk-based capital stress test for Fannie Mae
and Freddie Mac.
Your predecessor, who was the first director of OFHEO,
stated that a final stress test was expected to be completed by
the end of 1996. Here we are, 5 years later, and still, we do
not have those before us. What happened? How is it possible
that it has been 5 years later than what was anticipated? How
long have the proposed regulations been at OMB?
Mr. Falcon. Mr. Chairman, the agency, OFHEO, has not met
Congresses' expectations with respect to the timetable for
finishing this rule. I agree with you that that is
unacceptable. That is why I made it my first priority when I
came to OFHEO to get the rule completed.
The rule is the first of its kind. It will be a state-of-
the-art, risk-based capital regulation which more accurately
ties capital to risk than any other proposal which is out
Now, I would like to say that I don't like to make excuses
for the fact that the agency has had this lapse. It is more
important just to get the job done. And we have gotten the job
done. We are just working closely with OMB to make sure that
they understand the rule and so that they can clear it with
The agency started from scratch. It had administrative
issues that had to be dealt with. The agency did not have any
other model to work off of. This is the first time any
regulatory agency has had to devise a risk-based capital stress
So it was not a task that could be done realistically in
the 18 months that was laid out in the statute. But then,
again, I agree with you that it should not have taken this
long. However, we have gotten it done now, Mr. Chairman, and I
look forward to OMB clearing it soon so that we can put it in
Senator Allard. How long has it been at OMB?
Mr. Falcon. It has been at OMB since--I think March 29th is
the date when we officially sent it over to OMB, Mr. Chairman.
Senator Allard. And apparently, we are expecting some kind
of a report back from OMB here shortly?
Mr. Falcon. OMB will just convey to us when they have
cleared the rule and then we will be authorized to publish it
in the Federal Register as a final rule. I don't know whether
or not they will be submitting to Congress any formal report
with respect to the rule.
Senator Allard. After you get that, then that is going to
go through administrative procedures. There will be public
comment and what not. Is that right?
Mr. Falcon. I think that there will be a 60-day
Congressional review period.
We concluded the comment period and what is in the process
here is getting the final rule cleared. But we have gone
through several rounds of public comment on this rule.
Senator Allard. When is your best guess as to when this
rule will become fully effective?
Mr. Falcon. I expect this summer that the rule will be
published as a final rule. The statute, the 1992 Act, which
required this rule, states that there is a one-year delay. It
is effective upon publication, but there is a one-year delay
before OFHEO can enforce the risk-based capital standard. That
was done in order to give the Enterprises a chance to
transition into the rule during that one-year period.
Senator Allard. I would like to take a moment to compare
the OFHEO's resources to those of other regulators.
OFHEO has approximately one hundred employees and a budget
of $20 million. By comparison, the Comptroller of the Currency
has nearly 3,000 employees to oversee bank assets. Obviously,
the Comptroller has many more institutions to regulate, but a
recent article in The American Banker estimated that the
Comptroller of the Currency would assess fees of $71 million to
cover the cost of regulating Fannie Mae and Freddie Mac.
Mr. Falcon, does the OFHEO need more resources? Do you have
sufficient personnel and resources to do the job?
Mr. Falcon. Thank you for asking the question, Mr.
I think it is important that OFHEO have adequate resources
to conduct its oversight responsibilities. There are two points
that I would like to make here.
The first point is that we have requested additional
resources and in fact, this year, the President's budget gave
OFHEO a 23 percent increase in its budget. That will be a very
useful increase in our budget. And for the last 3 years,
Congress has given us an increase in our budget. I think it is
important that we continue to receive increases in our budget
so that we can continue to oversee the Enterprises with
The lack of more resources at this point has not hindered
OFHEO's ability to do its job. We leverage technology in a very
experienced and talented staff in order to oversee the
Enterprises. So it is important that the trend continue as far
as OFHEO obtaining resources. We have to manage our growth
properly, so we could not just double overnight in size. But
the trend has been positive.
The second point, if I could make it, is I think it is
important that OFHEO also have the flexibility to set its
resource needs on a real-time basis.
Right now, OFHEO is the only safety and soundness regulator
which is subject to the appropriations process. I have asked
before that OFHEO be removed from the appropriations process so
that we have the flexibility, should the need ever arise, to
increase our resources. If we ever needed to hire additional
examiners in response to any changes that the Enterprises, I
would have to wait until the next appropriations cycle to do
I think, like all safety and soundness regulators, OFHEO
needs to have the flexibility to adapt its budget needs to the
situation that it faces on a quick basis.
Senator Allard. Just as a quick follow-up on that--with the
tolerance of the Committee, I would like to step over my
allotted time a bit with this follow-up question.
Some have proposed a new safety and soundness regulator for
Fannie Mae and Freddie Mac and have even suggested the Treasury
Department or the Federal Reserve Board or some new entity. In
the alternative, what changes would you recommend to strengthen
OFHEO as a regulator? You have partially answered that
question, but I wanted to get a specific answer from you. Then
I will yield to the other Members.
Mr. Falcon. Thank you, Mr. Chairman.
Let me say, first of all, that OFHEO is an effective and
strong regulator with or without any changes to its statutory
regime. However, like any other regulator, there are always
modifications that can be made to enhance our authorities. I
mentioned the appropriations issue. I think that is a very
In addition, there are things that could be done to our
statute to enhance our independence, such as independent
litigating authority, as well as other modifications to our
statute to clarify our safety and soundness powers, including
our enforcement powers.
Last year, I submitted to the House Banking Committee a
package of proposed modifications. I think those modifications
would enhance OFHEO's ability to fully do its job. But the lack
of those changes has not hindered us from doing our job, Mr.
Senator Allard. Thank you.
Senator Reed. Thank you very much, Mr. Chairman. Thank you,
Let me follow up on your testimony where you make reference
to the Basel guidelines.
For most banking institutions, they develop their own
internal risk-based capital model, subject to supervision by
their regulatory authorities. But you have developed your own
regulatory models outside of Freddie Mac and Fannie Mae. Can
you comment about that approach? Does that give you more
confidence? Why did you take that direction?
Mr. Falcon. Thank you, Senator.
I think as a matter of law and as a matter of public
policy, we have taken the right approach with respect to the
risk-based capital requirement. I think the 1992 Act requires
that we implement the risk-based capital requirement with
respect to the Enterprises. So if there were to be another
approach taken, that would require a change in the 1992
Second, as a matter of policy, I think if OFHEO did not
implement the risk-based capital requirement, you would very
likely have two different capital requirements for each
There are hundreds of little decisions which, individually
and cumulatively, could have a major impact on the capital
requirement of the Enterprises. The statute only identifies a
handful of those parameters. And so, the way those hundreds of
other issues are resolved could have a huge impact on the
In order for there to be one capital standard that applies
to both Enterprises, it is important that OFHEO be the entity
that decides how those issues get resolved and ensures that
they apply equally to both Enterprises.
Although the Basel Accord leans toward some internal models
approach, I think that is in recognition of the reality of the
situation banking regulators face. They regulate hundreds and
thousands of individual banks. It is not quite practical to
devise one stress test that could apply to hundreds and
thousands of different banks with different types of
Here we regulate two entities and they are virtually
homogenous in nature. So, we are able to implement one stress
test for both of the entities that we regulate.
Senator Reed. Let me just follow up. There are two, among
many, but two critical items in terms of safety and soundness.
First is the capital adequacy levels; and the second, as you
just mentioned, is the stress test.
With respect to the capital adequacy levels, Mr. Raines and
Mr. Brendsel will testify later this morning about the very low
losses that they have experienced in the last several years.
And yet, there is a statutory requirement for a much higher
multiple in terms of the capital reserve.
My first question, do you think that that statutory level
is adequate? Too high? Should it be reconsidered or relooked
My second question, with respect to the stress test, you
have taken a regional meltdown, more or less, and applied it
nationally as your stress test. Is that, in your view, a valid
approach? Can you comment on those two things, Mr. Falcon?
Mr. Falcon. Yes, Senator. The statute required that we take
the worst regional historic loss experience and apply it to the
entire portfolio of the Enterprises.
Now that is a very stressful economic condition for the
Enterprises to have to survive. But I think Congress made the
correct judgment in 1992 that, having come out of the savings
and loan crisis, Congress wanted to be sure that there was an
appropriately conservative stress test that applied to the
Enterprises. And this stress test is a very conservative stress
You referenced a couple of other items in the 1992 Act.
I think, on balance, what we have done is sufficiently
stressful for the Enterprises. And when you look at the capital
requirements as part of a broader package of what we do, I
think we have a very strong conservative regulatory regime with
respect to the Enterprises. It consists not just of risk-based
capital, but also of our examination program. It consists of
our research agenda. It consists of our regulatory
infrastructure and our constant analysis of their capital and
their balance sheets.
So, I think, as a whole, we do have a very strong
regulatory program and the judgments that Congress made in the
1992 Act are appropriate.
Senator Reed. Obviously, from your testimony, you do
believe you have very strict and stringent rules for safety and
soundness. Do you feel you have adequate staff ? And
particularly with respect to being able to timely review the
One of the problems--you might have great standards but if
there is an inability to process information on a real-time
basis nowadays, you could find yourself suddenly going from a
very good situation to a very bad situation.
So assuming, as you say, that you have good standards, do
you have the resources to, in a timely way, review the
Mr. Falcon. I would like additional resources, Senator.
That is why it is important that the President's budget, which
gives us a 22 percent increase, does get adopted by the
Congress. And I think it is very important that the trend
continue in the following years.
We want to grow, but we need to manage our growth
prudently. But it would be important for us to make sure that
we continue to increase the resources so that we can always
oversee the Enterprises with adequate depth.
Senator Reed. Thank you.
Senator Allard. Thank you.
Senator Corzine. Mr. Falcon, how do you stay current with
such a complex risk-based system? I know we just got out a
rule, but new instruments are invented. Different elements of
them. How do you keep this system that your risk-based
assessment, current with the changing conditions and those
multiple variables that you are talking about?
One of my fears is that these things are static and not
attendant to changing risks that can occur through time.
Mr. Falcon. Senator, the risk-based capital rule has a
provision for new activities and new products at the
Enterprises. The rule gives us the flexibility to incorporate
new activities into the risk-based capital stress test.
I agree with you--if the stress test did not accommodate
new activities and new products, it would be obsolete the
moment that it became published. So it was very important to us
to make sure that it was flexible. At the same time, we have to
balance that with the need that the Enterprises have to have
predictability in their capital requirement.
So when a new activity or product comes on line, even well
before it comes on line, we will be working with the
Enterprises to ensure that we understand the nature of the
product, the nature of the risk involved, how they manage those
risks, and we will decide what the potential risks are and what
the capital requirements should be.
If we need additional time to understand the product and
the risks involved, we will impose a temporary capital
requirement on the activity until we can do the research
necessary to decide what the appropriate capital treatment is
for the activity.
Senator Corzine. Have you had some examples of that having
occurred as you were building this model in your 18 months?
Mr. Falcon. The proposed rule looked at the balance sheets
of the Enterprises as of the second quarter of 1997. And since
that time, there are additional products that have come on
line, certainly, one of which is Swaptions, which was not on
the balance sheet at that time. We have had to look at that
derivative in order to make sure that we incorporate it
properly into the stress test when it becomes final.
Senator Corzine. Okay. Now, you said that there are about a
hundred people, I think, on staff. How many of those people are
market professionals? How many research, quantitative types?
Rocket scientists, if you would? How does your staff break out?
Mr. Falcon. I think because OFHEO started in 1993 from
scratch, OFHEO did not have the luxury of hiring junior-level
people and then training them in what we need to do. We hired
very experienced people from other regulatory bodies. We hired
people with experience on Wall Street. Our examiner corps has a
great deal of experience. About 65 percent are examiners and
come from other regulatory agencies and have a great deal of
experience in examining institutions, large complex financial
institutions. I think the average length of experience for
examiners was about, when they came on board, 12 or 13 years.
In addition, in order to build this stress test, we hired a
great deal of people from Wall Street.
Senator Corzine. That is dangerous, by the way.
Mr. Falcon. They came with a great deal of experience in
writing sophisticated financial simulation models to process
cash flows for various products.
Senator Corzine. So, these people had worked with the kind
of instruments that you are now assessing the risks of.
Mr. Falcon. Absolutely, Senator.
Senator Corzine. Who's the accounting firm?
Mr. Falcon. Deloitte & Touche.
Senator Corzine. They have a specialized practice in
Mr. Falcon. Yes, Senator.
Senator Corzine. One final question. The debt of the GSE's
is growing fairly significantly and there are some that are
critical and others think it is the right strategy to expand
housing opportunities. Are you at all concerned about the
growing element of debt on the balance sheet of the GSE's? And
how do you assess that?
Mr. Falcon. As the safety and soundness regulator, we look
at this question from the standpoint of can they manage that
growth prudently? We focus on whether or not that growth poses
a safety and soundness concern to us. As of today, we are
comfortable that they do very prudently manage the risks
associated with their growth. And so, we have not taken any
steps as the safety and soundness regulator to do anything with
respect to their growth.
Now, I understand that their growth raises other issues.
And there are other concerns about whether or not it is growing
too fast and too large.
We have undertaken a study of the systemic risks that may
or may not be posed by the Enterprises and we expect to finish
that by the end of the year. So while we focus on the safety
and soundness of the Enterprises, we also are cognizant of the
bigger picture issues that arise with respect to the
Senator Corzine. Mr. Chairman, may I ask one follow-up?
Senator Allard. You may.
Senator Corzine. How would you distinguish the difference
between systemic, which I understand the definite of, and the
safety and soundness considerations as you look at the balance
Mr. Falcon. Safety and soundness goes to whether or not
they can manage the risk inherent in the growth. Systemic risk
concerns involve what kind of disruptions to the broader
financial markets might occur if there were financial problems
at the Enterprises? Or do financial problems external to the
Enterprises, can the Enterprises manage any collateral effects
from those shocks? I think that is the easiest way that I can
think of to distinguish between the two.
Senator Corzine. Thank you, Mr. Chairman.
Senator Allard. Thank you.
I have a brief question. Then if any of the Members have
any more questions, I think we can get through this easy
enough. I want to go to a question on derivatives.
In the last decade or so, some of the strategies in how
Fannie Mae and Freddie Mac manage their secondary market
securities has changed, and it involves the use of derivatives.
What is the amount of derivatives held by the two companies?
Mr. Falcon. I don't know that figure off the top of my
head, Mr. Chairman. I can get it for you.
Senator Allard. Okay. The Committee would be interested in
having that figure, if you would provide that to the us.
How does the OFHEO regulate the derivatives activities of
the GSE's? And what risks might be imposed by those
I realize that when we get into derivatives it is a very
specialized area. It is something that takes a pretty well-
trained individual to work with. So, I am anxious to hear how
you regulate the derivative activities of GSE's and those
Mr. Falcon. Let me state that the Enterprises use
derivatives in order to manage the risk. They use them in a
positive way. They did not use derivatives for speculative
purposes. In fact----
Senator Allard. For what purposes?
Mr. Falcon. They don't use them for speculative purposes.
Senator Allard. Speculative. Okay, yes.
Mr. Falcon. They use them for hedging. They are a very
important part of the Enterprises' method of mitigating the
interest rate risk that they face.
So, we look to make sure that they always use them as a
hedging device and that they are very useful in managing
interest rate risks by adding call features to noncallable
debt, for instance.
Senator Allard. I think that is a very important point
because hedging is used by many sound enterprises, in the
private sector, particularly, and banks. When properly managed,
it is a necessary management system. But if they get into the
speculative area, then that is when I think this Committee gets
particularly concerned. I am glad to hear your response in that
Senator Reed. Thank you, Mr. Chairman.
First, let me say that Senator Sarbanes very much wanted to
be here for your testimony, Mr. Falcon. He was delayed in
Baltimore. He will be here later for the second round.
Let me ask one additional question. One of the human
aspects of regulation, particularly with a small organization
and two regulated entities, is the potential for relationships
to develop between the regulator and the regulated entities
that get to be so routine and so comfortable, that you don't
challenge assumptions and you don't sometimes realize when the
train is going slightly off the track. How do you, in your role
as the leader of this organization, guard against that kind of
natural inertia or natural tendency to identify?
Mr. Falcon. Thank you for the question, Senator. I think it
is a very appropriate question.
I think OFHEO, like any other regulator, has to have a good
working relationship with the entities that it regulates. On
the other hand, we are very guarded about not allowing any kind
of relationship to develop where we cannot take an objective
approach to any issue. In fact, I think that has to start from
the top down within the organization. And I think OFHEO has a
culture within it that wants to have a good relationship, but
at the same time, has an arm's-length relationship with the
I tell everyone within OFHEO to just always do the right
thing. Do what is the best public policy. I think that is
something that I did not just bring to the agency, it was
always there. And if we do the right thing, I think we can
always defend ourselves in any forum. We do have a good
relationship with the Enterprises, a good working relationship.
Our examiners are in there day in and day out. They rotate
among different offices, so they don't always get too
comfortable in one particular area. We do maintain a healthy
arm's-length relationship with the Enterprises, but one which
is a good working relationship.
Senator Reed. Thank you.
Senator Allard. Senator Corzine.
Senator Corzine. I am fine, Mr. Chairman.
Senator Allard. Okay. We are right on schedule. We are not
sure just exactly when that vote is supposed to come up. Maybe
as soon as 3 minutes.
Mr. Falcon, I want to thank you for your testimony. I think
it is very helpful for the Committee. I want to thank the
Committee Members. I think we will just go ahead and proceed
with the next panel. If the bell rings for the vote, then we
will stop at that point and go vote.
Thank you, Mr. Falcon.
We will go ahead and bring up the second panel.
We just started the vote. I cannot believe it is working
out this smoothly this morning.
It usually doesn't work that way. I think we will go down
and vote, get back as quickly as we possibly can after these
series of votes, and then we will hear from the panel.
Senator Allard. I call the hearing back to order.
I want to apologize to everybody for the delay in the
Committee hearing. We were trying to get votes out of the way
on the floor of the Senate.
It gives me pleasure to welcome our next guests on panel
two: Mr. Franklin D. Raines, Chairman and CEO of Fannie Mae;
and Mr. Leland C. Brendsel, Chairman and CEO of Freddie Mac.
I know you are both very busy and I appreciate your taking
the time to show up before our Committee.
I think we will start with you, Mr. Raines.
OPENING STATEMENT OF FRANKLIN D. RAINES
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Mr. Raines. Thank you, Mr. Chairman. I am delighted to be
here. We appreciate the opportunity to appear before the
Subcommittee and appreciate the oversight that the Subcommittee
is providing in this area.
This hearing is happening at a propitious time for housing
in America, a time that demonstrates the stunning success of
the U.S. housing finance system.
More Americans own their homes than ever before. Home sales
in the first quarter of this year set a new all-time record.
Housing starts and home values are robust. And the mortgage
debt outstanding is growing at a healthy rate of 9 percent per
year. This year, mortgage originations are expected to reach an
all-time high of over $1.5 trillion.
Millions of homeowners are taking advantage of lower
interest rates to refinance their homes and save hundreds of
dollars a month. We estimate that mortgage refinancings this
year will put $40 billion in the pockets of consumers. The
process of financing a home on affordable terms has never been
faster, simpler, or more available to more families in more
Quite simply, the U.S. housing finance system is the best
in history and certainly the best in the world.
We all know that homeownership strengthens families,
communities, and the Nation as a whole. But it also strengthens
the economy. A generation ago, when the economy declined, so
did housing. Today, the strength of the housing sector and the
success of the housing finance system is helping to keep the
entire economy on a steady course. A great deal of credit for
this goes to the Congress and the work of this Subcommittee for
its stewardship of the U.S. housing finance system. In my
experience, support for housing has always been strong, deep,
When I first came to Fannie Mae in 1991, after 11 years on
Wall Street, we had a Republican Administration and a
Democratic Congress. When I left Fannie Mae to serve as Budget
Director, we had a Democratic Administration and a Republican
Congress. Today, we have a Republican President and the
political margin in the Congress is the closest in recent
history. But what continues to unite this Capitol city is what
unites our country, and that is a belief in the American dream.
And Fannie Mae's mission is to extend the American dream to
Mr. Chairman, I have submitted written testimony for the
record which describes how we do that and I would like just to
summarize that testimony this morning.
Fannie Mae began as a Federal agency in 1938. In 1968, the
Congress chartered Fannie Mae as a private company. In 1992,
the Congress strengthened our housing mission and our financial
Last year, Fannie Mae and Freddie Mac announced a series of
voluntary initiatives to further bolster our liquidity, capital
and market discipline, making our companies a new global model
for financial institution safety and soundness.
Today, Fannie Mae is a successful Fortune 50 financial
services company with a billion shares trading on the New York
Stock Exchange. Fannie Mae is one of the highest credit-rated
financial institutions in the country for the strength of our
business and risk management.
Indeed, one way to understand Fannie Mae is to compare us
with other major financial companies in America of similar
asset size. Like major national banks, for example, Fannie Mae
operates under a Federal charter that provides for certain
benefits, obligations, and limitations.
Unlike banks, Fannie Mae does not offer credit cards,
commercial lending, insurance, investment banking, or consumer
services. We focus strictly on funding mortgages that lenders
originate with homebuying consumers.
Fannie Mae is a private company, but we do have a compact
with the Government. We use the benefits of our charter to make
sure that consumer-friendly mortgages are available every day
in every part of our country under all economic conditions at
the lowest rates in the market.
With our charter also comes obligations, especially in the
area of affordable housing. We meet and exceed the toughest
affordable housing goals in the industry. In fact, Fannie Mae
is now the Nation's largest source of mortgage funds for
underserved families, including minorities and lower income
We achieve our mission by operating two businesses, using
100 percent private capital without a penny of public funding.
First, we operate a mortgage credit guarantee business. To
replenish their capital to lend, mortgage lenders bring loans
to Fannie Mae, swap them for mortgage-backed securities, and
then the lenders sell these into the market. Fannie Mae
guarantees the creditworthiness of the loans behind these
securities, and for that we receive a guarantee fee. But the
mortgage-lender controls and benefits from the sale of the
Second, we operate a mortgage portfolio business. Fannie
Mae buys mortgages and mortgage-backed securities from the
market and then manages the interest rate risk in our
portfolio. Fannie Mae's portfolio is almost entirely made up of
mortgage assets, including hold loans and mortgage-backed
securities. To purchase mortgages and mortgage-backed
securities for our portfolio, Fannie Mae sells debt securities
to investors on Wall Street and around the world.
Let me highlight three points about our businesses.
First, Fannie Mae's expertise is managing the credit risk
and the interest-rate risk on mortgages, particularly long-
term, fixed-rate mortgages. That is our special role in housing
finance. We mitigate and disburse mortgage risk by sharing it
with mortgage insurance companies, lenders, and investors. And
thus, our credit losses are at historic lows, the lowest in our
industry, and we are regarded among the best interest-rate risk
managers in the world.
The second point to understand about our businesses is by
helping lenders create mortgage-backed securities to sell, and
by selling our own debt securities, Fannie Mae gives investors
two additional attractive options for investing in housing.
If they don't want the credit risk of mortgages, they can
buy our mortgage-backed securities. If they don't want the
interest rate risk on mortgage-backed securities, they can
invest in Fannie Mae's debt securities. Either way, additional
investment comes into housing, lower costs for consumers.
The third point to understand about our business is that
Fannie Mae specializes in one particular kind of mortgage--the
long-term, fixed-rate loan, with an embedded option to
refinance. By financing these loans in large volume, we have
created a large, vibrant, and robust market for them. That is,
in fact, the reason that Fannie Mae was created in 1938--to
ensure the nationwide availability of the self-amortizing,
long-term, fixed-rate mortgage, which was then a very bold and
Sixty-three years later, Fannie Mae is still doing the very
same thing. The long-term, fixed-rate mortgage is still Fannie
Mae's bread and butter. It is 95 percent of the single-family
mortgages that we finance.
The main thing that has changed in 63 years is that we now
use private business practices, international capital markets,
information technology, and billions of dollars of private
capital to create a more efficient market for these essential
It is no wonder that 75 percent of homeowners choose this
kind of mortgage. Americans take it for granted that they can
get a 30-year, fixed-rate mortgage. But outside of America, you
can rarely obtain such a mortgage.
A few weeks ago I was in Europe, meeting with a group of
investors in equity in our debt. And at one of these meetings,
I asked a group of young analysts--how many of you have 30-
year, fixed-rate mortgages? Now most of them in that room owned
homes, but none of them raised their hand. None of them had a
30-year, fixed-rate mortgage available to them.
In most of the world, the mortgages that are available are
adjustable-rate mortgages and balloon mortgages. With down
payments of from 20 to 40 percent. In order to refinance, you
have to pay a stiff refinance prepayment penalty. It is simply
harder to get a mortgage.
In the United States, you can get a 30-year, fixed-rate
mortgage, down payments as low as 3 percent, with an option to
refinance any time that rates fall. You can see the benefit
that we provide every week in your newspaper. This week, our
loans that we buy are up to $21,000 cheaper over the 30-year
life of the mortgage than a jumbo mortgage.
To sum up, Mr. Chairman, two questions capture how Fannie
Mae's business carries out our compact with the Government. Are
long-term, fixed-rate mortgages available every day in all
communities? Do the ones we finance have the lowest rate in the
The answer to both these questions is demonstrably yes.
Fannie Mae brings over $21 billion of private equity capital to
the housing market and the results have been spectacular. We
have the best housing finance system in the world. Mortgages
consumers prefer are widely available. And mortgages cost less.
Mr. Chairman, I am delighted for the opportunity to be able
to testify before the Committee. We are delighted that we have
been able to be a participant in this growing and effective
housing finance system. And we are certain that, as we move
forward, particularly with items such as our $2 trillion
American Dream commitment to assist an additional $18 million
underserved Americans become homeowners, that we will continue
to have the kind of success that we have had over the previous
Senator Allard. Mr. Brendsel.
OPENING STATEMENT OF LELAND C. BRENDSEL
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Mr. Brendsel. Thank you, Mr. Chairman.
Good morning, Chairman Allard, Senator Sarbanes. It is a
pleasure to be here. I am Chairman and Chief Executive Officer
of Freddie Mac. I certainly appreciate the opportunity to
appear here this morning, along with Frank Raines of Fannie
Mae, to, in my case, talk about Freddie Mac's financial
strength and how it enables us to bring real benefits to
Freddie Mac is among the strongest, best capitalized, and
most transparent financial institutions in the world. We are
fiercely committed to maintaining the confidence of Congress,
of investors, and of the public in our financial strength.
There can be no doubt that Freddie Mac will meet our vital
mission for generations to come, which depends on that
Freddie Mac is a Congressional success story. We are at the
heart of the best housing finance system in the world. Today, I
think the mortgage market in many ways works so well, that we
take it for granted. Let me summarize some of the key benefits
that we bring.
First, there is never a shortage of mortgage money to
finance America's homes. That is because Freddie Mac has
developed high quality securities that attract global investors
throughout the world. As a result, when other markets are
rocked by turmoil, there is no disruption in the mortgage
market that we serve.
Second, as Chairman Raines has discussed, America's
homebuyers enjoy the lowest possible mortgage rates. In the
real estate section of the newspaper, two rates are always
listed--the low rate for the loans that Freddie Mac buys, and
the higher rate for the jumbo loans that we cannot buy.
Consumers save real money--currently up to $23 billion a year,
according to former OMB Director Jim Miller.
Third, in the market we serve, America's families choose
from a broad array of mortgage products. These include the 30-
year, fixed-rate mortgage with a low down payment, which is
simply not available in most other countries. In addition, even
in the jumbo market in the United States, it is far less
Fourth, Freddie Mac is at the forefront of innovation. Our
technology and our underwriting systems enable lenders to make
fast, fair, and accurate decisions to serve the growing
diversity of America's homebuyers. Our innovations enable even
the smallest lenders, and the newest ones, to compete and to
substantially reduce costs to consumers.
Fifth, Freddie Mac protects consumers from predatory
lending. The sad stories about abusive lending practices do not
come from our segment of the market. We buy loans from
reputable lenders and we standardize lending and servicing
practices. In addition, we foster competition so that consumers
have more choices among reputable lenders. Our goal is to drive
responsible lending throughout the mortgage market.
Sixth, Freddie Mac brings strength to housing and the
economy. In a downturn, Freddie Mac transmits lower interest
rates to the mortgage market. Refinancing puts real money in
borrowers' pockets. Plus, the boost to housing is often just
the spark that the economy needs. Certainly, low mortgage rates
have made housing one of the bright spots on today's economic
Seventh, by financing homes for millions of families,
Freddie Mac has helped the Nation reach the highest
homeownership rate ever.
In sum, Freddie Mac brings tremendous benefits to the
Nation. These benefits are tangible and they are significant.
They far outweigh any value that we derive from our
Congressional charter. America's homebuyers can depend on
Freddie Mac continuing to meet our vital mission because we are
safe, sound, and strong.
We are in a single line of business that is inherently
safe--the mortgages on people's homes. Our risk management is
disciplined, skilled, and second to none. And we hold enough
capital to withstand a severe economic recession that would
last for 10 years.
Now Standard & Poor's recently provided an independent view
of Freddie Mac's financial strength. They gave us a risk-to-
the-government rating of AA-. To put this in perspective, only
five bank holding companies have a rating this high on their
senior debt, and none has a higher rating.
Freddie Mac operates under the continuous oversight of
Congress and our regulators--both the Office of Federal Housing
Enterprise Oversight and the Department of Housing and Urban
Development. We also operate under the constant scrutiny of the
marketplace. Freddie Mac discloses comprehensive information
about our exposure to risk--and our effectiveness in managing
This high degree of transparency subjects us to the rigor
of market discipline every minute of every day. Freddie Mac has
long been at the vanguard of world practices in risk and
capital management and information disclosure.
Last October, we raised the bar with six voluntary actions
or commitments. Fannie Mae joined us in making them. As a
result, we will provide more information to the marketplace, to
investors than any other financial institution in the world. We
implemented all six commitments in just 6 months. The details
about each are provided in my written statement.
In developing these commitments, we sought out the best
thinking of international regulatory experts, particularly the
Basel Committee on Banking Supervision. I believe our six
commitments are a model for all financial institutions. In
fact, Moody's called them ``new standards . . . for the global
financial market.'' They added, and I quote: ``The leadership
shown by Fannie Mae and Freddie Mac could prove difficult for
other firms to ignore and could usher in a wave of enhanced
financial risk disclosure.''
The importance of all of this is the future. Over the next
decade, America's families will need an additional $6 trillion
to finance their homes. There are many doors to homeownership
to open for families that do not have that opportunity today.
Freddie Mac's strength and vitality will enable us to open
those doors to the homebuyers of the future.
Mr. Chairman, Members of the Subcommittee, I look forward
to working with you to secure the future of America's housing
finance system and, with it, the dreams of millions of
Thank you very much.
Senator Allard. Thank you. I want to start off with a
question that is directed to both of you.
We have had an opportunity for the regulator, OFHEO, to
comment about you. I want to give you an opportunity to comment
about OFHEO. I would like to hear how you rate OFHEO. Do you
believe that they have adequate resources to do the job?
Mr. Raines. Well, Mr. Chairman----
Senator Sarbanes. In case you were not here, they said nice
things about you.
Mr. Raines. I have some nice things to say about them as
It is always treacherous for the regulatee to be rating
your regulator. But I think there are a couple of things that I
can say that might be of use to the Committee.
First, I think that OFHEO, from its beginning, when it
first organized, put a great emphasis on its supervision role,
which most safety and soundness regulators do. In fact, with
most of them, all you really hear about, is their bank
examination and supervision role. They hired very experienced
examiners. We currently have 13 examiners dedicated full time
to Fannie Mae alone. To put that into perspective, that is the
same number of examiners that are dedicated to CitiCorp by
their bank examiners, to cover a company that operates in 100
different countries. We operate in one country, and one asset,
and all of our records are in one place.
So it is a larger amount of effort they put in and we think
that they do a very professional job. I think it can stand up
to scrutiny against any other regulator.
With regard to their implementation of the minimum capital
standards, again, they have been quite efficient and effective
in doing that. I think the market has been very appreciative of
their timely assessment of our meeting our minimum capital
With regard to the risk-based capital standard, as the
Committee Members have noted, it has taken too long. It has
taken too long and it has not been of benefit, either to OFHEO
or to the two companies. It would be better for us to have the
standard in place and operating because we think it is a world-
class approach to managing interest rate and credit risk in an
We wish it had taken less time. If we had any suggestions
for how to speed it up, it's to more actively engage with the
companies. We think we can be helpful in that process. But when
it is done, when there is an effective standard in place, it
will be world-class. It is a standard that we would be eager to
have other financial institutions subject to. And I think it is
one that should give great comfort to the Congress because it
does require us to hold capital against one of the most
unlikely scenarios you can imagine, interest rates rising or
falling up to 600 basis points and staying that way for 10
The largest credit losses in history, not just in one
region, but applied nationwide, and those losses go on for 10
years. We have to have 100 percent of the capital to survive
that scenario, plus 30 percent in additional capital, to handle
what is called management risk. I often say I am not sure what
I could do to the company that this risk scenario hadn't
already done to it. But we need 130 percent of the capital to
survive that scenario.
When that is in place, it will be a world-class risk-based
capital standard, giving the correct incentives to the
companies to manage risk and hold risk down, and at the same
time ensuring that we are able to carry out our mission.
Senator Allard. Mr. Brendsel.
Mr. Brendsel. Thank you.
I think there are many things that OFHEO has done very
well, extremely well. Certainly, as Chairman Raines has said,
if I look at the examination staff, the supervision is really
excellent. I think they have hired a great group of people.
They have a lot of experience coming from banking, regulatory
agencies. From my perspective, they do an excellent job of
examination and reviewing us. And they are with us every day in
Certainly, there are many aspects of the regulation that
they have implemented on a timely basis. As has already been
said here at this hearing, the risk-based capital rule has been
tardy. My hopes are that it is finalized soon and that it be a
sensible rule and one that meets the requirements of the 1992
I believe they do have enough resources to perform their
regulatory activities today. Particularly, when you consider we
are just two Enterprises that they have to focus on in one line
Senator Allard. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman. And thank
you, Mr. Raines and Mr. Brendsel, for your excellent testimony
There are two significant issues we are grappling with.
First, safety and soundness, and the other issue is one that
has been raised, the advantages of GSE's, in general, and to
whom these advantages specifically accrue.
First, with respect to safety and soundness, what I have
heard from the regulator and what I have heard from you is that
the legislation has established very rigorous safety and
soundness standards and that your organization is responsive to
In addition, you are conscious of the potential volatility,
as things can change very quickly in this area. But, in
general, might you make another summary comment, Mr. Raines and
Mr. Brendsel, on the safety and soundness of your institutions.
You feel you are well-positioned, I presume.
Mr. Raines. I think we are very well-positioned, indeed. As
Moody's said, both companies are leading the world in terms of
the measures, both those that are mandatory in the statutes and
through our regulation, and our voluntary initiatives, which
take us far beyond what others have done.
When we looked at this, there was a lot of theory about
these things. And we said, well, why don't we just do them all?
Let's not debate whether it should be more disclosure or
subordinated debt or implementing the risk-based capital
standard on our own or liquidity. Let's do them all.
I believe that these two companies are the only companies
in the world that are subjected to all of these means of
maintaining safety and soundness.
Senator Reed. Mr. Brendsel.
Mr. Brendsel. I think we are in excellent financial shape.
I think the current results show it. Beyond that, though, the
information that we are providing to investors and to the
marketplace, our standard disclosures, as well as the enhanced
disclosures, as well as the additional ratings, all confirm the
outstanding financial condition of the company.
Again, to emphasize, we start from a basis that both
companies are in essentially one line of business--not many,
not spread throughout the world--we are focused on providing
mortgage credit secured by American homes. A homeowner makes
their mortgage payment among one of the first obligations that
they meet beyond, I think, putting food on the table for their
families. So when you start from that, it is not surprising
that the company should be in such strong financial condition.
Second, we carefully manage the risks that are ever present
in the residential mortgage market--very carefully, whether it
is credit or default risk or whether it is interest rate risk.
In order to ensure the long-term future of the housing
finance system, of the availability of mortgage credit, and
indeed, the viability of the Enterprises' ability to meet our
public mission must start from the basis and the foundation of
running an extremely strong institution.
Senator Reed. Mr. Brendsel, you have hit on the public
mission, which is important. But you also have obligations to
your private shareholders which are equally compelling to any
In terms of this public mission, first, Mr. Brendsel, and
then Mr. Raines, what are you doing to, one, ensure that this
public mission benefits consumers and homeowners; and second,
continue, and in fact is expanded, with respect to Freddie Mac
and Fannie Mae?
Mr. Brendsel. First of all, it is our only mission. It is
our singular mission. And it is the one that is dictated in our
charter. So every one at Freddie Mac, starting with me, is
singularly focused on ensuring that we meet the purpose and the
mission for which Freddie Mac is chartered and created, and
that we are expected to attract private capital from our
shareholders and investors around the world to fund housing in
the United States.
That is why sometimes people have a sense that there might
be a tension between our public mission and our shareholders. I
don't believe so. The two have to go hand in hand. You have to
serve your mission in order to meet your public purpose. In
order to do that, you must have the confidence of your
shareholders and continue to attract private capital.
What we are doing is continuing to innovate every day to
continue to find new ways to drive down costs, to increase the
availability of mortgage money throughout the Nation, and to
find new ways to attract capital from throughout the world.
There are no boundaries other than the boundaries provided by
We are using technology to find new ways to qualify
homebuyers, to drive down the costs for closing a loan. It is
just one example. We are expanding into more parts of the
subprime mortgage market, trying to find better ways to finance
those mortgages than the ones traditionally that have been
available to homebuyers who are in that market today.
Senator Reed. Thank you.
Mr. Raines, if you could comment.
Mr. Raines. Yes. Thank you, Senator.
Just two points that I would make. First, from the
standpoint of our shareholders and our mission. There is a very
close congruence. By being in the U.S. housing market and the
mortgage market, it is an enormous market. It is a market of
$5.6 trillion outstanding. It is a market that is growing for
the last 3 years at 9 percent.
I have no problems going to my shareholders and saying,
where we are chartered to operate is an area where we can do
good things for our shareholders while carrying out our
mission. They need not worry about there being a conflict.
The second point is Fannie Mae has a tradition of
establishing big goals for ourselves when it comes to our
mission--to ensure that there is no doubt that we are doing
everything we can to achieve that mission.
We just completed last year a trillion-dollar initiative
that was begun by my predecessor to focus one trillion dollars
on affordable housing for 10 million families.
I announced last year a new American Dream commitment--a $2
trillion commitment over this decade to try to move up the
homeownership rate of those people who have not yet broken the
50 percent homeownership rate--minority Americans, young
Americans, female-headed families, urban Americans. We want to
move up their homeownership rate by investing $2 trillion. And
that includes commitments of over $400 billion now aimed on an
area-by-area basis, and where our partnership offices are now
sponsoring investment plans, focused on individual communities
to ensure that we are not simply operating at a very high level
out of Washington, but having an impact in local communities.
Senator Reed. Thank you very much.
Senator Allard. The Senator from Maryland.
OPENING STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Mr. Chairman.
I was not here at the outset and I want to take just a
moment or two to make a short statement before I pose a
First of all, Mr. Chairman, I want to commend you and
Senator Reed for holding this hearing.
I looked at the hearing notice and it said, a hearing on
oversight--oversight, I underscore that--of the mission of the
Office of Federal Housing Enterprise Oversight and the
Financial Safety and Soundness of Fannie Mae and Freddie Mac.
It did not have any bill number with respect to which this
hearing was going to be held. And I must say that this is a
very welcome, as it were, initiative because I think we don't
do enough oversight and we are always gearing everything to a
new piece of legislation.
I am frank to say I don't think we need any new legislation
in this area. What we need is appropriate oversight. And so, I
commend you and Senator Reed for, in a sense, perceiving that
and holding this hearing.
Senator Allard. Thank you.
Senator Sarbanes. It is a very good departure, I have to
Fannie Mae and Freddie Mac have been strong engines of
homeownership in this country. Homeownership continues to be at
the heart of our Nation's housing policy because of the
benefits it brings, not just to the homeowners, but to the
entire community. We, in effect, perceive it as very important
to community stability, and I think there have been studies
which will substantiate that.
The GSE's continue to be a crucial link in bringing this
important benefit to millions of Americans. Now given their
size, and they have been, in my view, very effectively managed,
but obviously, they need to be regulated and supervised in a
thorough and appropriate manner.
OFHEO has now come forward, or is about to come forward, I
gather, with its risk-based regulation. It has been forwarded
to OMB for final review and publication and we await its final
publication, and then I am sure we will examine it and receive
the benefit of comments and so forth.
The other functions that OFHEO is required to perform, it
seems to be doing well. It is regarded as having an examination
staff that is qualified and experienced. The staff is devoted
full time to overseeing the two housing Enterprises that are
now at the table.
I am told that if you compare the insured financial
institutions and their supervision and examination, that the
two GSE's are as closely supervised and examined as any of
those insured financial institutions.
OFHEO has invested considerable time and resources. It has
developed significant expertise. And I think one of our charges
is, of course, to make sure that it has the resources necessary
to do the job and it is carrying through on its statutory
In the meantime, Fannie Mae and Freddie Mac have decided to
take a number of steps to increase the transparency of their
operations, including their risk management, and to get
continuous reviews of their financial conditions by Standard &
These are obviously important steps that will allow the
market to exercise considerable discipline on these
institutions, which should increase our confidence as well.
I look forward to the final regulations publication and its
review, and again, redirecting our attention, then, to the
goals Fannie and Freddie have been chartered to support,
increased homeownership and more affordable rental housing.
I am pleased to welcome these two witnesses before us, to
thank them for the leadership they are providing, and for their
responsiveness to many of these public policy and public
interest concerns. I just have a couple of questions. I think I
still have a little bit of time.
As we said, we regard homeownership, affordable rental
housing as important to building strong communities, increasing
civic engagement, laying the foundation for educational
attainment for our children. And these two institutions have
played a central role in advancing that cause.
There is, however, still a significant differential in the
homeownership rates among whites and minorities. Minority
homeownership rates have risen in the past several years, but
they continue to lag significantly behind those of white
Americans. Maybe you could outline for us what steps you have
taken and perhaps even more, what further could be done to try
to close this gap.
Mr. Raines. Well, Senator Sarbanes, thank you for that
statement. Thank you for that question.
There is no more important issue facing the housing finance
system than how do we bring the benefits of housing ownership
to more Americans?
You are correct that about 74 percent of white Americans
own their own home. And less than 50 percent of everybody else,
including young white Americans own their own homes.
We have established an effort to focus attention on
bringing up these homeownership rates, particularly among
minority Americans. We have made progress in the last several
years. Homeownership has risen faster among both Hispanic
Americans and African-Americans than other groups.
We have established a new program, a $400 billion effort
over this decade to move up the minority homeownership rate.
And we will do that through the creation of new products. We
will do that by penetrating markets that have not been
adequately served. We will do it by reducing the cost of
homeownership. Let me give you just one example.
The subprime lenders have done a phenomenal job in
penetrating minority communities. They have brought credit to
those communities that did not have credit before. But that
credit has come at a cost.
For many people in those communities, they deserve lower-
cost mortgages. And so, we have developed products and programs
to try to increase competition in those communities to bring
lower-cost products, such as our timely payment reward
mortgage, which is a mortgage that, if you make your payments
on time for 24 months, we will reduce the interest rate. But
many of these communities are very suspicious of conventional
lenders and have not been served well by them in the past.
And so, we are going to have to work with community groups,
with our lenders and with others, to try to convince these
communities that mainstream lenders will provide them with
service so that they will, in fact, go to those lenders and
obtain much more cost-effective products. We are working across
the board on each of the problems, whether it is down payment,
whether it is credit, whether it is affordability, to try to
knock down these barriers and to raise the minority
Senator Sarbanes. Mr. Brendsel.
Mr. Brendsel. Thank you, Senator.
Increasing homeownership is a major goal of Freddie Mac and
particularly reducing the homeownership gap that confronts
African-Americans, Hispanic Americans. We think that there are
many things that we can do and we are committed to doing. And I
will mention five.
First is improving underwriting qualifying decisions that
families face. Certainly, over the course of the last 5 years,
Freddie Mac has been an innovator and a leader in developing
new underwriting systems that are fair for borrowers.
Second, lowering costs, finding ways to lower costs,
particularly costs of qualifying for a mortgage loan and
closing on that loan.
Third is the design of new products that are more
attractive and better fit the needs of underserved borrowers
today. Whether it is products that reduce down payments or
allow borrowers to qualify for a mortgage loan, we have
instituted many new products--too many to list.
Fourth is education and counseling. This is an important
part, I think. We recently completed a couple of studies that
demonstrate the importance of financial education and
understanding of how to qualify for a mortgage loan, how to
improve credit if you have blemishes on your credit today. In
addition, another study confirmed the success that homeowner
counseling has in improving homeownership opportunities.
Fifth, we are building more alliances with organizations
that help us to penetrate minority neighborhoods and
I am really pleased with the results that we are showing
and, certainly, as I mentioned before, we are continuing to
penetrate more parts of the mortgage market, the subprime
market, to drive out practices of predatory lending by bringing
in more qualified quality mortgage lenders. I think this is an
important activity that Freddie Mac is currently engaged in.
Senator Sarbanes. Thank you very much.
Mr. Chairman, I see that my time is up. I was going to ask
about predatory lending, but since the time has run out, I
won't do that.
Just let me make this observation.
I know you both made constructive contributions in
addressing that problem. I would hope that you would continue
to try to be as active as possible, including whether there is
some way to provide more liquidity to reputable subprime
lenders who avoid these predatory practices and products. And
thereby, by doing that, strengthen their position and perhaps
bring greater quality assurance into the subprime market.
They are all being tainted by the outrageous actions of a
few. Most of the lenders in that market should also be
interested in finding ways to cut these offenders, as it were,
out of the market and the rest of them can go on doing their
business in a responsible way.
Thank you very much, Mr. Chairman.
Senator Allard. Thank you, Senator.
OPENING COMMENTS OF SENATOR THOMAS R. CARPER
Senator Carper. Thank you, Mr. Chairman.
Welcome, gentlemen. It is especially nice to see our old
OMB Director back here wearing his new hat. I was fortunate
enough to be able to talk with you earlier this year, Mr.
Raines--I don't know if you recall this part of our
conversation. We were talking about whether there is some
things that we could do within the Congress to help promote not
just homeownership, but decent housing, in ways that involve
the relationship between Fannie Mae and HUD.
We talked about constraints to partnerships that existed,
either through regulation or just through attitudes. We talked
a bit about how we might eliminate some of those barriers,
either regulatory, through statute, or just through attitudinal
I have thought a good deal about that since. You may not
have thought about it at all. But if you have, and if you have
any thoughts or examples that you might share with us today, I
would be grateful. And if not, I would just ask you to submit
something to us in writing.
Mr. Raines. No, I would be delighted to. I have thought
about it quite a bit since our conversation, and I have talked
actually to Secretary Martinez about it as well. I think that
the key to our success going forward is how do you have
effective risk-sharing? Not risk-shedding, but risk-sharing.
Very often, when HUD enters into partnerships, they get the
raw end of the deal because people want to simply shift risk
from themselves over to HUD. And HUD often is not in a position
to adequately measure that risk and to assess it, and then we
all get disappointed that yet another program did not work.
And so, my thoughts are, and I have mentioned this to the
Secretary and I will be meeting with him again to discuss it,
is how can we have a collaboration between the kinds of
technology, risk management, risk assessment, product
development skills that we bring and the Government's ability
to take on risk that perhaps is beyond our ability to do that,
but to do it in a way in which there is a fair sharing of the
risk and a fair sharing of the revenue.
I think that has to work because we engage in risk-sharing
with lots of players today. We engage in risk-sharing with the
mortgage insurance companies, where they are our partner in
managing credit risk. We engage in interest-rate risk-sharing
with counterparties around the world. We have Wall Street every
day coming up with new ideas of how we can share risk, mitigate
risk, move risk around the system so that there is no systemic
There has to be a way for us to do that with FHA and with
HUD if each of us goes into this where the goal is to be able
to serve more people. I think if we put our resources together,
our private capital together with the Government's capital, we
can serve more people and we can do that without shifting risk
onto HUD that HUD is not in a position to undertake, or simply
take loans that otherwise were going to be made and simply put
them into a new guise. I think we can reach out to more people
if we put the resources together and work hand-in-hand in a
Senator Carper. My guess is that what you just described
here could have been at least begun in the last couple of
years, but it wasn't. And I presume that among the reasons why
it did not was that people had concerns about this particular
course. What are those concerns and how do we address them?
Mr. Raines. Well, we have had discussions since I have been
at Fannie Mae, 1991, we have had discussions with Secretary
Kemp along this line, with Secretary Cisneros. Unfortunately,
in the last Administration, there was less interest in this
sort of partnership.
Senator Carper. Why do you think that might have been? Any
Mr. Raines. I don't know. One time, Ginnie Mae and Fannie
Mae were part of one organization. And I think from that time
on, there has been this sort of silly competition that has gone
on, as opposed to looking at a partnership. I think,
periodically, that raises its head and gets in the way of
really sitting down and trying to figure out how you can work
better together. This should not be about who is better than
the other one or who is more dedicated than the other. It
really ought to be about how can you put resources together and
do more than you can if they are separate.
Senator Carper. Thank you very much. I am glad I was not
the only one thinking about that.
And you gave us the name of a person within your team to
follow up with. I think we have him. We certainly will after
Mr. Raines. Right. Terrific.
Senator Carper. I wasn't here earlier for the testimony. Is
it Mr. Falcon or Mr. Fal-cone? How does he pronounce it?
Senator Allard. Mr. Falcon.
Senator Carper. Mr. Falcon. I understand that he may have
made a comparison between the regulatory regimen established by
the statute, the proposed rule and your voluntary commitments,
and the Basel Accords that are applied to internationally
active financial institutions. I would just ask, and let me
address this to Mr. Brendsel--is it Brendsel?
Mr. Brendsel. Yes.
Senator Carper. Mr. Brendsel, in your view, what are the
similarities and what are the differences?
Mr. Brendsel. Between our capital regime and the regulation
and the Basel Accord?
I think the Basel Committee established three basic
principles for sound regulation and supervision. First is
market discipline. Second is capital related to risk. Third is
If you stack up the legislation of 1992 passed by Congress
that OFHEO is charged with implementing, it stacks up extremely
well. In fact, in many ways, it goes beyond the principles
outlined by the Basel Committee.
Specifically, our risk-based capital rule that is in
process now, as directed by Congress, is very innovative, very
forward-thinking, and goes beyond anything that banking
regulators have developed for banking institutions, or even
that the Basel Committee describes.
Second, in terms of market discipline, which contemplates
having information out there that allows investors to judge,
that allows the public to judge the activities of the
Enterprises and whether we are safe and sound. Certainly, with
the six commitments, the amount of information that we disclose
to the marketplace exceeds anything disclosed by even the
largest banking institutions.
Finally, as we have already commented earlier, I think that
the examination and supervision staff is professional. They are
focused on two Enterprises and do an outstanding job.
Senator Carper. Good. Thank you very much.
Senator Allard. I want to direct the next question to you,
Mr. Brendsel. Then, I have one for Mr. Raines.
The main line of business for Fannie Mae and Freddie Mac is
to grant pools of mortgage-backed securities. However, in
recent years, you have dramatically increased your own
investment in mortgages. This is done in two ways, I
understand. By the direct purchase of mortgages from lenders
and the purchase of mortgage-backed securities that have your
guarantee on them. Is this line of business riskier than the
guaranteed business? And how do you protect against these
Mr. Brendsel. That line of business is not riskier than the
All risks in mortgage finance, particularly the two
principal risks of credit risk and interest rate risk that are
involved in the guarantee and the portfolio businesses, are
risks that, number one, we understand extremely well,
understand better than anyone else. I was going to pay a
compliment to Fannie Mae here--they almost understand it as
well as we do.
Let's put it that way.
In any case, we don't take those risks and just put them on
our balance sheet. We intermediate the risks. We use mortgage
insurance and reinsurance, for example, on credit risk. In
addition, on interest rate risk, we use callable debt options
to redistribute that risk to other investors. And so, the fact
is that we take very little risk. We are extremely well-
capitalized relative to that risk.
Finally, both activities are ways of attracting the
broadest range of investors to finance housing in the United
States. Some prefer to invest in mortgage-backed securities.
Others prefer to invest in debt. We try to provide as broad a
range of financing options that we can that are attractive to
investors that will provide those funds. And then we manage
that in an extremely conservative and sound way.
Senator Allard. Thank you.
Mr. Raines, you purchase a significant amount of mortgage-
backed securities for your own portfolio. When you purchase
these certificates, this is financed with short-term borrowing.
Does this increase your risk and how do you guard against the
risk of an increase in the short-term interest rates?
Mr. Raines. Well, Mr. Chairman, first, Fannie Mae has been
in the mortgage portfolio business for our entire 63 years. So
this is the way Fannie Mae first began doing business. This is
not a new business for us. Indeed, the mortgage-backed
securities business came much, much later. We have been in the
business of managing mortgage risk on our balance sheet for
quite some time.
Second, there is no difference, really, in the risk of
owning what we call a whole loan or a mortgage-backed security.
It is exactly the same risk that is there. Lenders now prefer
to put all of their loans into mortgage-backed securities
before they sell them into the market because they can get a
better price. But that is a decision the lenders make to put
them in the mortgage-backed securities.
The third point is, we don't buy long-term mortgages and
fund them short. Indeed, we match the funding of the expected
duration of the mortgage with our debt. We have a very close
match. And that is why in the new disclosures we have made on
our interest rate risk, even significant changes in interest
rates in the short term have very little effect on our income,
because of this very close match.
We don't match it exactly because if we matched it exactly,
there would be no way to make any income with running the
portfolio. But we have a very, very low level of risk in that
business and that is shown by our success over the last 14
years of solid earnings increases as interest rates have risen
or fallen, and by very large amounts over time.
The other factor that is important in understanding this is
not just what you think the duration of the mortgage will be
when you put it on your books, but it is also the option that
we provide to the homebuyer to refinance the mortgage. That is
an enormous consumer benefit, that if rates go down, they can
refinance their mortgage. And that option risk we also manage
by putting options into our debt. So, we will sell callable
debt or we will structure the equivalent of callable debt.
If we think the mortgage, for example, is going to last 7
years, interest rates fall and the consumer says, I would now
like to refinance, we don't say, as they say in other
countries, well, you cannot. Or you have to pay us a big fee.
What we say is fine, you are going to send us back the mortgage
early. We will call back our debt early. And by that way, we
can keep this close match of duration, even if the consumer
undertakes their option to refinance.
A tremendous benefit to consumers, as I mentioned, is we
are going to put as much as $40 billion in the pocket of
consumers just this year alone.
Senator Allard. Mr. Raines, how do you respond to the
criticism that the derivatives are necessary only because of
the higher risk associated with your direct purchase of
mortgages and mortgage-backed securities?
Mr. Raines. Again, we have two businesses. One business is
to manage credit risk and the other business is to manage
business-rate risk. And we have been in the interest-rate risk
management business for our entire history.
The reason we have the use of derivatives is that the
American people want more long-term, fixed-rate mortgages than
any group of investors by themselves are willing to finance.
If investors are willing to finance all the long-term,
fixed-rate mortgages that Americans want, then they would all
go into mortgage-backed securities. They would all be sold into
the market. And there would be no opportunity for us to own
We only own mortgages when other investors don't want to
own them. In fact, we can only own a mortgage if investors are
willing to buy our debt because we sell our debt to investors
and use that debt to buy mortgages. If the investors wanted to
buy the mortgages themselves, they could just do that.
Clearly, we have more Americans who want long-term, fixed-
rate mortgages with an option to refinance than we have
investors willing to do that directly. So, we will issue debt
so that we will buy those mortgages and the investors can own
our debt because they believe that our debt, either our
callable debt or our bullet debt, is a better match for them.
But it also turns out that there are people who are in the
derivatives market--particularly large financial institutions.
It is dominated by banks in the derivatives market--who say,
well, we will help you put together debt in a way that will
attract even more investors, who may be short-term investors
who don't want to provide long-term funds.
We have other investors over here who are willing to extend
the maturity of that short-term debt. And we say, great. If we
can bring in more investors to help us own these mortgages that
consumers want, that is terrific.
Over our lifetime, we have gone from financing just with
bullet debt, to then financing with callable debt. Now, we are
able to put together debt that uses derivatives. All of which
is simply expanding the range of people around the world
willing to invest in American mortgages.
Last year, 30 percent of the money we raised to buy
mortgages came from outside the United States. Much of that
from countries who have homeownership rates lower than ours.
But they would rather invest in the U.S. mortgage system than
invest in anything else. And so, I believe that this array of
products that we offer on the debt side give us the ability to
provide Americans with what they want.
Seventy-five percent of Americans have chosen in the
marketplace, they want a long-term, fixed-rate mortgage. And it
is been our job to go out and scour the world to find the
equity, to find the capital, to make that possible.
Senator Allard. Now let me understand this. You have
provisions on your debt so that, if somebody pays off their
loan early, then you can recall the debt in early. Is that
Mr. Raines. That is right. In the first quarter of this
year, for example, we called in $80 billion of debt because of
the number of refinancings that have happened.
Senator Allard. And they all understand that with the
Mr. Raines. That is the contract we have with them. Of
course, they charge us more. They charge us more for that
Senator Allard. We are familiar with that.
Mr. Raines. So every feature, there is an expense. But it
is worth it because these are the mortgages Americans want. If
the American people said, all I want is an adjustable-rate
mortgage, which is the mortgage that is available in most of
the world, then this would all be a lot simpler because we
would simply say, we will borrow short and we will lend to you
You take the interest rate risk, consumer.
In England, if interest rates go up, if the short-term
rates go up, they simply announce to you that your rate has
gone up, with no cap, no limitation. Your interest rate could
Well, that is not what Americans have wanted. Americans,
since Fannie Mae was created in 1938, for the purpose of buying
long-term, fixed-rate mortgages, have said with their actions--
we want long-term, fixed-rate mortgages. We want to lock in
Somebody else should manage interest-rate risk. But we
should not put that burden onto the American family.
Senator Allard. Senator Reed.
Senator Reed. Thank you, Mr. Chairman.
Mr. Raines, let me follow up on a line of questions that
Senator Sarbanes opened up with respect to trying to increase
the minority homeownership.
Typically, you find, and my experience in Rhode Island is
that they are very hard-working individuals. They want to buy a
home and they have stable employment. They just cannot afford
an interest rate comparable to what you would find in the
When lending institutions try to provide a subsidized
interest rate, it runs afoul of your underwriting rules. Is
there anything that we can do in Congress or anything you can
do to try to identify those worthy credit risks who will pay,
but just run afoul of your rules?
Mr. Raines. Well, certainly, we are constantly modifying
our rules in order to ensure that we can penetrate markets and
serve more people.
Our research shows that there are a number of reasons why
minority homeownership rate is low. The first problem has been
information, the lack of knowledge of how the system works. And
the Fannie Mae Foundation has led with the largest information
campaign ever run. They have been doing it since 1994. Eleven
million people have reached out to the foundation for
information about homeownership and how do I get through all
the hoops and requirements.
The second problem we have found has been lack of money,
lack of wealth for down payments. In the 1990's, Fannie Mae led
the way in reducing down payment requirements from 20 percent
down to 3 percent, and in some cases, down to zero. So that we
are able to help people who can make the monthly payments, but
who don't have the wealth.
A third problem has been credit. There are many people who
have lacked the knowledge of what determines good credit. We
have done a lot of research and we found, for example--and this
is not just minorities. But a majority of Americans do not know
that if they don't pay their bills on time, that that can
affect their credit rating.
Many people believe that if I pay it late, but pay the late
penalty, then it is okay. And it is only when they apply for a
mortgage, that they find that they now have all of these lates
on their record.
The Fannie Mae Foundation has launched a campaign to try to
improve knowledge of credit. I hope that you have seen some of
their commercials, asking people to reach out and to get
information before they try to become a homeowner.
The final item as you mentioned that affects minority
homeownership has been the ability to afford even the market
rate, even after they have gotten over all those hurdles.
We have done a number of things in that regard.
First, to try to hold down all of the ancillary and other
costs that drive up that rate. Our technology and other means
are making it less expensive for lenders to lend.
Second, we are the largest buyer of mortgage revenue bonds
in the country. And through mortgage revenue bonds, your State
housing finance agencies are able to make available below-
market interest rates.
One of the limitations they have is that there is a cap on
the amount of mortgage revenue bonds that they can buy. Indeed,
there is a cap on the amount we can buy.
Certainly, in terms of the most efficient way to get lower
cost finance available would be to expand the availability of
mortgage revenue bonds through the State housing finance
agencies. We would be delighted to have an opportunity to
invest in more of these. It is an extraordinarily efficient
mechanism that has been created.
Another one, the President has a proposal for a new tax
credit to provide an incentive for investors to provide funds
for rehabilitation, particularly in older communities where the
rehabilitation costs are so high. It drives the cost of the
house so high, that people who live there cannot afford it.
We are strong supporters of that credit and would be
investors in that credit because that would, again, make it
possible, particularly in our older areas, for minorities and
others who live there to be able to afford to buy the house.
Senator Reed. Thank you, Mr. Raines.
My time is running out, Mr. Chairman, would it be
appropriate to submit written questions so that we can cover
some other areas that have not been addressed?
Senator Allard. Absolutely. In fact, I was going to point
that out to the Committee. We are going to give a 10-day period
of time for them to get questions and then we will submit it to
them. Hopefully, they can respond back promptly.
Senator Reed. Thank you.
Senator Allard. In fact, I am getting ready to adjourn the
Senator Reed. I sensed that when I raised the issue of
Senator Allard. I want to apologize for the interruption
that we had in the middle because of our series of three votes.
Before we adjourn the hearing, I want to announce that the
record will remain open for 10 days for Members to submit
statements and for the Committee to receive any written
questions for our witnesses.
Finally, I would just like to state that I will be
following up with the Office of Management and Budget to
determine when the proposed risk-based capital regulations are
likely to be released and made final.
Also, you will be asked from time to time to show up before
this Committee for no other purpose than we just want to hear
from you. We have not decided how frequently that would be, but
as I mentioned earlier I am known for oversight. We will
probably be spending a good deal of our oversight on agencies
such as HUD and those problems, but on occasion, we will want
to hear from you.
Thank you very much for showing up.
Mr. Raines. Thank you.
Mr. Brendsel. Thank you.
Senator Allard. The hearing is adjourned.
[Whereupon, at 12:37 p.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF SENATOR JON S. CORZINE
I want to welcome the witnesses and thank them for taking the time
to testify before the Committee today. I also thank my colleagues,
Senators Allard and Reed, for holding this important hearing on the
regulatory oversight and the safety and soundness of Fannie Mae and
Few would dispute that the mission of the GSE's--in seeking to make
housing more affordable and accessible --is an important one.
One need only look to our Nation's 68 percent homeownership rate --
the highest it has ever been--and the increasing number of African-
American and Latino families who own their own homes to see that Fannie
and Freddie have helped improve the quality of life for American
However, this hearing is about the regulatory role of OFHEO and
whether our Government Sponsored Enterprises (GSE's) operate in a safe
and sound manner. The central role that they play in America's capital,
finance and housing markets requires Congress to periodically assess
whether they are being well-managed, well-regulated, and held to the
highest of standards.
Last fall, Fannie and Freddie reached an agreement with Congressman
Baker of the then-House Banking Committee to voluntarily implement six
initiatives that would provide additional safety and soundness
protections. And it is my understanding that both institutions are well
on their way to fully implementing these initiatives. On that note, I
applaud the efforts of Mr. Raines and Mr. Brendsel for exercising their
leadership and working with Members of Congress.
Regarding OFHEO--well, I think one can safely say that this is an
agency that has been subject to a lot of questioning and criticism.
There are many questions regarding their proposed risk-based capital
requirements, and even more questions about the lengthy delay in their
While aware that Mr. Falcon inherited much of this problem, I
nonetheless look forward to his testimony and his views on what, if
any, measures he believes the Congress could take to enhance his
agency's performance and credibility.
Again thank you, Mr. Chairman, for holding this hearing and
allowing me to present my opening remarks.
PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
Mr. Chairman, I am pleased we are holding a hearing on this
critical topic. This is an opportunity to discuss the vitally important
function that Fannie Mae and Freddie Mac play in our housing market and
it is a chance to review their safety and soundness regulation.
There is no doubt that the role Fannie Mae and Freddie Mac have
played in creating a secondary mortgage market-- consequently promoting
liquidity risk--is key to much of the success in the housing market.
These two corporations should be proud of their role in promoting
Although there is a strong record of achievement, much more needs
to be done. There are still too many people for whom the dream of
homeownership is out of reach. Good intentions are not enough. We must
follow with concrete action, and there is obviously a vital role for
the GSE's in achieving our common goal.
One thing I would challenge the GSE's to do is to continue to
increase their involvement in the subprime market. As the lending
market has grown for consumers whose credit or income currently may
prevent them qualifying for a conventional loan, it has become all the
more clear that we need the benefits of reputable actors like Fannie
and Freddie. Aggressive GSE involvement in this mark would surely help
combat some of the outrageous predatory loans that are occurring in our
neighborhoods, by standardizing these loans and promoting competition.
Indeed, failure to become involved in this market could almost be
considered counter to the GSE's mission for it would deprive too many
working families the clear benefits that the GSE's bring to our housing
On the issue of regulation of the GSE's, I do not believe that now
is the time to do anything that would disrupt or radically change the
regulatory regime. The GSE's and their regulator have the opportunity
to serve as a model for how risk-based capital rules can work
effectively. Our Committee should follow the implementation of OFHEO's
rule carefully. The rule has been 8 years in the making and now is
clearly not the time to create undue uncertainty. Instead, we should
try to support OFHEO's effort and do what is necessary to ensure that
the rule is strong, effective, and well-implemented.
I welcome our witnesses and I look forward to an interesting and
informative hearing today.
PREPARED STATEMENT OF SENATOR RICK SANTORUM
Mr. Chairman, thank you for holding this oversight hearing on the
Office of Federal Housing Enterprise Oversight (OFHEO) and the two
largest housing GSE's, Fannie Mae and Freddie Mac. I appreciate any
opportunity to learn more about these companies and their regulator.
This hearing is particularly important because the three
institutions we are examining today are major partners in the effort to
open the door of homeownership to low- and moderate-income Americans.
Congress chartered Fannie Mae and Freddie Mac to purchase U.S.
residential mortgages at or below the conforming loan limit. As a
result, the secondary mortgage market was born. Although Fannie and
Freddie do not originate mortgages, the resources that their mortgage
purchases send back into the primary market provide lenders with more
money to offer more mortgages. On the other hand, Congress entrusted
OFHEO with the task of monitoring the financial safety and soundness of
the housing GSE's. Considering the size of the GSE's portfolios, OFHEO
has an enormous responsibility. As Members of the oversight committee,
it is our job to make sure that these institutions succeed in
fulfilling their statutory missions.
Congress and the Administration will continue working to increase
homeownership opportunities, particularly for low-income families and
minorities. In order to achieve this goal, the continued health of the
secondary mortgage market is essential. I am pleased that reports by
the OFHEO and other private-sector evaluators indicate Fannie Mae and
Freddie Mac are in good financial health. I encourage the GSE's to
continue to be mindful of sound management and financial practices as
they strive to meet the higher affordable housing goals that HUD, their
mission regulator, has set for them.
Mr. Chairman, homeownership rates are at record levels in the
United States. These numbers are encouraging, but we can do better.
Less than half of African-American and Latino families own their own
homes. Secretary Martinez is committed to raising the level of
homeownership among minority families. I look forward to working with
the Secretary and with the housing GSE's to make the dream of
homeownership, and the economic security it provides, a reality for
Again, Mr. Chairman, thank you for holding this important hearing.
PREPARED STATEMENT OF ARMANDO FALCON, JR.
Director, Office of Federal Housing Enterprise Oversight \1\
\1\ This testimony represents the views of the OFHEO Director,
which are not necessarily those of the President or Secretary of
Housing and Urban Development.
May 8, 2001
Chairman Allard, Senator Reed, Members of the Subcommittee, my name
is Armando Falcon and I am the Director of the Office of Federal
Housing Enterprise Oversight, or OFHEO. I commend the Subcommittee for
conducting this oversight hearing on the safety and soundness and
capital adequacy of the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation (or Fannie Mae and Freddie Mac)
and thank you for the opportunity to testify this morning.
As you know, following the savings and loan crisis and other
disruptions which occurred in the Nation's financial system in the late
1980's, Congress determined that it was prudent to establish a formal,
full-time safety and soundness regulator for Fannie Mae and Freddie Mac
to protect against similar events occurring at the Enterprises. To
achieve this objective, OFHEO was established as an independent entity
within the Department of Housing and Urban Development (HUD). OFHEO was
charged with ensuring the safety and soundness and capital adequacy of
the Enterprises, while HUD was given responsibility for regulating the
Enterprises' activities--so called ``Mission'' regulation.
As the Director of OFHEO, I am pleased to report that Fannie Mae
and Freddie Mac are currently in good financial health, are well-
managed, and have exceeded minimum capital requirements every quarter
the requirements have been in place. These conclusions are based on the
findings of our broad regulatory system, which includes a highly-
regarded examination program and quarterly minimum capital
requirements. While the current situation is good, I want to assure you
that OFHEO remains vigilant to ensure that this financial strength and
well-being will not be jeopardized by changes in the economy, the
markets in which the Enterprises operate, or even the Enterprises
As you conduct oversight hearings, it is important to do so with an
understanding of the responsibilities Congress gave OFHEO. As I
mentioned earlier, OFHEO's primary mission is to ensure the capital
adequacy and financial safety and soundness of Fannie Mae and Freddie
Mac. In fulfilling this mission, OFHEO helps ensure the Enterprises are
positioned to fulfill their Congressionally-mandated missions.
When considering OFHEO's oversight, it may be useful to compare our
program with contemporary global thinking regarding large financial
institution risk management and regulation. The Basel Committee on
Banking Supervision is an obvious point of reference. The Basel
Committee, which is a group of central bankers and international
financial regulators, has endorsed the ``three pillars'' of banking
supervision, consisting of: (1) supervisory review; (2) capital
requirements; and (3) market discipline. While the nature of the
institutions OFHEO regulates necessitate some adaptations to Basel's
recommendations, our regulatory structure implements contemporary
global risk management thinking. Specifically, OFHEO:
Conducts comprehensive annual examinations of both
Ensures compliance with minimum capital requirements and will
soon impose a risk-based capital standard.
Conducts financial research on the Enterprises and the markets
in which they operate.
Has developed a formal regulatory infrastructure to ensure
transparency and enforceability of its rules and regulations.
I believe it will be useful to expand on these areas and report,
where appropriate, on what we have found.
The 1992 Act establishing OFHEO directs the Office to conduct
annual on-site examinations to determine the Enterprises' financial
safety and soundness and requires OFHEO to report the results and
conclusions of these annual examinations in our annual Report to
Congress. This is unique among financial regulators and is a powerful
tool in influencing the behavior of the companies we regulate. While
that report is not due until June 15, I am pleased to tell you today
that both Enterprises have met or have exceeded safety and soundness
standards in all examination program areas.
OFHEO regulates just two institutions, but arguably two of the most
sophisticated financial institutions in the world. This has allowed us
to attract very talented individuals who are experts in their fields.
Our examiners, who are OFHEO's front line in ensuring the Enterprises'
safety and soundness, possess impressive skills and backgrounds, and
bring to OFHEO broad experience from banking and thrift regulatory
bodies, as well as from many sectors of the financial services and
mortgage industries. These experts maintain a physical presence at the
Enterprises, and have unlimited access to all levels of management and
to highly-sensitive corporate records. By staying apprised of the
Enterprises' risks and business activities on a timely basis, the
examiners are able to evaluate an extensive array of risk-related
factors and to assess the Enterprises' financial safety and soundness.
Each quarter, the OFHEO examination staff updates conclusions
relating to more than 150 separate components of financial safety and
soundness, thereby providing me with a comprehensive picture of the
Enterprises' financial condition. These conclusions pertain to such key
risk management areas as credit risk, interest rate risk, liquidity
management, information technology, internal controls, business process
controls, internal and external audit, management information and
process, and board of director governance and activities.
Our examiners meet frequently with management to discuss and assess
business strategies and plans, financial performance results, risk
management framework and practices, and each Enterprise's overall risk
profile. These discussions include future trends and management's
controls and practices to anticipate and prepare for potentially
adverse trends in any risk area, or combination of risk areas.
Examination teams identify opportunities for improvements in existing
Enterprise risk management practices and work directly with management
to address identified opportunities to enhance financial safety and
soundness. Through our risk-focused examination framework, OFHEO
constantly evaluates such critical areas as:
The Enterprises' overall risk management strategies and
The composition, risk profile, and significant trends in their
retained, and guaranteed, mortgage portfolios.
The Enterprises' ability to effectively manage interest rate
risk and other key financial exposures.
The Enterprises' ability to efficiently issue debt and hedge
financial exposures, and effectively manage liquidity.
The quality of financial performance and the quality of
information on which the Enterprises' boards and management rely in
reaching key business and risk management decisions.
Quite simply, our examination group provides me with an accurate
and timely understanding of the Enterprises' financial condition on an
ongoing basis and provides the Congress with an annual report card on
how the Enterprises are managing their risk.
While examinations are an important part of oversight, it is by no
means the only area in which Congress provided OFHEO with significant
regulatory responsibility. The 1992 Act also directed OFHEO to
establish and enforce two major capital tests for the Enterprises--a
minimum capital test and risk-based capital stress test.
Minimum Capital--Since its inception, the OFHEO has ensured that
both Fannie Mae and Freddie Mac have maintained a capital base
sufficient to meet statutory minimum capital requirements. These
requirements utilize a leverage test which is similar to existing
capital requirements for banks and thrifts.
The statutory leverage test is quite simple. Each quarter, OFHEO
aggregates the Enterprises' assets and places off-balance-sheet
obligations into buckets based on their characteristics. Then, each
group is multiplied by the capital ratios required in the statute.
Generally, an Enterprise's assets are multiplied by 2.5 percent and
outstanding guarantees of mortgage-backed securities and other off-
balance-sheet obligations are multiplied by .45 percent.
This number is then compared to the Enterprises' core capital--or
the sum of their (1) common stock, (2) preferred stock, (3) other paid-
in capital, and (4) retained earnings. If core capital exceeds the
requirement, the Enterprise is considered adequately capitalized.
However, if a capital shortage exists, the Enterprise is classified as
either undercapitalized, significantly undercapitalized, or critically
undercapitalized, based on the size of the deficit and OFHEO's
enforcement regime is triggered.
I am very pleased to report that for each quarter the test has been
applied to the Enterprises, both companies have exceeded their minimum
capital requirement and thus, have always been classified as adequately
Risk-Based Capital--The 1992 Act called for a second capital test
to be applied to both Enterprises--a sophisticated risk-based capital
requirement using a stress test. The stress test simulates dramatic
changes in interest rates and the highest historical declines in
property values to determine capital requirements.
This approach is consistent with the Basel proposal, which is
designed to increase the risk-sensitivity of capital requirements.
However, due to the homogeneous nature of the Enterprises' business--
and the fact that there are only two--OFHEO is able to take bank-like,
risk-based capital regulation to a higher level.
Our risk-based capital regulation will more accurately tie capital
to risk than any other current or proposed standard. Once calculated
using the stress test, the statute requires an additional 30 percent
capital charge for management and operations risk. This add-on is also
consistent with the opinion of the Basel Committee, which also calls
for a provision for operations risk.
I recognize that the OFHEO is long-overdue on this rule. So when I
took office in October 1999, I made finalizing the rule my top
priority. Last fall, we finished the text of the rule, continued work
on having the computer code, which effectualizes the rule,
independently tested and verified by an accounting firm. In addition,
we continue to assist Fannie Mae and Freddie Mac in meeting their
responsibility to process a vast amount of data in the form needed to
run the test.
Early last month, we submitted the rule to the Office of Management
and Budget (OMB) for review. Once the rule is cleared by OMB and the
rule is published in the Federal Register, Fannie Mae and Freddie Mac
will be subject to the most sophisticated regulatory capital standard
of any financial institution in the world. With that in mind, it is my
view that OFHEO has gone further in its capital regulation--both in
determining capital levels, as well as ensuring capital adequacy
through prompt corrective action--than the risk weighted leverage
approach employed by the banking regulators.
I don't mean to imply that the banking standard is inappropriate--
not at all. Many banks and thrifts have asserted that their standard
requires greater capital than that which applies to the Enterprises.
But the proposed new Basel Accord, like OFHEO's risk-based capital
standard, recognizes the need to more closely tie capital to risk. And
because these approaches give institutions credit for risk-mitigation
activities, the institutions that manage risk well will be rewarded
with a lower capital requirement. Thus, everyone can benefit if this is
done right. As the first agency to implement such a capital standard, I
have made sure that we got it right, even under the tight deadlines I
have imposed on our staff to finish the job.
As with all financial regulators, research is an area of great
importance to the OFHEO's ability to fulfill its mission. Upon taking
office, I set out to ensure the Office had sufficient research capacity
to provide me with the independent analysis necessary to consider our
examination and capital findings in the broader context of the economy
and the markets in which the Enterprises operate. I am very pleased
that this initiative has resulted in the OFHEO employing a group of
talented researchers with expertise in areas including economics,
financial regulation, and policy analysis.
From our periodic research on policy matters impacting the
Enterprises and the routine internal research on the economic and
financial environment in which the Enterprises operate, I find our
independent research critical to fully understand the industry, the
marketplace in which the Enterprises operate, and the stresses of
economic events in order to meet our Congressional mandate. Without the
benefit of economic, policy, and other research, it is clear that
decisions I must make would be done in a vacuum. Thus, although much of
our research is consumed by an internal audience, it is no less
critical to fulfilling our mission.
Finally, I want to briefly touch on the legal apparatus OFHEO has
put in place to deal with any problems which may occur at either
Enterprise. Last summer, I announced that OFHEO would be conducting a
regulatory infrastructure project, designed to provide a comprehensive
review of and increased transparency into OFHEO's regulatory
authorities. The project is designed to fully implement the statutory
mandates of OFHEO, to provide greater certainty for the regulated
entities and to produce greater transparency for the public in
understanding OFHEO's administration of its responsibilities.
This project builds on the existing body of rules and, in many
cases, formalizes that which the Office already does. To date, this
project has resulted in the issuance of policy guidances on minimum
safety and soundness requirements and the management of the
Enterprises' nonmortgage liquidity investments, as well as final
regulations on enforcement procedures and OFHEO's annual funding
assessments. Still pending are rules dealing with prompt supervisory
response and corrective action, executive compensation, and updating
the Enterprises' minimum capital requirements. I would also note the
creation of an internal policy mandating that OFHEO, not less than
every 5 years, review its regulations for inefficiencies and
unnecessary burden. The policy sets forth a procedure and even the
criteria for internal and external review and comments. Once the
project is complete, OFHEO's regulatory infrastructure will be an open
book for anyone to comprehend.
In conclusion, OFHEO is meeting the mission Congress gave us. The
Enterprises: (1) are subject to on-going oversight through our
examination program, (2) must meet quarterly minimum capital
requirements which are similar to existing capital requirements for
banks and thrifts, (3) will soon be the only entities subject to a
risk-based capital stress test which closely ties capital to risk, and
(4) can be held accountable if found lacking in any of these stated
areas. I assure you, OFHEO will remain vigilant in continuing to
fulfill our Congressionally-mandated mission.
Let me again thank Chairman Allard, Senator Reed, and the other
Members of this Subcommittee for the opportunity to provide my views on
this important topic.
PREPARED STATEMENT OF FRANKLIN D. RAINES
Chairman and Chief Executive Officer, Fannie Mae
May 8, 2001
Good morning, Chairman Allard, Ranking Member Reed, and Members of
the Subcommittee. My name is Franklin D. Raines, and I am the Chairman
and Chief Executive Officer of Fannie Mae. I appreciate the opportunity
to speak to the Subcommittee about Fannie Mae, our role in the
marketplace, and our regulatory structure. I would also like to commend
the Subcommittee for the very active role it has played in its
stewardship of our housing finance system.
The last time I appeared before the Banking Committee was in March
1996, when as Vice Chairman of Fannie Mae I testified on the
implementation of the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992 (``the Act''). In preparing for today's hearing,
I reviewed my testimony from 1996 to see where we are relative to the
course we articulated 5 years ago.
In 1996, I reported to the Subcommittee on Fannie Mae's progress in
meeting the statutory housing goals, expanding homeownership and
affordable rental housing, and strengthening the company's capital
reserves and risk management. I told the Subcommittee that Fannie Mae
would invest in technology to reduce the costs of buying a home, help
lenders provide services to underserved areas of the country, and help
small lenders succeed in a competitive market. Interpreted by any
measure the 1992 Act was a success because it recognized that American
homebuyers, and particularly the first-time homebuyers, are the
beneficiaries of the careful balance of obligations and benefits that
defines Fannie Mae's unique role in the housing finance system.
Today, I am pleased to report to the Subcommittee that Fannie Mae
has made tremendous progress in each of the areas on which I reported
to you 5 years ago:
Since 1996, Fannie Mae has provided $1.45 trillion in home
financing for 15 million American families. We have met or exceeded
the statutory housing goals every year, and for 2001, HUD has
raised the housing goals significantly. In 2000, we met our own
1994 goal to invest $1 trillion in targeted housing finance. We set
a new goal to invest $2 trillion to help 18 million families
achieve homeownership. As part of this goal, our National Minority
Homeownership Initiative aims to invest at least $420 billion to
serve more than three million minority households over the next
We have $21.5 billion of private equity capital, up from $13.5
billion at the end of 1996. Our single-family credit losses have
fallen from 5.3 basis points (0.053 percent) in 1996 to 0.7 basis
points (0.007 percent) in 2000.
Last October we announced a set of path breaking voluntary
initiatives to further strengthen our safety and soundness. Our
liquidity management, market discipline, and disclosure practices
are now at the vanguard of such practices globally, and we and
Freddie Mac are the only U.S. corporations to commit to creating a
deep and liquid market for our subordinated debt.
Our indisputable safety and soundness means that Fannie Mae
serves as a shock absorber for the entire financial system. In the
fall of 1998, the commercial credit markets contracted sharply in
response to global financial instability. Because Fannie Mae and
Freddie Mac stepped up their mortgage purchases, U.S. homebuyers
had ready access to fixed-rate financing at some of the lowest
rates in a generation.
Since 1996, technology has revolutionized the mortgage finance
industry. Our technology investments have reduced a lender's cost
of originating a loan by more than $1,000 and have helped smaller
lenders compete and thrive in a business environment of increasing
consolidation. Technology has also allowed us to work more
efficiently with smaller lenders in rural communities to expand
homeownership opportunities. As Senator Ensign said of a
partnership we recently formed with Nevada Bank and Trust, ``With
e-commerce, no bank is too small to help its customers realize the
dream of homeownership.''
In all, our record over the last 5 years shows that the compact
that Congress designed in 1992 between private investors and the
Federal Government to achieve the public goal of expanded homeownership
using private capital continues to be a spectacular public policy
Fannie Mae: A Private Company with a Public Mission
Congress articulated Fannie Mae's specific public mission clearly
in the 1992 Act:
To provide stability in the secondary market for residential
To respond appropriately to the private capital market.
To provide ongoing assistance to the secondary market for
residential mortgages (including activities relating to mortgages
on housing for low- and moderate-income families involving a
reasonable economic return that may be less than the return earned
on other activities) by increasing the liquidity of mortgage
investments and improving the distribution of investment capital
available for residential mortgage financing.
To promote access to mortgage credit throughout the Nation
(including central cities, rural areas, and underserved areas) by
increasing the liquidity of mortgage investments and improving the
distribution of investment capital available for residential
\1\ Title XIII of the Housing and Community Development Act of
1992, Pub. L. No. 102-550, 106 Stat. 3672.
The business defined by our charter is designed to attract private
capital to achieve these public purposes. The private individuals and
firms that hold 1.038 billion shares of Fannie Mae common and preferred
stock invest their capital in a company with a limited, specific public
and business mission. In exchange, the Federal Government embraces that
mission--through Fannie Mae's Congressional charter--and oversees
companies to ensure they operate in a safe and sound manner.
The charter includes certain specific benefits that support the
efficiency of the business venture and indicate the Government's
commitment to the specific public purposes it has asked Fannie Mae to
pursue. These benefits in and of themselves are not sufficient to
attract the private capital necessary to achieve the public goals. It
is also necessary for Fannie Mae's management to translate the public
mission into a profitable and sustainable business proposition. We do
that through expert risk management, constant innovation in every part
of the business, a tight rein on expenses, and dedication to a
strategic business plan aimed at expanding homeownership and affordable
Because Congress wanted to focus Fannie Mae's use of its benefits
on reducing costs for low-, moderate-, and middle-income homebuyers and
on improving market liquidity, Congress defined how Fannie Mae may use
these benefits. We are in a single line of business--U.S. residential
mortgages at or below the conforming loan limit (currently $275,000 for
single-family homes). Within that business, we participate in the
secondary market; we do not originate mortgage loans. We have specific
authorizations to deal in Government-insured and conventional single-
family mortgages, second mortgages, and energy efficiency loans.\2\ We
operate under a rigorous risk-based capital standard, one that most
banks and thrifts could not meet. We are affirmatively obligated by law
to operate in all markets under all economic conditions and to meet
three specific percent-of-business affordable housing goals. Congress
also requires Fannie Mae to tell investors explicitly that our debt and
MBS securities are not guaranteed by the Federal Government.
\2\ Fannie Mae Charter Act, 12 U.S.C. Sec. 1717(b).
The focus of Fannie Mae's charter is reflected in the composition
of our assets, which are dominated by single-family mortgages. Of our
$701 billion in on-balance-sheet assets at the end of the first quarter
of 2001, 89 percent were single-family mortgages, 3 percent were
multifamily mortgages, 6 percent were cash and other liquid assets, and
2 percent were other assets. In contrast, commercial banks hold a much
greater variety of assets.
To ensure we pursue our mission and do so in a safe and sound
manner, Congress established a comprehensive regulatory regime for
Fannie Mae and Freddie Mac. That regime places responsibility for
safety and soundness oversight with the Office of Federal Housing
Enterprise Oversight (OFHEO) and responsibility for mission oversight
with the Department of Housing and Urban Development (HUD).
OFHEO has been conducting a comprehensive, continuous, on-site
examination program since 1994, the scope and rigor of which equals or
exceeds that to which any other regulated financial institution is
subject. OFHEO devotes more staff resources to its examination program
of Fannie Mae and Freddie Mac than the OCC and the Federal Reserve
devote to large and far more complex banking institutions. In addition,
Congress required that the results of OFHEO's examinations be made
public in OFHEO's Annual Report to Congress. Other financial regulators
issue annual reports to Congress, but only the OFHEO reports on
individual companies' exam results.
OFHEO is also responsible for implementing the minimum and risk-
based capital standards in the 1992 Act. The 1992 Act requires that
Fannie Mae meet a ratio-based minimum capital standard, as well as a
stress-test requirement. Under the leverage requirement, we must have
capital equal to 2.50 percent of on-balance-sheet assets. We must also
hold capital equal to 0.45 percent for off-balance-sheet assets. Fannie
Mae must meet this minimum capital requirement using ``core capital''--
common stock, perpetual noncumulative preferred stock, paid-in capital,
and retained earnings.
The 1992 Act also includes a forward-looking capital standard for
Fannie Mae and Freddie Mac. The risk-based capital standard requires
the two companies to be able to withstand severe economic conditions
that are far more catastrophic and persist far longer than those of the
thrift crisis in the 1980's. As stated in the statute, the standard
requires each company to hold enough capital to withstand a 10-year
stress period characterized by unprecedented interest rate movements
and credit losses occurring simultaneously, with an additional capital
requirement to cover management and operations risk. The standard is
truly extraordinary, and Fannie Mae and Freddie Mac are unique in
having to meet such a test. Fannie Mae designed its own stress test
from the specifications in the statute in 1993 and has complied with
that risk-based capital test ever since. OFHEO is in the final stages
of promulgating regulations to implement the standard in the 1992 Act.
The agency has made a great deal of progress recently on the rule, and
we hope to see the final risk-based capital standard in place as soon
With regard to mission regulation, HUD is responsible for ensuring
that Fannie Mae and Freddie Mac carry out their housing missions and
comply with their charters. HUD sets the annual percent-of-business
housing goals for our service to low- and moderate-income borrowers, to
residents of central cities and other underserved areas, and to very
low-income borrowers. Regulations promulgated by HUD last year take
effect in 2001 and have raised all three goals substantially. HUD also
regulates the companies with regard to the fair lending laws, and must
give its prior approval to new conventional mortgage programs that are
significantly different than those in place before 1992.
Fannie Mae's Business
Fannie Mae achieves the purposes in our Congressional charter
through our two primary lines of business. In our credit guaranty
business, we create mortgage-backed securities (MBS) from pools of
mortgage loans originated and owned by lenders. We guarantee timely
payment of principal and interest on the loans in the MBS, which
enables lenders to sell the MBS more easily to investors. For taking on
this credit risk, Fannie Mae earns a guaranty fee on the MBS from the
lenders who originate the loans. As of March 31, 2001, Fannie Mae's
outstanding MBS--the MBS on which we provide a credit guarantee but do
not hold in the portfolio--totaled $726 billion.
Our second business is our mortgage investment business, in which
we buy mortgages from lenders in order to replenish the lender's supply
of cash to make new mortgage loans. We fund these mortgage purchases by
issuing debt in the global capital markets, and we earn income on the
spread between our cost of debt and the yield on the mortgages we buy.
As of March 31, 2001, Fannie Mae's mortgage portfolio investments
totaled $641 billion.
Fannie Mae's credit guaranty and mortgage investment businesses
draw additional investment capital from around the world to the U.S.
mortgage market, which increases the funds available for homeownership
and reduces mortgage rates for consumers:
When Fannie Mae guarantees the credit risk on lender-
originated MBS, the potential market of investors for mortgages
widens substantially. The vast majority of institutional investors
do not purchase individual mortgage loans because they are
unwilling to take the credit risk on such loans. Instead, they
purchase MBS enabling them to avoid the credit risk but still
receive compensation (in terms of higher yields) for taking the
risk that the loans will prepay if interest rates fall.
When Fannie Mae purchases mortgages for its investment
portfolio, we also greatly expands the range of investors
supporting the U.S. mortgage market. We fund those purchases with a
mix of four types of debt: short-term debt, and long-term bullet,
callable, and subordinated debt. These debt securities appeal to
investors who are unwilling to accept the prepayment risk that
comes with MBS, but want a yield higher than that on Treasuries.
Our short-term debt is safe, highly-liquid, and has stable prices;
investors purchase this debt to match short-term obligations and
for cash management purposes. Investors who want long-term
investments and are prepared to accept some repayment risk, but
less than the prepayment risk of MBS, purchase our callable debt
securities. Callable debt is debt that Fannie Mae can redeem
earlier than its stated maturity. Long-term investors who want more
predictable cash flows and no repayment risk purchase our bullet
debt, which Fannie Mae may only redeem at the stated maturity date.
Investors who want to avoid repayment risk but who want a higher
yield than is available on our bullet debt buy our subordinated
debt, and in return accept the risk that interest payments will be
deferred under certain circumstances.\3\
\3\ Prepayment risk is the risk to the investor that the borrower
will prepay their mortgage before the mortgage is due, causing a
disruption in cash flow to the investor and causing the investor to
reinvest their funds in potentially lower yielding investments because
of declining interest rates. Repayment risk for callable debt is the
risk to the investor that the issuer will repay (call/redeem) the debt
before the maturity date, also causing a disruption in cash flow and
reinvestment risk to the investor. Both risks typically are associated
with declining interest rates.
It is important to note that Fannie Mae's debt securities draw
investors to the U.S. mortgage market who would not otherwise invest in
mortgages. Investors who purchase Fannie Mae debt want securities with
less prepayment risk than MBS and are willing to accept lower yields to
avoid such risk. Without Fannie Mae debt in the market as an available
investment, these investors would turn to other instruments. The result
would be lower demand for less capital available to the U.S. mortgage
market and higher mortgage rates for U.S. homeowners.
A Housing Finance System That Is The Envy Of The World
The unique combination of obligations and benefits in Fannie Mae's
charter has given rise to a housing finance system that is the envy of
the world-- one that is safe, sound, and extraordinarily stable. The
system also provides U.S. consumers with the types of mortgages they
prefer: long-term, fixed-rate mortgages with a refinancing option. We
estimate that, of the $5.2 trillion in U.S. single-family mortgage debt
outstanding at the end of 2000, 75 percent was in the form of first-
lien, fixed-rate mortgages with terms of at least 5 years. In most of
the world, the predominant mortgages available to consumers are
adjustable-rate or balloon mortgages.
American consumers can obtain mortgages with lower down payments
and lower interest rates than their counterparts in the rest of the
industrialized world. In the United Kingdom, down payments are
generally more than 20 percent, and in Japan and France, they are more
than 30 percent. In the United States, homebuyers can put as little as
3 percent down, and increasingly zero-percent down payment mortgages
are becoming available. In the United Kingdom, the majority of
homebuyers' monthly mortgage payments change as mortgage rates change,
and most U.K. homebuyers do not know from 1 month to the next whether
they will be paying more or less than the month before. In Spain,
approximately 90 percent of mortgages have variable rates. In the
Netherlands, where fixed-rate mortgages with low down payments are
available (although the rate may be fixed only for an initial period),
homebuyers may pay a penalty if they prepay or refinance their
mortgages. Prepayment penalties in the U.K. can be as high as 6 percent
of the unpaid balance of the loan or 6 months of interest. In the
United States, very few mortgages outside of the subprime market carry
prepayment penalties. The contrast with our system could not be more
In countries other than the United States, mortgage finance systems
developed in different ways to solve the same problem: Who should
accept the prepayment, or interest rate, risk? In the United Kingdom,
homebuyers take the risk--and see their payments change as rates
change --because the financial institutions that fund mortgages have
historically not had access to long-term funding. In Germany, the
government takes the interest rate risk, and in return requires that
homebuyers make down payments of 40 percent on their first liens. In
Mexico, homebuyers bear some or all of the interest rate risk because
lenders and the government will not accept the rate uncertainty
stemming from inflation; if rates rise quickly, the extra interest
homebuyers owe as a result is added to their unpaid balances.
The housing finance system that Congress designed works very
differently. Our ability to issue debt across the yield curve, combined
with our expertise in matching the durations of our debt liabilities
with those of our long-term, fixed-rate mortgage assets, has allowed us
to build a specialization in managing the risk on the fixed-rate
mortgages U.S. consumers prefer. In contrast, banks and thrifts
specialize in the short-term adjustable-rate and home equity loans that
match the short-term Federally insured deposits that make up half of
To see this difference in specialization, one only has to contrast
the composition of the mortgages held by Fannie Mae and commercial
banks. Nearly all--95.7 percent-- of the single-family mortgages Fannie
Mae holds in its portfolio are fixed-rate. Another 4.1 percent are
adjustable-rate, and only a very small amount--0.2 percent--are home
equity or second mortgages.
In contrast, our estimates show that commercial banks and thrifts
hold a considerably lower percentage of fixed-rate mortgages (58.0
percent) than Fannie Mae, and more adjustable-rate mortgages (28.3
percent) and home equity and second mortgages (13.8 percent). This
reflects the advantage in short-term funding that depositories have
over Fannie Mae and Freddie Mac by virtue of their access to low-cost
deposits insured by the Federal Government and advances from their own
Government Sponsored Enterprise, the Federal Home Loan Bank System.
The difference in specialization between Fannie Mae and
depositories becomes even more apparent when looked at by mortgage
type. Reflecting their short-term funding advantage, depositories have
an 83.8 percent share of the market for home equity loans and second
mortgages, compared with Fannie Mae's 0.8 percent share. For
adjustable-rate mortgages, depositories have a 67.5 percent share
compared with Fannie Mae's 2.9 percent share. Only in the fixed-rate
segment is Fannie Mae competitive--with a 14.3 percent share compared
with depositories' 32.8 percent share.
Because of our presence in the market, consumers can not only get
the mortgage the long-term, fixed-rate mortgage they prefer, but they
can also choose among many innovative products to find the fixed-rate
mortgage that best fits their financial profile. For example, Fannie
Mae's Flexible 97 is a 30-year, fixed-rate mortgage that requires a
down payment of as little as 3 percent, and those funds may be in the
form of grants, gifts, and secured loans. Likewise, many of the
products under our Community Home Buyers Program offer fixed-rate
mortgages under more flexible underwriting criteria including lower
income requirements, lower cash reserve requirements, and lower closing
costs. Timely Payment Rewards is a mortgage option that allows
borrowers with slightly impaired credit the chance to finance their
home at a mortgage rate as much as 2 percent lower than what credit-
impaired borrowers typically pay, with an even lower rate after 24
months of on-time payments.
Safety and Soundness
Because Fannie Mae and Freddie Mac play a critical role in
providing consumers access to the long-term, fixed rate financing they
prefer, it is essential that the two companies remain at the forefront
of global safety and soundness practices.
In 2000, we recognized that there were additional measures we could
put in place that would assure policymakers that our safety and
soundness protections are at the forefront of evolving world practices.
To formulate these measures we turned to the experts: The reports and
studies of the Basel Committee on Banking Supervision, OFHEO, the
Federal Reserve, and other policymakers and market participants who
analyze risk in the financial markets.
After a comprehensive review of these recommendations, Fannie Mae
and Freddie Mac, in conjunction with policymakers, crafted a set of
initiatives designed to place the two companies at the leading edge of
safety and soundness practices. These commitments were announced with
Congressman Richard Baker, Congressman Paul Kanjorski, and other
Members of the House of Representatives last October. Fannie Mae
committed to issue subordinated debt, obtain an annual credit rating,
enhance our liquidity planning, disclose more information about
interest rate risk and credit risk sensitivity, and implement and
disclose the results of an interim risk-based capital standard.
Together, these initiatives will give investors and policymakers more
information about Fannie Mae's risk exposure --and confidence that
Fannie Mae can manage that exposure --than they can get from any other
financial institution. I am happy to announce that Fannie Mae has
implemented all six of these commitments.
These six new voluntary measures, combined with the regulatory
mechanisms Congress enacted in 1992, place Fannie Mae at the vanguard
of risk management and disclosure practices worldwide, with cutting-
edge regulatory discipline bolstered by cutting-edge market discipline.
Subordinated Debt. In October, we committed to issue publicly
traded and externally rated subordinated debt. We included subordinated
debt because it offers real benefits to the market and policymakers.
First, it is an important way to crystallize the views of thousands of
investors into a clear signal to policymakers, as to how investors view
the company's financial condition. Second, it provides an incentive for
subordinated debt holders to monitor our risk position very carefully.
Because subordinated debt interest is suspended in the event of
significant capital erosion, large shifts in the yield of Fannie Mae
subordinated debt will signal to the OFHEO that the company may have
increased its risk position. Last, it serves as an additional cushion
of capital on top of Fannie Mae's required equity capital as defined by
our statutorily-required minimum levels and our risk-based capital
In January 2001, Fannie Mae issued $1.5 billion of subordinated
debt with a maturity of 10 years, and last week we priced our second
issue of $1.5 billion in 5-year subordinated debt. We also signaled our
intention, consistent with our commitment in October, to issue
subordinated debt quarterly during 2001 and on at least a semiannual
basis thereafter. We expect that by 2003 we will have $12 to $15
billion in subordinated debt outstanding, with an average maturity of
at least 5 years.
Our first two subordinated debt issues received Aa2 ratings from
Moody's Investors Service and AA- ratings from Standard and Poor's
(S&P). The rating agencies rated the subordinated debt separate and
apart from Fannie Mae's relationship with the Federal Government. In
assigning its AA- rating, S&P stressed that they did not regard the
Subordinated Notes as being backed by the Government. They wrote:
Unlike Standard & Poor's triple `A' rating on the senior
obligations of Fannie Mae, which incorporates implied
Government support, the rating on the subordinated debt assumes
that the government would not intervene to prevent payment
default on the instrument.\4\
\4\ Standard and Poor's CreditWire, Rating Assigned to Fannie Mae
Subordinated Benchmark Notes, January 24, 2001.
Moody's said that:
The debt ratings assigned to the GSE's have the exact same
meaning as those assigned to all other firms in the USA and
elsewhere. They express Moody's opinion of the ultimate credit
risks of a particular debt instrument taking into consideration
all relevant factors.\5\
\5\ Fannie Mae and Freddie Mac Subordinated Debt Rating Rationale,
Moody's Investor Services Special Comment, March 2000, at 3.
By the terms of the subordinated debt Fannie Mae issued, interest
payments will automatically suspend if certain capital tripwires are
activated and, should the company experience difficulties, holders of
subordinated debt securities will stand in line behind senior debt
creditors and MBS investors to recover their principal. Unlike other
subordinated debt issues, the interest deferral cannot be delayed by
Fannie Mae or any other party if the defined conditions occur. For
these reasons, the consensus of market analysts was that Fannie Mae
subordinated debt would be regarded by the market as different from its
senior debt and would trade at a discount to our senior debt. This has
proven to be the case.
The prices at which our subordinated debt has traded indicate that
the market is behaving consistently with analyst expectations. Our
first issuance was initially priced at 98 basis points over the 10-year
U.S. Treasury and 22 basis points over the November 2010 Fannie Mae
Benchmark Note. Since issuance, our 10-year subordinated debt has
traded actively in the secondary market, with pricing ranging from 18
to 28 basis points higher in yield than our senior debt.\6\ Our second
issuance of 5-year subordinated debt was priced on May 2, 2001, at 71
basis points over the 5-year U.S. Treasury and 18 basis points over our
February 2006 Fannie Mae Benchmark Note.
\6\ More information on Fannie Mae's subordinated debt is available
in Fannie Mae's Funding Notes publication, Further Development of
Fannie Mae's Subordinated Benchmark Notes Program, Volume 6, Issue 4
(April 2001), at http://www.fanniemae.com/markets/debt/fundingnotes/
Moody's summarized the beneficial results from subordinated debt,
emphasizing the difference between it and Fannie Mae's and Freddie
Mac's senior securities:
The subordinated debt issued by Freddie Mac and Fannie Mae
will, in combination with common and preferred equity, improve
senior debtholders' position in the highly unlikely event of a
liquidation or similar event. This should help to alleviate
concerns about the systemic risks from GSE failure and help to
provide an early warning signal to the marketplace in times of
stress. . . . The GSE's proposed subordinated debt also would
not benefit from the same degree of implied support that senior
enjoys and could face mandatory interest payment suspension.\7\
\7\ New Freddie Mac and Fannie Mae ``Open Book'' Policy: A Positive
Credit Development, Moody's Investor Services Special Comment, October
2000, at 4.
Our planned, regular, and large-size issuances of subordinated debt
validate the idea of a dynamic and active subordinate debt market as a
means of market discipline. Fannie Mae expects that the market will use
its collective expertise in measuring our risk profile, capital
adequacy, and financial health each time we bring new issues of
Subordinated Benchmark Notes to market, as well as in ongoing trading
in the secondary market. In doing so, Subordinated Benchmark Notes will
truly be the ``canary in the coal mine'' that is crucial to
establishing Fannie Mae at the forefront of financial institutions
globally in adhering to the highest standards of market discipline.
As Morgan Stanley wrote recently:
Spreads between the Subordinated Benchmark Notes and its
senior Benchmark Notes will provide a real time indicator of
investors' perceptions of the adequacy of Fannie Mae's capital
relative to the risks it faces. Going forward Fannie Mae will
have an additional yardstick with which to gauge the success of
its capital policies. In striving to keep these spreads stable,
Fannie Mae will have an incentive to communicate more
extensively about the risks it faces and how it manages its
capital in relation to these risks. This increased transparency
to which Fannie Mae is already committed will enable investors
to better assess Fannie Mae's risk and the adequacy of its
\8\ Morgan Stanley Product Note on Fannie Mae Subordinated
Benchmark Notes, January 2, 2001.
Annual Rating. We also committed in October to obtain an annual
rating from a nationally recognized statistical rating organization of
our ``risk to the government'' or independent financial strength, and
that we would disclose this rating to the public.
On February 27, 2001, S&P assigned a AA- ``risk to the government''
rating to Fannie Mae. Only five commercial bank holding companies, and
no thrifts, have a rating this high on their senior debt. This rating,
according to S&P, ``refers to the inherent default risk of a Federally
related entity operating under its authorizing legislation, but without
assuming an infusion of cash from the Government.'' S&P incorporates
into the rating such criteria as an evaluation of Fannie Mae's business
fundamentals, including the company's competitive position, evaluation
of management and its strategies, and examination of relevant financial
At Fannie Mae's request, S&P's ``risk to the government'' rating
will be maintained on a continuous, ``surveillance'' basis. This goes
beyond the annual rating that Fannie Mae committed to obtain last
October. Under a surveillance rating, S&P will continuously monitor our
financial position and change the rating--with an accompanying press
release --if our risk posture changes.
In summarizing its analysis of Fannie Mae's credit strength, S&P
Fannie Mae has demonstrated consistently good operating
performance over a sustained period of time, testifying to its
ability to manage the risks inherent in holding a portfolio of
mortgage loans and the strength of its franchise as one of two
government sponsored mortgage guaranty agencies. It has
successfully weathered changing conditions in the demand for
mortgage guaranties, several regional housing market declines,
and changing interest rate environments. Asset quality is very
strong, and the risk profile of its portfolio of mortgages
remains very low. Capitalization has been stable, and is
expected to remain so given the regulated nature of the
\9\ Standard and Poor's, News, Fannie Mae's Risk to the Government
Assigned ``AA-'' Rating, February 27, 2001.
With this ``risk to the government'' rating, Fannie Mae now has
outstanding a full range of ratings, including those on senior debt,
subordinated debt, and preferred stock. This suite of ratings gives
investors a clear, comprehensive, and ongoing assessment of Fannie
Mae's credit position. And combined with the daily updates to the
prices of our subordinated debt, Fannie Mae now has more signals than
any other company of how market professionals view the company's risk
Liquidity. The third initiative from the October package was an
enhancement of Fannie Mae's liquidity management. When we looked at the
recommendations from the Basel Committee, we noted an emphasis on
liquidity management. In its February 2000 paper recommending enhanced
liquidity management for banks, the Basel Committee noted that:
Liquidity, or the ability to fund increases in assets and
meet obligations as they come due, is crucial to the ongoing
viability of any banking organization. . . . Sound liquidity
management can reduce the probability of serious problems.
Indeed, the importance of liquidity transcends the individual
bank, since a liquidity shortfall at a single institution can
have system-wide repercussions.\10\
\10\ Basel Committee on Banking Supervision, Sound Practices for
Managing Liquidity in Banking Organizations, Consultative Paper No. 69
(February 2000) at 7.
Based on the discussions of safety and soundness that we had with
the House Subcommittee and other policymakers last year, Fannie Mae
wanted to ensure that we met the very highest standards of liquidity
management. As a result, we committed to:
Maintain 3 months worth of liquidity, as recommended by the
Basel Committee, based on the assumption that the company has no
access to the public new-issue debt markets during this period.
Maintain at least 5 percent of our on-balance-sheet assets in
a liquid, marketable portfolio of nonmortgage securities.
Comply with the 14 principles of sound liquidity management
set forth by the Basel Committee in February 2000.\11\
\11\ Basel notes that ``[t]he relevant time-frame for active
liquidity management is generally quite short. . . . Banks which are
reliant on short-term funding will concentrate primarily on managing
their liquidity in the very short term (say the period out to 5 days).
. . . Other banks (for example, those that are less dependent on the
short-term money markets) might actively manage their net funding
requirements over a slightly longer period, perhaps 1 to 3 months
In mid-March 2001, Fannie Mae announced that we had met this
commitment. We have a contingency plan in place to ensure that we could
meet our funding needs for 3 months without access to the agency debt
markets. We are maintaining more than 5 percent of our on-balance-sheet
assets in high-quality, liquid, nonmortgage securities. In fact, Fannie
Mae's ratio of liquid assets to total assets was 6.3 percent as of
March 31, 2001, and we are disclosing this ratio to the public on a
quarterly basis. And last, our liquidity plan meets the 14 principles
for sound liquidity management set forth by the Basel Committee and
satisfies our safety and soundness regulator. We have briefed OFHEO on
our liquidity plan, and OFHEO has confirmed that the plan would ensure
that Fannie Mae could function for 3 months without access to the new
issue debt markets.
These commitments are in addition to a rigorous liquidity program
already in place at Fannie Mae. We begin with a close cash-flow match
between our assets and liabilities. In addition, we manage our liquid
assets under strict investment guidelines approved by our Board of
Directors. Under these limits, liquid assets have an explicit goal of
zero credit losses. Fannie Mae's typical liquid assets are money market
paper and AAA-rated securities. Understandably, the margins on these
high quality, liquid investments are much lower than those Fannie Mae
earns on our mortgage portfolio, but that is the opportunity cost the
company pays to maintain a safe cushion of liquidity.
By virtue of the company's sound liquidity practices and our
commitment to maintain more than 3 months worth of liquid assets,
Fannie Mae is positioned not only to withstand swings in the markets,
but also to provide liquidity to the market when other financial firms
withdraw. Thus, for example, during the market turbulence in the second
half of 1998, when other investors withdrew from the market, Fannie Mae
stepped up our mortgage purchases--largely by drawing down liquid
assets--which maintained the stability of the mortgage market and kept
mortgage rates at historic lows for homebuyers.
New Risk Disclosures. Our subordinated debt issuance and annual
ratings can serve as excellent signals to policymakers and investors,
but the company has added additional transparency that puts it at the
leading edge of risk disclosures. The fourth and fifth of our October
initiatives were our new monthly interest rate risk sensitivity
disclosures and new quarterly credit risk disclosures.
Interest Rate Risk Disclosures
We committed to disclose on a monthly basis the impact on Fannie
Mae's financial condition of a plus or minus 50 basis point
instantaneous change in interest rates and an instantaneous 25 basis
point shift in the slope of the yield curve in both directions. On
March 26, 2001, we made our first monthly interest rate risk disclosure
under this commitment to investors and the public. Going beyond the
commitment we made in October, Fannie Mae released the two primary
measures of interest rate risk that the company uses in managing our
interest rate business: Portfolio net interest income at risk and
effective asset/liability duration gap.
Fannie Mae's net interest income at risk measure discloses the
sensitivity of Fannie Mae's projected net interest income to an
immediate 50 basis point increase or decrease in interest rates and a
25 basis point increase or decrease in the slope of yield curve. Net
interest income at risk compares projected net interest income under
the more adverse of the interest rate and yield curve scenarios with
projected net interest income without the interest rate shocks. We are
disclosing our net interest income at risk over both a 1- and 4-year
period. For the 4-year disclosure, the net interest income at risk
calculation reflects the percentage difference in cumulative net
interest income over the period.
As of March 31, 2001, the company's net interest income at risk
from a 50 basis point change in interest rates was 3.8 percent over the
next 1 year, and 3.2 percent over the next 4 years. The company's net
interest income at risk from a 25 basis point change in the slope of
the yield curve was 3.1 percent over the next 1 year, and 4.7 percent
over the next 4 years.
These changes in interest rates and in the slope of the yield curve
encompass about 95 percent of the actual changes that are likely to
occur over the one-month reporting period. Fannie Mae generally expects
our net income at risk measures to range between 1 and 5 percent.
In addition, we are supplementing our net interest income at risk
disclosure with monthly disclosure of the company's effective asset/
liability duration gap. Effective duration is a measure of the
sensitivity of a security's value to changes in interest rates, and is
commonly used in fixed-income portfolio management. Fannie Mae has
successfully used effective duration gap as an internal risk management
tool for a number of years, and we report on duration management to our
Board of Directors. We also reported this information as of year-end in
our Annual Report to the shareholders.
As of March 31, 2001, the effective duration gap of our mortgage
portfolio was a positive 1 month. A positive duration gap indicates
that the effective duration of the portfolio's assets exceeds the
effective duration of its liabilities by that amount, while a positive
duration gap indicates the opposite. Fannie Mae has a target range for
our effective duration gap of plus or minus 6 months. When the duration
gap moves outside this range--which it can do if interest rates move
quickly or by large amounts--we rebalance our assets and liabilities to
bring the duration gap within the target band.
Fannie Mae's interest rate risk disclosures follow the
recommendations of the New Basel Accord and the report of the Working
Group on Public Disclosure, headed by Walter V. Shipley. Both recommend
that risk disclosures be consistent with internal risk management
practices. Net interest income at risk and duration gap are the primary
portfolio risk measures at Fannie Mae. Basel further proposes that
disclosures incorporate expected future activity, and that
sophisticated disclosures use multiple simulations of interest rates.
Fannie Mae's net interest income at risk measure is based on projected
future activity over the next one and 4 years, and both net interest
income at risk and duration gap are calculated using at least 300
interest rate paths.
Credit Risk Disclosures
We also committed in October to disclose on a quarterly basis the
sensitivity of expected credit losses from a 5 percent drop in property
values. On March 26, 2001, Fannie Mae released our first quarterly
credit risk disclosure under this commitment.
To calculate our credit risk sensitivity, Fannie Mae uses internal
credit models, as recommended by Basel, to project the present value of
future credit losses. We then calculate the present value of losses
assuming an immediate 5 percent decline in the value of all properties
securing mortgages owned or guaranteed by Fannie Mae. Following this
decline, home prices are assumed to increase at the same long-run rate
embedded in the company's credit pricing models. Projected default
incidence and loss severity are consistent with the assumed changes in
home prices. The sensitivity of future credit losses is the dollar
difference between credit losses in the baseline scenario and credit
losses assuming the immediate 5 percentage point home price decline.
As of December 31, 2000, the company's net sensitivity of future
credit losses, taking into account the effect of credit enhancements,
was $295 million. This figure reflects a gross credit loss sensitivity
of $1,065 million without the effect of credit enhancements, and is net
of projected credit risk sharing proceeds from mortgage insurance
companies, lenders, and others of $770 million.
Fannie Mae's current low level of sensitivity to credit losses
reflects the quality of our existing book of business, the impact of
our loss mitigation techniques, and the effectiveness of our credit
enhancement and risk-sharing strategies. While slightly less than 40
percent of Fannie Mae's single-family portfolio as of December 31,
2000, was covered by credit enhancements, we project that our credit
enhancement counterparties would absorb $770 million, or 72 percent, of
the increase in credit losses that would result from a 5 percent home
We expect our credit risk sensitivity to vary over time based on a
number of factors, including the composition of the company's credit
portfolio, recent home price changes, the level of interest rates, and
the amount of mortgage insurance and other credit enhancements that
reduce Fannie Mae's losses.
Interim Implementation of the Risk-Based Capital Rule. The final
component of the October 2000 voluntary initiatives is our commitment
to implement on an interim basis the risk-based capital stress test
included in the 1992 Act and disclose to the public whether we passed
or failed the test. We will run this interim implementation only until
the final risk-based capital standard is adopted by OFHEO.
The stress test spelled out in the 1992 Act requires Fannie Mae to
hold sufficient capital to withstand an unprecedentedly severe economic
and financial shock that extends for 10 years, without defaulting on
our obligations. The test includes severe adverse interest-rate
movements and nationwide depression-level conditions in residential
real estate lasting throughout the decade-long period. The required
level of current capital is an amount sufficient for Fannie Mae to
remain solvent in every quarter throughout the 10-year span of adverse
economic conditions plus, for good measure, an additional 30 percent to
account for operations risk.
The possibility of these two credit and interest-rate scenarios
happening simultaneously is extremely small, and very few companies
could survive for 10 years the type of environment assumed in Fannie
Mae's stress test. Indeed, a study commissioned by Fannie Mae found
that the thrift industry would have to boost its capital base by 60 to
90 percent to be able to survive the type of scenario envisioned by
Fannie Mae's stress test.\12\
\12\ Dave Dufresne, Risk-Based Capital and the Thrift Industry:
Implications of Risk-Based Capital Stress Test Requirements 7 (IPS-
Sendero, February 1999).
Fannie Mae has run our own internal version of the risk-based
capital stress test since 1993, and has built capital and managed our
business to remain in compliance with that test. For purposes of the
voluntary disclosure, Fannie Mae constructed an interim implementation
of the risk-based capital test using the OFHEO's Notice of Public
Rulemaking 2 (NPR2) as a basis, modified to reflect subsequent changes
implemented or suggested both by OFHEO and the company.
OFHEO's NPR2 was published in the Federal Register in April 1999,
and is extensively documented. Since April 1999, OFHEO has made
corrections to NPR2, and the corrections are noted on the OFHEO web
site. In constructing our interim stress test, Fannie Mae incorporated
OFHEO's NPR2 changes along with the changes we recommended in our March
10, 2000, comment letter to OFHEO and other refinements enumerated on
our web site (www.fanniemae.com). Fannie Mae will disclose whether we
have passed or failed our interim risk-based capital test as of the end
of each quarter, and also give an indication of the amount by which our
total capital exceeds or falls short of the calculated risk-based
In March 2001, we announced that we had sufficient capital to pass
our interim version of the OFHEO risk-based capital test as of December
31, 2000, and that our capital cushion on that date was between 10 and
30 percent of total capital. We were able to pass the interim risk-
based capital test because of the substantial amount of hedging and
loss-sharing arrangements in which we engage. Typically between 45 and
50 percent of Fannie Mae's liabilities consist of callable debt or
other option-based instruments. Our reliance on mortgage insurance and
credit risk sharing arrangements reduce credit risk exposure and allow
the company to withstand the stresses in the risk-based capital test.
Fannie Mae's interest rate risk and credit risk disclosures
complement the results of our quarterly stress test. In summarizing the
value of the package of disclosures to which Fannie Mae and Freddie Mac
committed themselves, Moody's stated:
These financial disclosure commitments by Fannie Mae and
Freddie Mac set new standards not only for them, but also for
the global financial market.
The provision by Fannie Mae and Freddie Mac of periodic,
detailed risk information to the broad market will permit
better independent reviews and monitoring of their risk
profiles and should substantially reduce the uncertainty about
their actual financial health, as well as dampen any systemic
risks they present.
The regular disclosure of their interest and credit risk
exposure, combined with stress testing of their capital base,
should significantly increase market comfort with their risk
management disciplines and capital adequacy. The stress test,
in particular, will show whether the two GSE's have sufficient
capital to withstand very harsh market developments over a long
\13\ Moody's Investor Service, Op. Cit. at 4.
A generation ago, the housing industry was more cyclical than it is
today, and when the economy slowed, housing slowed as well. Today, the
housing sector--which makes up about 8 percent of annual gross domestic
product--is more stable than other sectors of the economy. Indeed,
while the manufacturing sector is in a downturn, overall job growth has
slowed sharply and orders for high-tech equipment have dropped
significantly, housing activity has remained robust. Total home sales
in the first quarter of 2001 were at a record level--with new sales in
March at an all-time high and existing sales at their second highest
The strength of the housing industry translates into greater
financial stability for American families. Strong home price
appreciation in recent years has increased the average net worth of
homeowners, and these gains in housing wealth have helped offset
declines in equity wealth.\14\ With the declining trend in mortgage
rates--from 8.62 percent last May to the current rate of slightly over
7 percent--many homeowners have refinanced, allowing them to reduce
their monthly mortgage payments. The extra cash from refinancing has
enabled households to increase their spending, which has helped cushion
the slowing economy. We estimate conservatively that consumer spending
may increase by $40 billion this year as a result of refinancing
\14\ According to the House Price Index from the Office of Federal
Housing Enterprise Oversight, the year-over-year average increases in
home prices in 1998, 1999, and 2000 were 5.5 percent, 5.8 percent, and
7.7 percent, respectively.
The financing that Fannie Mae provides through all types of
economic circumstances is one reason that housing is so stable. Despite
stagnating home prices in California in the first half of the 1990's
and in New England in early 1990's, Fannie Mae delivered a steady
supply of financing to lenders across the country and consistent
earnings to our investors. Our strong financial performance over time
is a key factor in drawing investors from around the world to invest
their capital in U.S. housing finance.
This financial strength means that we are ready to meet the housing
finance challenges ahead. The homeownership rate in America today
stands at a record 67.5 percent, but the gap between whites and
minorities is huge. Seventy-four percent of white Americans own their
homes, but that figure is less than 50 percent for minorities. We have
the best housing finance system in the world. Now we must make it work
for more American families.
In this context, I would like to propose a straightforward test for
examining policy proposals that affect the housing finance system:
Do they reduce costs for consumers?
Do they improve the safety and soundness of the housing
Do they expand opportunities for homeownership?
Do they allow innovation in the market without cumbersome
I proposed a test similar to this in 1996, when I testified before
the Banking Committee, and they remain relevant, particularly in view
of the challenges we continue to face in expanding homeownership
opportunities for all Americans.
Thanks to Congress' wisdom in understanding the power of private
enterprise to meet this critical public purpose --and in crafting a
compact with private investors--no single company in America is
focusing more capital and commitment to closing the homeownership gap
than Fannie Mae. We are in the American Dream business, and our mission
is to ``tear down barriers, lower costs and increase the opportunities
for homeownership and affordable rental housing for all Americans.'' In
partnership with mortgage lenders, elected leaders, housing leaders,
community groups, and many others, Fannie Mae will bring more
homeownership to more people and places than ever.
Thank you for inviting me to testify before you today. I look
forward to working with the Subcommittee on these important issues.
PREPARED STATEMENT OF LELAND C. BRENDSEL
Chairman and Chief Executive Officer, Freddie Mac
May 8, 2001
Good morning, Chairman Allard, Senator Reed, and Members of the
Subcommittee. It is a pleasure to be here. I am Leland C. Brendsel,
Chairman and Chief Executive Officer of the Federal Home Loan Mortgage
Corporation, known as Freddie Mac.
Freddie Mac plays a vital role in financing homeownership and
rental housing for the Nation's families. Mortgage funds are available
whenever and wherever they are needed. Mortgage rates are lower, saving
homeowners thousands of dollars in interest payments. Thirty-year
fixed-rate mortgages are plentiful, protecting families from unexpected
interest-rate increases. In addition, the availability of low down
payment loans has helped open the door of homeownership to more low-
and moderate-income families.
Freddie Mac's ability to continue to provide these benefits rests
on our financial strength. As a result of our superior risk management
capabilities, strong capital position and state-of-the-art information
disclosure, Freddie Mac is unquestionably a safe and sound financial
institution. Freddie Mac is fiercely committed to maintaining the
confidence of Congress, investors and the public in our financial
strength because that is what we need to meet our mission.
Last October, Freddie Mac made six commitments that keep us at the
vanguard of world financial practices. These commitments are
significant. They outpace the financial management practices of other
institutions; they meet or exceed recommendations of international
experts in financial risk and capital management; and they set a new
standard for global financial institutions. We made these commitments
voluntarily. There can be no doubt that Freddie Mac will be able to
serve our vital mission in a safe and sound manner for generations to
Freddie Mac Brings Tremendous Benefits To Consumers
Freddie Mac is a shareholder-owned corporation chartered by
Congress in 1970 to create a stable flow of funds to mortgage lenders
in support of homeownership and rental housing. We bring tremendous
benefits to America's families.
Constant Availability. There is never a shortage of mortgage money.
Freddie Mac's high-quality, liquid mortgage and debt securities attract
global investors to finance America's housing. A diversified investor
base makes the housing finance system highly resilient and stable. When
other markets face disruption--as they did during the global financial
turmoil in the fall of 1998--there is no disruption whatsoever in the
mortgage market we serve.
Low Cost. By linking local communities with global investors,
Freddie Mac enables homebuyers to compete for funds in the capital
markets alongside the largest corporations. As a result, families save
thousands of dollars in mortgage interest. In a recent report, former
Office of Management and Budget Director Dr. Jim Miller and fellow
economist Dr. James Pearce totaled the savings to America's families to
between $8 billion and $23 billion each year.\1\
\1\ Pearce, James E. and Miller III, James C., ``Freddie Mac and
Fannie Mae: Their Funding Advantage and Benefits to Consumers,'' at 29
(2001). Available at http://www.fhlmc.com/vitalrole/docs/cbo-final-
pearcemiller.pdf. The Freddie Mac commissioned report estimates the
funding advantage between $2.3 billion to $7.0 billion. Drs. Pearce and
Miller concluded: ``Thus, even using the lowest estimate of consumer
benefits and the highest estimate of the funding advantage in our range
of estimates, the value of consumer interest-cost savings resulting
from Freddie Mac and Fannie Mae's activities significantly exceeds the
highest estimate of their funding advantage.''
Perhaps the best evidence of how we save consumers money is in the
weekly real estate section of major newspapers. For example, in its
Saturday Real Estate section, The Washington Post provides two sets of
mortgage interest rates: Those for conforming mortgages, which are
eligible for Freddie Mac purchase (currently up to $275,000 for a
single-family home), and those for higher-balance jumbo loans.
Invariably, rates on conforming mortgages are lower than those on jumbo
loans by as much as 50 basis points. Furthermore, Freddie Mac's
activities lower mortgage interest rates on all conforming loans, not
simply the ones we purchase. Whether a conforming loan is held in
portfolio by a bank or a credit union, mortgage rates are lower for all
conforming market borrowers.
Uniformity. Freddie Mac purchases mortgages in every community in
the country. As a result, a borrower in Denver pays the same for a
mortgage as a borrower in Providence. This stands in sharp contrast to
1970 when mortgage interest rates differed by as much as one and a half
percentage points across the country.
Product Choice. America's families choose from a broad array of
mortgage products, including the 30-year fixed-rate mortgage with a low
down payment. In many other countries, this type of mortgage is simply
Innovation. From the development of the mortgage securities market
in the 1970's to the development of automated underwriting in the
1990's, Freddie Mac has been at the forefront of innovation in the
mortgage market. Borrowers are the direct beneficiaries of Freddie
In 1995, Freddie Mac introduced automated underwriting to the
market with our Loan Prospector automated underwriting
service. Loan Prospector has revolutionized the mortgage
origination process, reducing the time and expense of getting a loan.
Automated underwriting also brings greater objectivity and fairness to
lending decisions. Every piece of information is evaluated the same way
for every borrower, every time, with an accuracy no human underwriter
can match. This high degree of accuracy has led to the development of
new products that would have been deemed too risky a few years ago. The
Joint Center for Housing Studies at Harvard University concludes that
these products enable ``more income-constrained and cash-strapped
borrowers at the margin to qualify for mortgage loans.'' \2\
\2\ Joint Center for Housing Studies of Harvard University, State
of the Nation's Housing 1999, p. 4.
High Standards. By bringing competition, standardization, and
accountability to the mortgage market, Freddie Mac promotes responsible
lending. We have taken a leadership role in combating predatory lending
Economic Stability. Freddie Mac's activities also play a vital role
in stabilizing our Nation's economy. When the economy weakens, we
deliver lower interest rates to the mortgage market. This, in turn,
boosts housing activity, which is often just the spark the economy
needs. According to Barron's:
If the Fed has staved off a recession, some of the credit
should go to Freddie Mac and Fannie Mae. By helping to transmit
the benefits of the central bank's rate cuts to the mortgage
market, these agencies have done their part in cushioning the
impact of the Nasdaq knockdown on the American consumer.\3\
\3\ Ablan, Jennifer, ``Despite Treasury Selloff, More Fed Easing
Ahead?'' Barron's Online (January 15, 2001).
Lower mortgage rates also enable existing homeowners to refinance
their mortgages, putting real money back into their pockets. The easing
of mortgage interest costs and the strength of the housing market are
among the bright spots on today's economic horizon.
Homeownership. The stability, efficiency, and innovation that
Freddie Mac brings to the mortgage market turn homeownership dreams
into reality. Since our inception, Freddie Mac has purchased more than
$2 trillion in residential mortgages, financing homes for more than 27
million families. In so doing, we have contributed to an all-time high
homeownership rate. Today, more than two-thirds of America's families
are homeowners, building wealth and brighter prospects for their
Freddie Mac brings tremendous benefits to the Nation. They far
outweigh any benefits we derive from our Congressional charter.
America's homebuyers can depend on Freddie Mac because we are safe,
sound, and strong.
Superior Risk Management
Freddie Mac has a 30-year record of successfully managing our
business in a rigorous and disciplined way. The tools we have developed
to manage both credit and interest-rate risk are second to none, and
our exposure to these risks remains at very low levels.
Credit Risk Management: Freddie Mac operates in only one business--
residential mortgages. This business has low credit risk, which is the
risk that borrowers will default on their loans. Because of the value
attached to homeownership, families pay their monthly mortgage payment
first and faithfully. More than $500 billion in home equity stands
between Freddie Mac and the risk of default on the mortgages we own. We
are further protected through the use of third-party credit
enhancements on a large share of our mortgage purchases. These
enhancements include recourse arrangements with our lenders and
mortgage insurance on low down payment loans. Finally, by funding
mortgages nationwide, geographic diversity mitigates the risk of local
These extensive loss protections support mortgages that are
underwritten and managed using state-of-the-art statistical tools. Loan
Prospector is used by thousands of lenders to originate
mortgages that Freddie Mac purchases; in fact, Loan Prospector
recently processed its 10 millionth loan. Automated
underwriting's sophisticated evaluation of risks allows us to purchase
mortgages with low down payments in a safe and sound manner. Freddie
Mac further mitigates credit losses by actively seeking alternatives to
foreclosure. Our loss mitigation techniques reduce credit costs and in
many cases enable struggling borrowers to keep their homes.
Our credit risk management techniques have produced extraordinarily
low credit losses. Freddie Mac's mortgage delinquency rates are
consistently and significantly lower than the overall conventional
market, and much lower than those of the Federal Housing
Administration. Our loan charge-offs are significantly lower than those
of banks and thrifts. We maintain loan loss reserves that are seven
times our credit losses, and hold capital against credit losses
sufficient to withstand severe losses.
Interest-Rate Risk Management: Freddie Mac also is a leader in
managing interest-rate risk. Interest-rate risk is the risk that
changes in the level of interest rates could adversely affect the value
of a portfolio and could lead to mismatches in the expected cash flows
between assets and liabilities. Freddie Mac's interest-rate risk
exposure results primarily from the uncertainty as to when borrowers
will pay off their mortgages. When mortgage interest rates decline,
borrowers tend to prepay their mortgages by refinancing into lower-cost
loans. This creates financing challenges for mortgage investors who
must find alternative investment instruments in a lower yield
Freddie Mac manages this risk on the mortgages we buy using
extremely disciplined standards. We fund our mortgage investments with
an appropriate mix of bullet debt, callable debt, and effective
callable debt. We closely monitor the sensitivity of our portfolio to
changes in the interest-rate environment and rebalance our portfolio as
needed. We regularly reassess the accuracy of our prepayment models.
Strong Capital Management And Supervisory Oversight
Not only is Freddie Mac highly skilled at managing risk, we are
extremely well-capitalized for the risks we take. We manage our
business to hold enough capital to withstand 10 years of economic
stress resembling the Great Depression. In addition to our own rigorous
capital management, the Federal Housing Enterprises Financial Safety
and Soundness Act of 1992 (the GSE Act) subjects us to both a minimum
capital requirement and a stringent risk-based capital standard. The
minimum capital requirement applies to both on-balance-sheet and off-
balance-sheet assets, unlike bank capital standards. The risk-based
capital standard is the industry's toughest, requiring us to withstand
10 years of extremely severe stress.
Our safety and soundness regulator, the Office of Federal Housing
Enterprise Oversight (OFHEO), currently assesses our financial strength
using the minimum capital standard.\4\ Each quarter since OFHEO began
assessing Freddie Mac's capital in 1993, our regulator has determined
that Freddie Mac is adequately capitalized, which is the highest
rating. OFHEO is required to communicate examination results, as well
as its determination of our capital strength in an annual report to
\4\ The GSE Act established a minimum capital requirement as the
sum of 2.5 percent of on-balance-sheet assets and 0.45 percent of
outstanding mortgage-backed securities and other off-balance-sheet
obligations. 12 U.S.C. Sec. 4612.
The risk-based stress test required by the GSE Act is innovative,
stringent, dynamic, and more responsive to risk than any ratio-based
capital regulation.\5\ It requires Freddie Mac to maintain sufficient
capital to withstand a 10-year period of extreme swings in both credit
and interest-rate risks.
\5\ 12 U.S.C. Sec. 4611.
The credit risk portion of the stress test is based on the
assumption that defaults and losses on mortgages occur throughout the
United States at a rate and severity equal to the highest default rates
experienced in a regional downturn.\6\ In implementing this extremely
severe scenario, OFHEO intends to subject Freddie Mac's entire mortgage
portfolio to the actual default experience of the collapse of real
estate in the oil-belt States in the 1980's. The default rates on
mortgages with low down payments during this period were approximately
25 percent; loss rates were approximately 60 percent.
\6\ 12 U.S.C. Sec. 4611(a)(1).
The interest-rate risk portion of the test mandates a stress test
in which yields on 10-year Treasury bonds fall or rise by as much as
600 basis points.\7\
\7\ 12 U.S.C. Sec. 4611(a)(2).
Further, the GSE Act requires a 30 percent add-on to required
stress test capital to account for management and operations risk.\8\
\8\ 12 U.S.C. Sec. 4611(c)(2).
A pioneer in the use of risk-based stress tests, Freddie Mac
believes that a well-implemented regulation would meet four key
The test must be consistent with the GSE Act. For example, the
Act calls for the projected stressful conditions to reasonably
reflect economic reality and past experience. This means that every
assumption from interest rates to prepayment rates to house-price
appreciation must be derived from historical data.
The test must tie capital to the actual risks we face.
Assigning too little capital or too much both have negative
consequences. Too little capital could jeopardize our ability to
withstand an extreme downturn in the economy. On the other hand,
requiring too much capital would impose unnecessary costs on the
Nation's families. Mortgage rates would rise, and mortgage products
attractive to lower income borrowers might become unavailable.
The test must be operationally workable. For Freddie Mac to
purchase mortgages on a daily basis, we must be able to calculate
the amount of capital that will be required and incorporate it into
our business processes. The test must produce reliable and accurate
The test must foster innovation. Freddie Mac is relentless in
our search to wring out every inefficiency and barrier to
homeownership. New instruments for managing risk and financing
housing are constantly being developed in the markets. The test
must encourage Freddie Mac to quickly respond to new opportunities
while remaining safe and sound.
Freddie Mac is working with OFHEO toward final risk-based capital
regulations that will be a model for the industry.
OFHEO currently carries out a detailed and comprehensive
examination program, which includes continuous on-site examinations and
quarterly capital determinations. OFHEO's highly regarded examination
staff focuses all day, every day on two companies in one line of
business. By comparison, examiners of large banks must inspect
activities ranging from annuities to foreign currencies to commercial
loans to credit cards taking place at hundreds of subsidiaries here and
around the world. Despite the monoline nature of Freddie Mac's
business, there are roughly the same number of examiners reviewing
Freddie Mac as there are reviewing a large bank's dozens of business
Comprehensive Disclosure That Promotes Market Discipline
We disclose more information to the public about the risks we face
and our effectiveness at managing them than almost any other financial
institution. The annual report and quarterly information statement
supplements of Freddie Mac provide comprehensive information related to
credit risk. They include extensive discussion, analysis, and
quantification of types of credit risk exposures, such as the ``at-
risk'' share of delinquent loans, loan-to-value ratios, and geographic
Freddie Mac's interest-rate risk disclosures are similarly
comprehensive. Our quantitative methodologies measure the change in
portfolio market value that would be caused by immediate upward or
downward shifts in interest rates.\9\ Freddie Mac provides these
disclosures on a regular basis, exceeding the annual disclosure
requirements required of financial institutions by the Securities and
Exchange Commission (SEC).
\9\ Freddie Mac's quantitative disclosures employ sensitivity
analysis, one of three methods of quantitative disclosure prescribed by
the Securities and Exchange Commission. SEC's rules require SEC
registrants to provide quantitative disclosure about market risk
sensitive instruments, and permit them to use: (1) a tabular
presentation of fair value information and of contractual terms; (2) a
sensitivity analysis; or, (3) a value-at-risk methodology.
Last year, Freddie Mac requested that PriceWaterhouseCoopers (PWC)
compare our public risk disclosures to those of selected financial
institutions generally recognized to be providing best-in-class risk
management disclosures.\10\ PWC found that our risk management
disclosures ``are among the best of the risk management disclosures
provided by the recognized best-in-class group included in this
\10\ PriceWaterhouseCoopers, ``Freddie Mac: Risk Disclosure
Benchmarking Study'' (May 15, 2000).
\11\ Id. p. 4.
Greater transparency through information disclosure exposes an
institution to the rigorous discipline of financial markets. If
investors perceive that a company's financial condition has
deteriorated, they will require higher yields on their investments to
assume the higher risk.
Market discipline is not a replacement for strong capital and
vigilant oversight, but is a necessary and desirable complement.
Recently, Federal Reserve Chairman Alan Greenspan called market
discipline the ``first line of regulatory defense.'' \12\ In a speech
to the American Bankers Association, he stated that:
\12\ Remarks by Federal Reserve Chairman Alan Greenspan in his
address ``Banking Supervision,'' before the American Bankers
Association, Washington, DC (September 18, 2000).
We are moving toward a system in which . . . public
disclosure and market discipline are going to play increasing
roles, especially at our large institutions, as a necessity to
avoid expansion of invasive and burdensome supervision and
regulation. Bank regulators are perforce being pressed to
depend increasingly on greater and more sophisticated private
market discipline, the still most effective form of
OFHEO also has endorsed market discipline as an important component
of a comprehensive regulatory framework. In its most recent annual
report to Congress, OFHEO stated:
If creditors have accurate and timely information on the
financial risks of Fannie Mae and Freddie Mac and believe that
they are exposed to material risk of loss if the Enterprises
get into financial trouble they will take steps to ensure that
the Enterprises strike an appropriate balance between risk and
\14\ Office of Federal Housing Enterprises Oversight, 2000 Report
to Congress, at 33, (June 15, 2000).
Six Commitments Set A New Standard In Financial Management
Freddie Mac is a leader in risk and capital management and
information disclosure. Last October, Freddie Mac made six commitments
that keep us at the vanguard of evolving worldwide practices. In
developing these commitments, we sought out the best practices among
financial institutions. We looked at the recommendations of global
financial regulators, including the Basel Committee on Banking
Supervision. In its first revision to the 10-year-old Basel Accord, the
Committee embraced a ``Three Pillars'' framework for financial
regulation.\15\ The pillars, are Capital, Supervisory Oversight and
Market Discipline. Viewed against these three pillars, Freddie Mac
already is among the ``best-in-class'' for risk and capital management
and disclosure practices.
\15\ A New Capital Adequacy Framework, Consultative Paper on
Capital Adequacy No. 50, Basel Committee on Banking Supervision (June
1999); The New Basel Capital Accord, Consultative Document, Basel
Committee on Banking Supervision (January 2001).
Freddie Mac's Six Commitments
1. Publicly disclose our independent rating.
2. Maintain a high degree of liquidity.
3. Issue subordinated debt on a semiannual basis.
4. Implement a risk-based capital stress test on an interim basis.
5. Publicly disclose a forward-looking measure of credit risk every
6. Publicly disclose interest-rate risk every month.
Since we announced our six-point plan, other regulatory experts
have voiced support for similar principles and best practices:
In December 2000, the Federal Reserve Board and the Department
of Treasury released a joint report to Congress entitled ``The
Feasibility and Desirability of Mandatory Subordinated Debt.'' \16\
The report concludes that the use of subordinated debt may
contribute to market discipline.
\16\ The Feasibility and Desirability of Mandatory Subordinated
Debt, Report to Congress by the Board of Governors of the Federal
Reserve System and the Department of the Treasury, December 2000.
In January 2001, the Working Group on Public Disclosure, also
known as the Shipley Commission, issued a report to the Federal
Reserve, SEC, and Office of the Comptroller of the Currency
(OCC).\17\ The report recommends improved and more frequent
disclosure of credit and interest-rate risk.
\17\ Letter of the Working Group on Public Disclosure (January 11,
In March, the Federal Reserve Board and the OCC released
supervisory guidance urging large banks to adopt the Shipley
\18\ Board of Governors of the Federal Reserve System, Supervisory
Staff Report SR 01- 6 (March 23, 2001). See Appendix A.
These reports and recommendations provide strong affirmation that
Freddie Mac's six commitments are aligned with the best and most up-to-
date thinking on financial risk management.
Freddie Mac asked William Seidman, the former Chairman of the FDIC,
for his assessment of our commitments. He concluded:
Your package of disclosures and standards puts [Freddie Mac]
in a position of providing more and better public information
than any other financial institution, both regulated and
nonregulated, of which I am aware.\19\
\19\ Memorandum of L. William Seidman to Freddie Mac (December 13,
Our six commitments set the pace for other institutions to adopt
similar practices and to enhance their public disclosures. In fact,
Moody's Investors Service said that the commitments ``set new standards
not only for themselves [Freddie Mac and Fannie Mae], but for the
global financial market.'' \20\ They added:
\20\ New Freddie Mac & Fannie Mae `Open Book' Policy: A Positive
Credit Development, Moody's Investors Service (October 2000).
The leadership shown by Freddie Mac and Fannie Mae could
prove difficult for other firms to ignore, and could usher in a
wave of enhanced financial risk disclosure. This may prove to
be one of the most important ramifications of the GSE's
Freddie Mac met all six commitments in just 6 months. I will
briefly describe each commitment and how it sets a new standard in
financial practices and disclosure.
Commitment 1: Public Disclosure of Independent Rating
What we accomplished. On February 27, 2001, we released our ``AA-''
risk-to-the-government rating from Standard & Poor's (S&P). We
originally pledged to obtain a rating once a year. Now Freddie Mac is
going beyond that. We have asked S&P for a continuous ``surveillance''
rating. This means that the S&P will be obligated to notify the public
if there is ever a change in our financial position that affects the
Why it is important. Independent ratings are crucial to our
financial system. Every day, millions of securities change hands on the
basis of rating agency opinions of financial quality. Freddie Mac's
commitment to seek an annual independent rating provides a readily
discernible measure of capital strength that promotes market
discipline. Ratings provide an independent early warning signal to the
public, Congress and investors regarding our financial condition.
In the preamble of the joint agency proposed rulemaking on risk-
based capital standards for recourse and direct credit substitute
transactions,\22\ the Federal bank and thrift regulatory agencies
\22\ 65 Fed. Reg., at 12320, 12321 (March 8, 2000).
In the opinion of the agencies, ratings have the advantages
of being relatively objective, widely used and relied upon by
investors and other participants in the financial markets.
Ratings provide a flexible, efficient, market-oriented way to
measure credit risk.\23\
\23\ 65 Fed. Reg., at 12321.
How we measure up. A risk-to-the-government rating of AA- places
Freddie Mac in the top tier of financial institutions. To put this in
perspective, of the 10 largest bank holding companies, only two have
earned a rating this high on their senior debt--and none has a higher
Commitment 2: Liquidity Management and Contingency Planning
What we accomplished. On March 8, 2001, we announced that we met
our liquidity commitment. Freddie Mac holds enough liquid, high-quality
assets so that we can meet all of our financial obligations, even in
the event of a market disruption so severe that we are unable to issue
debt for 3 months. With this commitment, we also are meeting the Basel
Committee's 14 principles of sound liquidity management for large
\24\ ``Sound Practices for Managing Liquidity in Banking
Organizations,'' Consultative Paper No. 69, Basel Committee on Banking
Supervision (February 2000).
Why it is important. Liquidity is the lifeblood of any financial
institution and of any financial market. We take it for granted until
it is gone. Freddie Mac's liquidity commitment, together with public
disclosure, will provide strong assurances to investors about Freddie
Mac's financial strength. Regardless of disruptions in the capital
markets that may make it impossible to borrow, Freddie Mac has the
means to meet our financial obligations for at least 3 months.
Summary of Principles
Basel Sound Practices for Managing Liquidity
1. Strategy for day-to-day management of liquidity.
2. Approval of liquidity strategy by bank's Board of Directors.
3. Effective management structure for implementing liquidity
4. Adequate information systems to measure and monitor liquidity
5. Process for measuring and monitoring net funding requirements.
6. Use of scenario analysis to analyze liquidity needs.
7. Frequent review of underlying assumptions.
8. Periodic review of relationships with liability holders.
9. Contingency plans for handling liquidity crisis.
10. Control system for managing currency risk.
11. Limits on possible cash flow mismatches arising from currency
12. Effective internal control systems, including independent
13. Mechanism to ensure adequate public disclosure.
14. Supervisory oversight.
How we measure up. Freddie Mac's ability to withstand 3 months
without access to debt markets and still meet our financial commitments
is an extraordinary indication of our financial strength and liquidity.
It is unlikely that many other financial institutions can meet this
standard. In its 1999 liquidity paper, the Basel Committee suggested
that large institutions be prepared to weather a liquidity crisis of
between 1 and 3 months.\25\ We chose the more stringent 3 months.
\25\ Basel Liquidity Paper, at 7, par. 28.
Our liquidity commitment also exceeds current market practices and
represents a new best practice for financial institutions. For example,
the Federal Housing Finance Board recently adopted a minimum liquidity
requirement for the Federal Home Loan Banks.\26\ The rule requires the
FHLB's to withstand only 5 days without access to the debt markets.
\26\ FHLB Final Rule, 66 Fed. Reg. at 8261-321 (January 30, 2001).
Commitment 3: Periodic Issuance of Subordinated Debt
What we accomplished. On March 21, 2001, we met our subordinated
debt commitment with the issuance of $2 billion of 10-year subordinated
debt securities, known as Freddie SUBSSM. This will create a
supplement to our already strong capital position. The amount of
subordinated debt we issue, when combined with our core capital, will
equal at least 4 percent of on-balance-sheet assets. We expect that
within 3 years, there will be an additional $8 billion to $10 billion
of investor funds standing in front of our senior debt holders.
Why it is important. Subordinated debt is a tool for market
discipline. Subordinated debt is paid to the holders only after all
other debt instruments are paid. Interest payments on Freddie Mac SUBS
will be suspended and allowed to accumulate for up to 5 years if
Freddie Mac's core capital deteriorates materially. As a result, the
yield at which our subordinated debt trades will provide a market-based
indication of our financial strength.
Chairman Greenspan has likened the use of subordinated debt to a
``canary in the mine,'' alerting investors and the public of potential
financial weakness well before any regulatory or other governmental
intervention would be needed.\27\ Similarly, the December 2000 joint
report by the Federal Reserve and the Treasury concluded that issuing
subordinated debt contributes to market discipline. While the report
stopped short of recommending mandatory issuance by banks, Freddie Mac
stepped up to the challenge of frequent, large issues.
\27\ Testimony of Federal Reserve Board Chairman Alan Greenspan in
his renomination hearing before the Senate Banking Committee (January
How we measure up. Freddie Mac's subordinated debt commitment
exceeds practices of other financial institutions. According to the
joint report and a 1999 Federal Reserve study, typically only the
largest banks and bank holding companies issue subordinated debt, and
most banks' subordinated debt is not publicly traded.\28\ Moreover, no
bank has voluntarily committed to issue publicly traded subordinated
debt on a regular basis to enhance its transparency and market
\28\ ``Using Subordinated Debt as an Instrument of Market
Discipline,'' Federal Reserve Study Group on Subordinated Debt and
Debentures, Staff Study 172 (December 1999).
Commitment 4: Interim Implementation of Risk-Based Capital Stress Test
What we accomplished. We met this commitment on March 26, 2001,
when we announced that we passed the risk-based capital stress test
envisioned in GSE Act. Our interim disclosure will not substitute for
OFHEO's regulatory process. We are working with OFHEO toward final
risk-based capital regulations that will be a model for the industry.
Why it is important. Adequate capital is critical to an
institution's ability to weather adverse circumstances. Freddie Mac's
commitment to implement the risk-based stress test and disclose the
outcome ensures that we are adequately capitalized for the risks we
How we measure up. Freddie Mac's statutory risk-based capital
stress test is the toughest test in the financial industry and is
entirely consistent with the 2001 New Basel Capital Accord. A 1999
study conducted by the economic consulting firm IPS-Sendero concluded
that the thrift industry would run out of capital after 5 years of this
stress test and would need to triple its capital to survive.\29\
\29\ Thrift Industry Analysis: Implications of Risk-Based Capital
Stress Test Requirements IPS-Sendero (August 19, 1999).
Commitment 5: New Quarterly Credit Risk Disclosures
What we accomplished. We met this commitment on March 26, 2001,
when we disclosed the impact on Freddie Mac of a 5 percent decline in
house prices everywhere around the country. Since we began keeping
track of house-price changes in 1975, there has not been a nationwide
decline of this magnitude. Our new disclosure demonstrates the
outstanding credit quality of Freddie Mac's portfolio.
Why it is important. Freddie Mac's commitment to disclose quarterly
our exposure to credit risk represents a new best practice for
financial institutions. Most credit risk disclosure is backward
looking, focusing on charge-offs and loans that are already delinquent
and in default. This type of information is useful, and Freddie Mac
will continue to report it. The addition of our new credit-risk
disclosure, which predicts exposure to a worsening economy, provides
forward-looking insights into our business.
How we measure up. By subjecting ourselves to this test, Freddie
Mac has set a new standard in the measurement and reporting of mortgage
credit risk. The Basel Committee issued a paper in July 1999 regarding
best practices for credit risk disclosure \30\ stating the Committee's
expectation that banks disclose sufficient, timely, and detailed
information to allow market participants to perform meaningful
evaluations of the bank's credit risk profile.\31\ Our commitment is
consistent with the Basel approach.
\30\ ``Best Practices for Credit Risk Disclosure,'' Basel Committee
on Banking Supervision, Basel, July 1999 (``Basel Credit Paper'').
\31\ These best practice recommendations are consistent with the
recommendations concerning hedge fund disclosures in ``Hedge Funds,
Leverage and the Lessons of Long-Term Capital Management'' a report of
the President's Working Group on Financial Markets (April 1999). The
President's Working Group (comprised of representatives from the
Department of Treasury, Federal Reserve Board, Securities and Exchange
Commission, and Commodities Futures Exchange Commission) concluded that
the current scope and timeliness of information about hedge funds was
limited and recommended that ``more frequent and meaningful information
on hedge funds should be made public.''
Commitment 6: New Monthly Interest-Rate Risk Disclosures
What we accomplished. On April 18, 2001, we began the monthly
disclosure of interest-rate risk. We disclosed the impact on Freddie
Mac of an abrupt change in our funding costs--both a 50 basis-point
shift in interest rates and a 25 basis-point shift in the slope of the
Treasury yield curve. The disclosure demonstrates Freddie Mac's
disciplined and skilled risk management, as our interest-rate risk
exposure remained at very low levels in a volatile environment.
Why it is important. In modern financial markets, interest-rate and
other market risks can expand and contract at great speed. To
understand the impact of rapidly changing interest-rate environments
and manage their investment positions, investors need current
information about their risk exposure.
How we measure up. Freddie Mac's commitment to monthly disclosure
of interest-rate risk significantly raises the bar; no banking
institution reports interest-rate risk as frequently. Our commitment
also exceeds the recommendation of the Shipley Commission. In its
January report to the Federal Reserve, the SEC, and the OCC, the
Commission recommended quarterly disclosure of interest-rate risk. In
supervisory guidance released on March 23, 2001, the Federal Reserve
and the OCC urged large banking organizations to adopt Shipley
recommendations to improve both their quantitative and qualitative
disclosures.\32\ Institutions also were encouraged to seek new avenues,
such as company web sites, for disseminating financial information more
frequently than regular annual or quarterly disclosures.\33\ Freddie
Mac is using our web site at freddiemac.com to give the public and our
investors financial information about our six commitments.
\32\ Board of Governors of the Federal Reserve System, Supervisory
Staff Report SR 01- 6 (March 23, 2001).
\33\ Federal Reserve Advisory Letter (March 23, 2001).
Taken together, our six commitments represent a watershed in
financial practices and disclosure.
The Commitments Support Our Vital Mission
Freddie Mac is safe, sound, and strong. We are committed to the
highest standards in financial management and disclosure, because we
are committed to opening doors to housing for more of America's
Because of the high level of support provided by Freddie Mac and
the secondary market, America enjoys the world's best housing finance
system. By attracting global capital to finance homeownership in
America, we reduce mortgage costs, saving families billions of dollars.
The extraordinary liquidity we bring to the Nation's mortgage markets
also helps stabilize our Nation's economy.
To meet our mission, Freddie Mac is relentlessly wringing out every
unnecessary cost and barrier to homeownership; we are pushing the
limits of technology; and we are searching the globe to find the lowest
costs funds for housing. As a result of our activities, more families
than ever before can afford to buy a home. In addition, they compete on
an equal footing with the largest corporations for low-cost funds in
the world's capital markets.
America is projected to grow by 30 million people over the next 10
years. The country is expected to form 1 million new households yearly.
All told, America's families will need an additional $6 trillion to
finance their homes over the next decade. Freddie Mac will open doors
of opportunity for the homebuyer of the future, who is more likely to
be a low-income, minority or immigrant family, eager to realize the
Recently, HUD Secretary Martinez captured the essence of why
housing holds a special place in the Nation. He said:
We believe that if you help a man or a woman buy a home, you
are helping to make a better citizen. Homeownership is vital in
creating strong communities. It helps average Americans build
equity and increase their household wealth.\34\
\34\ Remarks by HUD Secretary Mel Martinez to the National
Association of Counties' Legislative Conference (March 5, 2001).
Freddie Mac's strength and vitality ensure that we are able to meet
the housing finance needs of the future. Our superior risk management
capabilities, strong capital position and state-of-the-art information
disclosure make Freddie Mac unquestionably a safe and sound financial
institution. The six commitments demonstrate our determination to stay
that way, so that we can finance housing for generations to come.
Thank you for the opportunity to appear today. Freddie Mac is a
great Congressional success story. I look forward to working closely
with Chairman Allard, Senator Reed, and the Members of this
Subcommittee to ensure that Congress is confident that Freddie Mac is
meeting our very important mission in a safe and sound manner. Together
we will secure the future of our housing finance system and, with it,
the dreams of millions of families.