    [Senate Hearing 108-849]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 108-849

                            PROPOSALS FOR IMPROVING
                         THE REGULATION OF THE HOUSING
                        GOVERNMENT SPONSORED ENTERPRISES

    =======================================================================

                                    HEARINGS

                                   before the

                                  COMMITTEE ON
                       BANKING,HOUSING,AND URBAN AFFAIRS
                              UNITED STATES SENATE

                          ONE HUNDRED EIGHTH CONGRESS

                           FIRST AND SECOND SESSIONS

                                       ON

     ESSENTIAL ELEMENTS AND PROPOSALS OF REGULATORY REFORM, RESOLUTION OF
            ACCOUNTING ISSUES, AND FUNDING OF A NEW OVERSIGHT OFFICE

                                   __________

              OCTOBER 16, 23, 2003, FEBRUARY 10, 24, AND 25, 2004

                                   __________

      Printed for the use of the Committee on Banking, Housing, and Urban
                                    Affairs

          Available at: http: //www.access.gpo.gov /congress /senate/
                                senate05sh.html

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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      RICHARD C. SHELBY, Alabama, Chairman

    ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
    WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
    MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
    CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
    RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
    JIM BUNNING, Kentucky                EVAN BAYH, Indiana
    MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
    JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
    ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
    LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

                 Kathleen L. Casey, Staff Director and Counsel
         Steven B. Harris, Democratic Staff Director and Chief Counsel
                        Douglas R. Nappi, Chief Counsel
                           Mark F. Oesterle, Counsel
                           Bryan N. Corbett, Counsel
                   Peggy R. Kuhn, Senior Financial Economist
                 Martin J. Gruenberg, Democratic Senior Counsel
                  Stephen R. Kroll, Democratic Special Counsel
                       Sarah A. Kline, Democratic Counsel
                 Jonathan Miller, Democratic Professional Staff
       Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                           George E. Whittle, Editor

                                      (ii)

                                C O N T E N T S

                                  ----------

                           THURSDAY, OCTOBER 16, 2003

                                                                       Page

    Opening statement of Chairman Shelby.............................     1

    Opening statements, comments, or prepared statements of:
        Senator Sarbanes.............................................     2
        Senator Bennett..............................................     3
        Senator Reed.................................................     4
        Senator Dole.................................................     5
        Senator Corzine..............................................     6
        Senator Enzi.................................................     7
        Senator Schumer..............................................     8
            Prepared statement.......................................    71
        Senator Hagel................................................     8
        Senator Crapo................................................    10
        Senator Carper...............................................    11
        Senator Sununu...............................................    12
        Senator Stabenow.............................................    13
            Prepared statement.......................................    71
        Senator Bunning..............................................    13
        Senator Allard...............................................    15
        Senator Chafee...............................................    16

                                   WITNESSES

    John W. Snow, Secretary, U.S. Department of the Treasury,
      Washington, DC.................................................    16
        Prepared statement...........................................    72
        Response to written questions of:
            Senator Shelby...........................................    91
            Senator Reed.............................................    92
            Senator Sununu...........................................    96
            Senator Bunning..........................................    96
            Senator Miller...........................................    97
    Mel Martinez, Secretary, U.S. Department of Housing and Urban
      Development, Washington, DC....................................    18
        Response to written questions of:
            Senator Shelby...........................................    99
            Senator Reed.............................................   100
            Senator Bunning..........................................   112
            Senator Miller...........................................   113
    Franklin D. Raines, Chairman and Chief Executive Officer, Fannie
      Mae............................................................    42
        Prepared statement...........................................    75
        Response to written questions of:
            Senator Shelby...........................................   113
            Senator Reed.............................................   115
            Senator Hagel............................................   120
            Senator Miller...........................................   126
    George D. Gould, Presiding Director, Freddie Mac.................    45
        Prepared statement...........................................    81
    Norman B. Rice, President and Chief Executive Officer, Federal
      Home Loan Bank of Seattle......................................    48
        Preared statement............................................    87

                  Additional Material Supplied for the Record

    Letter to Robert Ney, a U.S. Representative in Congress from the
      State of Ohio and Maxine Waters, a U.S. Representative in
      Congress from the State of California from Franklin D. Raines,
      Chairman and Chief Executive Officer, Fannie Mae, dated
      September 12, 2003 submitted by Senator Debbie Stabenow........   128
    ``Potential Costs Related to the SEC Registration of the FHLB's
      Stock,'' by the First Manhattan Consulting Group dated October
      15, 2003 submitted by Senator Richard C. Shelby................   137

                                  ----------

                           THURSDAY, OCTOBER 23, 2003

                                                                       Page

    Opening statement of Chairman Shelby.............................   183

    Opening statements, comments, or prepared statements of:
        Senator Sarbanes.............................................   184
        Senator Bunning..............................................   184
        Senator Johnson..............................................   185
        Senator Hagel................................................   186
        Senator Reed.................................................   187
        Senator Bennett..............................................   187
        Senator Corzine..............................................   203
        Senator Allard...............................................   205

                                   WITNESSES

    John T. Korsmo, Chairman, Federal Housing Finance Board..........   188
        Prepared statement...........................................   223
    Armando Falcon, Jr., Director, Office of Federal Housing
      Enterprise
      Oversight......................................................   189
        Prepared statement...........................................   231
        Response to written questions of:
            Senator Shelby...........................................   249
            Senator Reed.............................................   250
    Douglas Holtz-Eakin, Director, Congressional Budget Office.......   192
        Prepared statement...........................................   233
        Response to written questions of:
            Senator Shelby...........................................   253
            Senator Reed.............................................   254
    John D. Koch, Executive Vice President and Chief Lending Officer,
      Charter
    One Bank, NA, Cleveland, Ohio, on behalf of America's Community
      Bankers,
      Washington, DC.................................................   213
        Prepared statement...........................................   238
    Dale J. Torpey, President and CEO, Federation Bank, Washington,
      Iowa,
      on behalf of the Independent Community Bankers of America......   214
        Preared statement............................................   241
        Response to written questions of:
            Senator Shelby...........................................   254
            Senator Hagel............................................   256
            Senator Reed.............................................   256
    Allen J. Fishbein, Director for Housing and Credit Policy,
      Consumer Federation of America, on behalf of National
      Association of Consumer Advocates, National Community
      Reinvestment Coalition, National Congress for Community
      Economic Development, National Fair Housing Alliance, and
      Consumer Federation of America.................................   216
        Prepared statement...........................................   243
    Robert M. Couch, Chairman, Mortgage Bankers Association..........   218
        Prepared statement...........................................   245
        Response to written questions of:
            Senator Shelby...........................................   257
            Senator Hagel............................................   258
    Iona C. Harrison, Realty Executives-Main Street, U.S.A., on
      behalf of the National Association of REALTORS'.....   219
        Prepared statement...........................................   246

                                  ----------

                           TUESDAY, FEBRUARY 10, 2004

                                                                       Page

    Opening statement of Chairman Shelby.............................   261

    Opening statements, comments, or prepared statements of:
        Senator Reed.................................................   262
        Senator Sununu...............................................   262
        Senator Crapo................................................   268
        Senator Corzine..............................................   269
        Senator Sarbanes.............................................   273
        Senator Hagel................................................   275
        Senator Carper...............................................   276
        Senator Chaffee..............................................   278
        Senator Bennett..............................................   279
        Senator Dole.................................................   304

                                   WITNESSES

    David M. Walker, Comptroller General, Accompanied by Tom McCool,
      Managing Director, Financial Markets and Community Investments,
      U.S. General Accounting Office.................................   262
        Prepared statement...........................................   305
    Alan L. Beller, Director, Division of Corporation Finance, U.S.
      Securities
      and Exchange Commission........................................   283
        Prepared statement...........................................   331
        Response to written questions of Senator Reed................   364
    Richard S. Carnell, Associate Professor of Law, Fordham
      University School
      of Law, New York, New York.....................................   287
        Prepared statement...........................................   336
    James R. Rayburn, President, National Association of Home
      Builders                                                          290
        Prepared statement...........................................   352

                                  ----------

                           TUESDAY, FEBRUARY 24, 2004

                                                                       Page

    Opening statement of Chairman Shelby.............................   367

    Opening statements, comments, or prepared statements of:
        Senator Allard...............................................   367
        Senator Dole.................................................   368
        Senator Carper...............................................   369
        Senator Bunning..............................................   369
        Senator Reed.................................................   370
        Senator Crapo................................................   371
        Senator Enzi.................................................   372
            Prepared statement.......................................   401
        Senator Sarbanes.............................................   372
        Senator Stabenow.............................................   389
        Senator Sununu...............................................   392

                                    WITNESS

      Alan Greenspan, Chairman, Board of Governors of the Federal
        Reserve System, Washington, DC...............................   373
        Prepared statement...........................................   402
        Response to written questions of:
            Senator Shelby...........................................   407
            Senator Allard...........................................   425
            Senator Reed.............................................   427
            Senator Dole.............................................   435

                                  ----------

                          WEDNESDAY, FEBRUARY 25, 2004

                                                                       Page

    Opening statement of Chairman Shelby.............................   437

    Opening statements, comments, or prepared statements of:
        Senator Johnson..............................................   437
        Senator Hagel................................................   439
        Senator Crapo................................................   440
        Senator Stabenow.............................................   441
        Senator Dodd.................................................   454
        Senator Sarbanes.............................................   455
        Senator Bennett..............................................   460
        Senator Carper...............................................   464
        Senator Corzine..............................................   470

                                   WITNESSES

    Franklin D. Raines, Chairman and Chief Executive Officer, Fannie
      Mae............................................................   442
        Prepared statement...........................................   485
    Richard F. Syron, Chairman and Chief Executive Officer, Freddie
      Mac............................................................   445
        Prepared statement...........................................   516
        Response to written questions of:
            Senator Hagel............................................   530
            Senator Reed.............................................   530
    Norman B. Rice, President and Chief Executive Officer, Federal
      Home Loan
      Bank of Seattle................................................   448
        Prepared statement...........................................   525
        Response to written questions of Senator Reed................   539

                          PROPOSALS FOR IMPROVING THE
                           REGULATION OF THE HOUSING
                        GOVERNMENT SPONSORED ENTERPRISES

                                  ----------

                           THURSDAY, OCTOBER 16, 2003

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:12 a.m., in room SD-538, Dirksen
    Senate Office Building, Senator Richard C. Shelby (Chairman of
    the Committee) presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The hearing will come to order.
        I would first like to welcome Treasury Secretary Snow and
    HUD Secretary Martinez again to the Committee. They are no
    strangers here. It is a pleasure to have both of you back. That
    will be our first panel.
        Our second panel of witnesses will be Franklin Raines,
    Chairman and Chief Executive Officer of Fannie Mae; George D.
    Gould, Director of Freddie Mac; and Norman Rice, President and
    CEO of the Federal Home Loan Bank of Seattle.
        Today's hearing focuses upon a very important topic:
    improving the regulation of the housing Government Sponsored
    Enterprises, or GSE's, as they are commonly known.
        The mission of the housing GSE's is one I strongly support.
    Federal Home Loan Bank advances are a vital link to the capital
    markets for financial institutions nationwide. The secondary
    mortgage market access that Fannie Mae and Freddie Mac provide
    also serves as an important source of liquidity for our
    Nation's mortgage market. By enhancing liquidity, the
    Enterprises make possible the lending activity that is critical
    to economic growth and to expanding homeownership.
        The enterprises are large institutions. Collectively,
    Fannie Mae and Freddie Mac carry $1.6 trillion in assets on
    their balance sheets and have outstanding debt of almost $1.5
    trillion. The Federal Home Loan Bank System is not far behind,
    with combined assets of over $780 billion and outstanding
    advances to member institutions of $495 billion.
        Due to the importance of the housing GSEs' mission and the
    size of the assets, I believe that the Enterprises require a
    strong, credible regulator. I remain concerned that the current
    regulatory structure for the housing GSE's is neither strong
    nor credible.
        In July, this Committee examined OFHEO's oversight of
    Fannie Mae and Freddie Mac and their accounting practices. I
    remain troubled by the fact that OFHEO never detected the
    complete breakdown in the accounting and audit function at
    Freddie Mac. While this breakdown did not directly implicate
    Freddie Mac's financial strength, I believe the integrity of
    financial data is a vital barometer of safety and soundness.
    The breakdown in internal controls that produced Freddie Mac's
    accounting mishap was a managerial failure that, if duplicated
    in a different function, could have had catastrophic
    implications. Sound corporate governance and management is a
    key element of safety and soundness.
        In September, the Subcommittee on Financial Institutions
    held a hearing on the current oversight of the Federal Home
    Loan Bank System, and I want to commend Senator Bennett for his
    leadership and foresight in having that hearing. That hearing
    raised many questions regarding the current oversight of the
    Federal Home Loan Banks. I am hopeful that we will be able to
    expand upon some of those questions today.
        Several Members of this Committee have put forth proposals
    to reform the regulation of the housing enterprises, and I want
    to recognize the efforts of Senators Hagel, Dole, Sununu, and
    Corzine in that regard. Your efforts have given this Committee
    a solid foundation upon which to build. I again want to thank
    all of the witnesses for appearing before the Committee today.
    We look forward to your testimony.
        Senator Sarbanes.

                 STATEMENT OF SENATOR PAUL S. SARBANES

        Senator Sarbanes. Mr. Chairman, thank you for convening
    this important hearing. We were originally scheduled to hear
    Secretary Snow on this very day with respect to the exchange
    rates and manipulation of currency to gain trade advantage.
    This is, of course, very much a pressing issue now, and the
    President goes to the Far East and will be meeting with
    officials in Japan and China. Of course, the subject of this
    hearing is an important issue as well, and I recognize that the
    Treasury has not yet come forth with its exchange rate report.
    I understand it will come by the end of the month and that you
    have rescheduled a hearing with Secretary Snow for October 30.
        Chairman Shelby. Absolutely, right here.
        Senator Sarbanes. And I look forward to that hearing and
    discussing that subject, in depth with the Secretary.
        I take it we will have the report before that hearing, Mr.
    Secretary?
        Secretary Snow. Senator, I originally intended, to have the
    report with the testimony.
        Senator Sarbanes. All right. So we will have it before or
    at the hearing.
        Secretary Snow. Yes.
        Chairman Shelby. Will it be contemporaneous with the
    hearing?
        Secretary Snow. Contemporaneous with the hearing, right.
        Chairman Shelby. Okay.
        Senator Sarbanes. On today's subject, Mr. Chairman. The
    entities that we are examining--Fannie Mae, Freddie Mac, and
    the Federal Home Loan Banks--together with the Federal Housing
    Administration, have made the American home finance system the
    deepest, most liquid, and most innovative system in the world.
        These GSE's collect capital from around the globe to invest
    in mortgages for homeowners and rental properties here in
    America. They have helped to create the historically high
    homeownership rates we are currently enjoying in this country.
    About two-thirds of all Americans own their homes.
        I might mention, since I see Secretary Martinez at the
    table, I heard the story on the radio this morning of your
    people in Florida. They own their home, but they do not own the
    land on which their home is located. These are these trailer
    homes in Florida.
        Senator Martinez. Yes, sir.
        Senator Sarbanes. Now they are going to redevelop high-cost
    condominiums. These people are being told they have to move
    their trailers, which they have not done in 25 years.
    Apparently they will just fall apart if they try to move them.
    You have a lot of elderly down there. It seems to me it is a
    problem HUD better look at. I hope you are doing that.
        Mr. Chairman, you mentioned the size and complexity of the
    GSE's. I will not repeat those figures, but they obviously make
    the point. That, together with the central role they play in
    the smooth running of our mortgage markets, obviously means
    that we have a special responsibility in this Committee to
    ensure the public that the institutions are well-regulated,
    properly supervised, and thoroughly examined.
        We are fortunate that at least thus far, as best we know,
    the problems at Freddie Mac appear to be governance and
    accounting problems rather than risk management problems. And
    the issues at the Federal Home Loan Banks, some of them, while
    serious, are still relatively small in nature. But it is
    appropriate that we look carefully at these issues.
        I look forward to working with my colleagues to try to
    craft a piece of legislation that provides for strong safety
    and soundness with respect to the GSE's.
        Finally, Mr. Chairman, let me say the Administration has
    requested an additional $7.5 million for OFHEO to conduct
    reviews of accounting practices at the Enterprises it
    regulates. I very strongly support that request, and I hope we
    will be able to work to make sure the appropriators include
    this additional funding in the fiscal year 2004 budget.
        While we are deliberating on creating a new, more effective
    regulatory structure, I think we need to make certain that the
    current regulator is adequately funded in order to address the
    immediate situation which they confront. And I very much hope
    that that appropriation will make its way through the process
    and that the Administration's request will be positively
    addressed.
        Thank you very much.
        Chairman Shelby. Senator Bennett.

                 STATEMENT OF SENATOR ROBERT F. BENNETT

        Senator Bennett. Thank you, Mr. Chairman. I appreciate your
    holding these hearings. I think they are probably some of the
    more significant hearings we will hold this year, not because
    there is a crisis with respect to Fannie, Freddie, and the
    Federal Home Loan Banks in this area, but because we need to be
    alert to the possibility that a crisis might arise.
        We have to recognize with some significant approval the job
    that Fannie and Freddie have done. The fact that some Federal
    Home Loan Banks want to get into that market more aggressively
    than they have been illustrates how important it is. Markets
    are working. They are working in ways that benefit Americans,
    and as Senator Sarbanes has indicated, Americans have a higher
    degree of homeownership than any other industrialized country.
    And the success of Fannie and Freddie is a large reason why
    that is the case.
        But as they grow, people get nervous. As the numbers get
    into the trillions, even Congress begins to pay attention. And
    it is very appropriate that we air all of the issues as
    thoroughly as this hearing and other hearings will do, and that
    we look at the question of appropriate regulation in as careful
    a manner as we possibly can.
        So, I congratulate you on holding the hearings. I look
    forward to the witnesses. I think it is a demonstration of the
    seriousness of the topic that we have two Cabinet officers as
    our first witnesses and three CEO's as our second panel of
    witnesses. This is not an issue that should be dealt with by
    the second team, and we are very glad that we are getting the
    first team here, both with this panel and the one that will
    follow. And I look forward to hearing what they have to say
    with great interest.
        Chairman Shelby. Senator Reed.

                     STATEMENT OF SENATOR JACK REED

        Senator Reed. Thank you very much, Mr. Chairman. I
    appreciate the fact you are holding this very important
    hearing, and I welcome Secretary Martinez and Secretary Snow.
        As we all know, the Government Sponsored Enterprises have
    played an invaluable role in stabilizing and improving the
    availability of funds to support homeownership in our country.
    This has resulted in the United States having one of the
    highest homeownership rates in the world, and strong and
    effective oversight of the GSE's is clearly an important part
    of their long-term success.
        As we begin to delve into how to strengthen our GSE
    regulators, it is increasingly clear how complicated this task
    may be, especially if we decide to change the regulator for the
    Federal Home Loan Banks as well. It is my hope, Mr. Chairman,
    that you intend to hold several more hearings on this matter so
    that we can fully debate the many issues and hear from other
    stakeholders in the housing industry as well as housing experts
    on this matter. For example, proposals such as allowing the new
    regulator to set the minimum capital standard for the GSE's are
    worthy of their own hearing so that this Committee can better
    understand the ramifications of such a change in the housing
    market.
        Needless to say, I look forward to this morning's testimony
    and hope it can help this Committee begin to decide what we can
    do to strengthen the regulation of our housing GSE's.
        Thank you very much, Mr. Chairman.
        Chairman Shelby. I believe Senator Dole was here much
    earlier.

                  STATEMENT OF SENATOR ELIZABETH DOLE

        Senator Dole. Thank you, Mr. Chairman.
        First of all, I would like to reiterate something we all
    believe in: Homeownership is a cornerstone in the foundation of
    the American Dream. Each of us here today is committed to
    ensuring that every American can one day own his or her own
    home. Homeownership creates wealth and improves our
    neighborhoods and communities to the greater benefit of us all.
        It is for this reason that we committed to strengthening
    every step in the mortgage process. This past June, when the
    Freddie Mac board removed its three highest executives, we
    learned of violations of generally accepted accounting
    principles at the GSE in order to hide profits so as to
    minimize volatility in earnings. That is an unacceptable
    practice that must never happen again.
        While the uncovering of this scandal will result in the
    eventual restatement of earnings for the past 3 years, I fear
    that the clear lack of oversight could result in a coverup of
    potential future losses. Changes should be made to prevent
    this.
        During the last Congress, the Banking Committee passed the
    Sarbanes-Oxley corporate accountability law to ensure greater
    transparency of our Nation's corporations. It strikes me as
    ironic that the next scandal would occur at a Government
    Sponsored Enterprise.
        Let me be clear: Fannie Mae and Freddie Mac serve very
    important roles in our mortgage finance system by providing
    liquidity in the market. They were given a charter that, in
    2001, the Congressional Budget Office estimated to be worth a
    $10.6 billion annual subsidy. With these built-in advantages,
    Fannie Mae and Freddie Mac have been able to increase
    homeownership, especially for low-income and minority families.
    We all support this goal and will ensure that such efforts
    continue.
        We must take steps to guard against the potential of any
    more scandals and to ensure that these organizations can
    continue their important mission. Because of the recent
    recognition that the current regulator lacks the tools and the
    mandate to adequately regulate these enterprises, I have
    introduced legislation with Senators Hagel and Sununu to create
    a world-class regulator in the Department of the Treasury. A
    consensus has formed in support of this initiative, and I
    strongly urge all of my colleagues to take a look at our
    legislation.
        As we move forward on this issue, it must be remembered
    that the operations of these housing enterprises entail a
    certain degree of risk. Fannie and Freddie do a tremendous
    amount of hedging with derivatives, such as interest rate
    swaps. Together, they held more than $1 trillion worth of these
    interest rate swaps in 2002. A February OFHEO study concluded
    that not only might the GSEs' demand for hedges outstrip supply
    in the near future, but also that a financial problem at one
    GSE could quickly spread to counter-
    parties.
        Clearly, this is not a situation we can afford to ignore,
    and we certainly cannot make only half an effort. I want to
    thank Chairman Shelby for scheduling this hearing and, in doing
    so, making this issue a priority. I look forward to working
    with my colleagues as we seek to properly address the need for
    a well-funded, well-equipped, world-class regulator for Fannie
    Mae and Freddie Mac.
        Finally, let me thank Secretaries Snow and Martinez for
    coming here today to discuss this issue. We thank you both for
    your time, your dedicated service, and for your interest in
    working with us on this issue of such importance to all
    Americans.
        Thank you.
        Chairman Shelby. Senator Corzine.

                  STATEMENT OF SENATOR JON S. CORZINE

        Senator Corzine. Thank you, Mr. Chairman. I appreciate your
    holding this hearing, and I welcome the witnesses. I would
    concur with the view that it obviously speaks to the importance
    of this issue that we have the leaders of the appropriate
    organizations to be here, both in this panel and the next.
    GSE's play an essential role, in my view, in aiding our economy
    and aiding one of those parts of our economy that has been a
    bright spot not only in recent years but also for a very
    extended period of time as our economy has been the strongest
    in the world over a period of history. Homeownership is a
    cornerstone of the American Dream, as Senator Dole mentioned,
    and that is both for individuals and our communities. And the
    size and the complex nature of the structures of the GSE's--and
    they truly are complex within any kind of context of one
    looking at a financial institution--account for billions of
    dollars of mortgage finance dollars. And the critical role they
    play in our housing market does require the oversight by a
    credible, capable regulator that is up to the job of providing
    rigorous oversight.
        In my mind, the current system of supervision has failed to
    meet those standards, and I think the ongoing accounting issues
    at Freddie Mac and those that are now appearing at some of the
    Federal Home Loan Banks attest to that.
        To that end, I introduced legislation several weeks ago
    that I believe evolves the regulatory structure in a way that
    meets the problem without undermining the successful role that
    the GSE's play specifically in the housing market and for our
    economy in general. There are really four key elements to this
    legislation I proposed, actually common with a number of the
    other discussions that others have put forward: Establish a
    new, independent regulator that is credible and capable;
    assuring safe and sound capital; promoting transparency through
    enhanced disclosures; and taking an incremental approach as
    opposed to a one-shot approach to consolidating the supervision
    of the Federal Home Loan Bank System under the regulatory
    framework contained in the bill.
        I do believe we have to be careful here that we do not
    tinker with a system that has actually produced an enormous
    capacity to promote homeownership in this Nation. I think it
    has been absolutely key to that effort. And I understand that
    there are others that have proposals. I look forward to working
    with all on the Committee and certainly you, Mr. Chairman, and
    the Ranking Member. Doing this right is more important than
    doing it immediately. I concur with Senator Bennett that while
    there are serious problems and ones that we need to address, I
    do not think we are dealing with a crisis here. It is one that
    I think needs to be addressed in a way that makes certain that
    our markets continue to have the breadth and depth that these
    two institutions and actually the Federal Home Loan Banks have
    helped fund.
        I will leave the balance of my statement for the record,
    but I have tried to be detailed about the nature of the
    proposal that I have laid down. Hopefully, we will all have
    continuing discussions on this, and I am sure we will.
        Thank you, Mr. Chairman.
        Chairman Shelby. Thank you.
        Senator Enzi.

                  STATEMENT OF SENATOR MICHAEL B. ENZI

        Senator Enzi. Thank you, Mr. Chairman. I appreciate your
    holding this hearing and the Secretaries for being here for it.
        The past decade has brought tremendous change to the
    housing industry. The increase of homeownership for families
    has been one of the great success stories of our economy. In
    Wyoming, the housing market presents many difficulties. Rural
    housing needs are ever increasing, affordable housing in
    atypical places like Jackson are in great demand, and the
    unique challenges of home lending to our Native American tribes
    are but a few of the issues that Wyomingites face.
        In Wyoming, the Government Sponsored Enterprises have
    greatly helped to pull together the necessary financing and
    community backing to make homeownership in these challenging
    environments possible. Fannie Mae, Freddie Mac, and the Federal
    Home Loan Bank of Seattle have worked closely with nearly 50
    community banks in the State to find creative solutions that
    are essential in helping families achieve the American Dream.
        While the Government Sponsored Enterprises have facilitated
    and expanded the homebuying opportunities for families, the
    Enterprises, overall, engage in very complex and intricate
    financial transactions. At this time, the financial stability
    of the housing enterprises does not appear to be in jeopardy.
    However, I believe the regulators of the Enterprises should
    have the tools and resources necessary to oversee the complex
    financial transactions.
        In early August, I sent a letter to Secretary Snow,
    together with Senators Bennett, Johnson, and Schumer,
    supporting the move of the financial oversight responsibilities
    of the Office of the Federal Housing Enterprise Oversight,
    OFHEO, to the Department of the Treasury, providing that the
    new regulator was sufficiently financed. I still support that
    move.
        Since that time, the issues surrounding the move of the
    regulator have become more complex. Recently, there have been
    calls to add the regulator of the Federal Home Loan Bank System
    to the proposed regulator. While I believe that the Federal
    Finance Housing Board needs to improve its financial oversight
    over the Federal Home Loan Banks, I also believe that bringing
    the two regulators together just because they regulate
    Government-sponsored entities is shortsighted.
        Fannie Mae and Freddie Mac operate quite differently than
    the Federal Home Loan Banks. Any proposal to bring the
    regulators together must recognize their unique differences and
    must place sufficient firewalls to keep the regulatory
    oversight of the two systems separate. I strongly encourage
    that we review this matter more thoroughly before rushing to a
    judgment.
        Again, I thank you for being with us today, and I would
    also like to thank the distinguished second panel for being
    with us as well. I look forward to their testimony.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Schumer.

                STATEMENT OF SENATOR CHARLES E. SCHUMER

        Senator Schumer. Thank you, Mr. Chairman. I appreciate the
    opportunity to say something here. I will be brief and ask
    unanimous consent that my opening statement be put in the
    record.
        Chairman Shelby. Without objection, your opening statement
    will be made part of the record.
        Senator Schumer. Thank you. And I want to thank the
    Secretary for being here as well.
        I would just make one point here. What is vital to me here
    is that Fannie and Freddie be able to continue in their mission
    to perform--to fill in niches in the market that the private
    sector may not be able to fill in or it takes 10 years to fill
    in afterwards.
        I have found in my State, when we have particular problems
    in suburban areas, for instance, where costs have gone way up
    and policemen, firemen, and teachers cannot afford a home,
    Fannie and Freddie have been the only group to devise policies,
    working with banks, that will fill in those gaps and make it
    easier for those people to live there rather than commute 100
    miles away. Or in our inner city, we have some poor people who
    have--these are Hassidic Jews who have 10 or 12 children and
    are very poor. And they continue to live in the city. It is
    very hard for them to make out.
        Again, Fannie and Freddie have filled in the lurch. If we
    go to a strictly actuarial standard here, I think we will lose
    those things. And so I am deeply concerned, Mr. Secretary, that
    while I have no problem giving Treasury an oversight
    responsibility in terms of safety and soundness--and I want to
    make sure that capital requirements--which, as you may know, I
    have been very much involved with when we wrote the old S&L law
    as a way to strengthen the S&L industry--are strong. I would
    feel very strongly--I would fight very strongly against the
    mission parts of Freddie and Fannie, the approval of new
    products going to Treasury, which has a more actuarial point of
    view, than to HUD--and I love both of you dearly; this has
    nothing to do with either of you--than to HUD, which cares
    about the housing mission. And that will guide much of what I
    do.
        I think you can have both. You do not have to throw out the
    baby with the bath water. You can tighten up the actuarial
    oversight of Fannie and Freddie, given their importance, and
    still maintain the vigor of their mission. And having the
    actuarial part in Treasury and the mission part in HUD makes a
    great deal of sense to me.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Hagel.

                    STATEMENT OF SENATOR CHUCK HAGEL

        Senator Hagel. Mr. Chairman, thank you. And welcome to our
    panelists this morning. It is always helpful and a pleasure to
    see the Secretaries of Treasury and HUD with us. And we also
    appreciate the second panel, President Rice, Director Gould,
    and Chairman Raines. We look forward to their testimony.
        As we discuss significant changes to the supervision of
    Fannie Mae, Freddie Mac, and perhaps to Federal Home Loan
    Banks, I think it is important to reflect on why we are here.
    What is our central purpose in the reform we are considering?
    Confidence.
        Confidence in the regulation of Fannie Mae and Freddie Mac
    is critical for the future. The accounting and management
    problems discovered at Freddie Mac earlier this year shed light
    on a problem that some of us have been concerned about for some
    time. We must do a more responsible job of regulating Fannie
    Mae and Freddie Mac, we owe it to the residential mortgage
    market, we owe it to the investors, and we owe it to the
    American taxpayer.
        Congress created Fannie and Freddie and provided them with
    an implied Government backing. Congress must, therefore,
    provide a world-class regulator. Our goal here is to create a
    strong, independent regulator with the tools necessary to
    effectively examine two of the world's largest financial
    institutions and the expertise to minimize the risk to
    investors and the public.
        In introducing the Federal Enterprise Regulatory Reform
    Act, S. 1508, Senators Sununu, Dole, and I offered one model, a
    beginning for an effective new regulator. And I want to
    highlight two principles contained in our bill, and the
    Administration's proposal, which are, in my opinion, essential
    to a credible regulator for Fannie and Freddie.
        First, the new regulator at the Treasury Department must
    have the authority to approve new programs and ensure Fannie
    and Freddie continue to focus on their core missions as defined
    and established by the Congress of the United States. I agree
    with Secretary Martinez that HUD should focus its energies on
    setting and enforcing meaningful, affordable housing goals for
    Fannie and Freddie. Treasury needs the authority to approve the
    new programs.
        Second, an effective regulator must have broad authority
    over capital standards and the ability to adjust them as
    appropriate to balance risk and ensure safety and soundness. I
    am not advocating for immediately increasing the amount of
    capital that Fannie and Freddie must hold, but I strongly favor
    giving the new regulator the ability to do so when it believes
    it is appropriate.
        Some have recently asserted that too much attention on
    safety and soundness will undermine Fannie and Freddie's
    ability to play a leading role in affordable housing. I believe
    just the opposite to be true. The more soundly these companies
    are capitalized, the stronger they will be perceived in the
    marketplace. Higher confidence by investors leads to lower
    interest rates for homebuyers. Mr. Chairman, to be effective, a
    world-class regulator needs these two components.
        Finally, I want to comment on another important aspect of
    the reform we are considering, that is, the inclusion of the
    Federal Home Loan Bank System under the same new regulator that
    we construct for Fannie and Freddie. While I am not opposed to
    including the Federal Home Loan Banks, they differ
    significantly, greatly, as Senator Enzi has just mentioned,
    from Fannie and Freddie. And these differences must be
    addressed and factored into any new regulatory reform we
    consider. Unlike Fannie and Freddie, the banks are
    cooperatives, owned by member institutions in their assigned
    States. They are locally controlled and sensitive to the unique
    and varied financial needs of local communities and issue their
    debt securities through a central Office of Finance, which is
    operated by the 12 Banks collectively.
        While a consensus seems to be forming around inclusion of
    the Federal Home Loan Banks, that does not mean we have to do
    it right away or in the same bill as Fannie and Freddie. This
    is an option. It surely is an option. As with all reform, it is
    more important that we do it right than we do it quickly.
        Again, Mr. Chairman, I appreciate your holding the hearing,
    and I also look forward to our witnesses and working with them
    through this process. Thank you.
        Chairman Shelby. Senator Crapo.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you very much, Mr. Chairman. I will be
    brief. I know we want to get to the witnesses.
        I share the concern that has been raised by, I think, all
    of my colleagues with regard to the failure of OFHEO to pick up
    on the problems that have come to light recently and the
    impetus for this hearing. I appreciate the Chairman holding
    this hearing and the important issues that we are dealing with.
    I will just make a couple of brief comments on a couple of the
    issues that have already been raised.
        First, I am very interested in the proposal to include the
    Federal Home Loan Banks in the regulatory system that we are
    considering establishing. I recognize the differences that
    exist and I am very concerned that as we approach this matter,
    we recognize those differences and assure that whatever we
    establish does not overlook the fact that very different
    approaches need to be taken with regard to the regulation and
    oversight of the Federal Home Loan Banks vis-a-vis Fannie and
    Freddie.
        That having been said, I can also see some very significant
    benefits of having them both housed at Treasury and having a
    system where an independent regulator oversees the operations
    of both, because although there are major differences, there
    are also increasing numbers of similarities in the types of
    activities and objectives that both are seeking to address. And
    I am looking forward today very closely to listening to the
    testimony on that issue.
        Second, with regard to the question of where the authority
    over missions and programs of the GSE's should be housed, I
    tend to see the validity, as several of my colleagues, most
    recently just Senator Hagel, have indicated, that the authority
    over the new programs, the new missions, needs to be with the
    financial regulator in Treasury. I will listen very carefully
    to testimony and points brought up on both sides of that issue,
    but it seems to me that we need to be certain that the
    regulatory system we put into place is one in which there is
    fairness, there is that balanced playing field that we always
    talk about in different contexts as we have different types of
    entities being regulated in the same arena, and that we make
    certain that the scope of regulatory authority is sufficient
    for effective regulation and oversight to be accomplished.
        With that, Mr. Chairman, I will withhold the rest of my
    comments and concerns until a later time. Thank you.
        Chairman Shelby. Thank you.
        Senator Carper.

                 STATEMENT OF SENATOR THOMAS R. CARPER

        Senator Carper. Thanks, Mr. Chairman.
        To Secretary Snow, Secretary Martinez, welcome. It is good
    to see you both. We thank you for your presence here and for
    your stewardship, your responsibilities.
        Before I talk just a little bit about some areas where I
    think there seems to be general consensus, and maybe a couple
    of areas where there is not, let me just say that some of you
    may recall hearing the old adage, ``If it ain't broke, do not
    fix it.'' I have said that once or twice. Maybe some of you
    have as well. ``If it ain't broke, do not fix it.'' I think
    what applies here, instead of that approach, is an approach
    that says, ``If it is not perfect, make it better.''
        We have a wonderful ability in this country to generate
    capital and provide that capital for housing, and it is not
    broken. It is not perfect, and we can make it better, and my
    hope is that we will.
        The problems that led to the passage of the Sarbanes-Oxley
    legislation are in many cases created when companies
    understated expenses and they overstated revenues. And they
    were deceitful about it. There was not enough disclosure or
    transparency. They got into trouble and, frankly, created a lot
    of problems for our country and led to the passage of the
    legislation.
        This is not that kind of situation. The problem they had at
    Freddie Mac was a problem, for the most part, where they were
    not overstating revenues, but where they actually were
    understating revenues, and in some cases overstating expenses.
    Quite a different problem. I guess if you are going to have a
    problem, that is the better problem to have. But it is not
    right. It is not the right thing to do.
        I want to mention three or four areas where I think there
    is general consensus for us to go forward, and one of those is
    the idea that we need to create an independent, strong
    regulator, and there seems to be consensus that it should be in
    Treasury. Second is that the regulator should not be subject to
    the annual appropriations process. A third area of general
    consensus, it seems at least to me, is that affordable housing
    goals should remain the purview of HUD. And, finally, the
    housing mission of the GSE's should not be changed. Not
    everybody agrees with those, but I think for the most part
    there is consensus around those points.
        There are a number of areas where there is not a consensus.
    I will mention maybe three. One is the ability of the new
    regulator to set minimum capital standards. Second would be the
    location of program approval authority and the standard for
    those new programs. And last is the inclusion or whether or not
    we should include within this new regulatory scheme Federal
    Home Loan Banks in any kind of approach or the way we change
    business.
        My hope, Mr. Chairman and colleagues, is that what is going
    to flow from these hearings, this hearing today and maybe those
    that follow it, is that some of the items--if you put two
    columns together where there is general consensus and areas
    where there is not consensus, we will be able to move maybe by
    the end of the day some of those items under lack of consensus,
    maybe move a couple of those over to the column where there is
    consensus. And if we can do that with a few of those today, we
    will have done good work.
        Thank you.
        Chairman Shelby. Senator Sununu.

                  STATEMENT OF SENATOR JOHN E. SUNUNU

        Senator Sununu. Thank you very much, Mr. Chairman.
        What is the saying? ``Everything has been said, but not
    everyone has had a chance to say it.'' But I will do my best to
    make a couple of additional observations that I do think are
    important as we begin this hearing.
        As Senator Bennett said, we are here because we must be
    alert that a crisis might arise. We are trying to be proactive.
    We are trying to do the right thing in dealing with this
    important regulatory issue for the GSE's.
        We have heard about some significant accounting issues,
    cases where in the Federal Home Loan Banks we have had
    portfolio losses. And I happen to believe that misleading
    investors is always wrong. I do not care whether you understate
    profits or overstate profits or intentionally suggest that
    things are not as good as they really are. That is always
    wrong. And the credibility and reliability of our capital
    markets depend on effective regulation to ensure confidence.
        Let us all agree that the affordable housing issues that
    HUD has traditionally dealt with are very important, and the
    role that the GSE's might play in affordable housing is
    important. And those are issues that we will probably want to
    continue to deal with regardless of the final dispensation of
    this legislation. But let us also understand that the record
    has shown that the GSE's have actually lagged the markets in
    meeting affordable housing targets and goals. And I would ask
    unanimous consent that I be allowed to submit the
    documentation, studies, evaluations put together by HUD to that
    effect.
        Chairman Shelby. Without objection.
        [The information follows:]
        Senator Sununu. That does not mean that they have not done
    important work in affordable housing, but it means that if we
    try to look at it objectively and on a statistical level, they
    have not always provided the kind of leadership that we might
    expect from a Government-chartered institution.
        This is about safety and soundness of the GSE's and
    ultimately the credibility and strength in our capital markets.
    It is about having an effective regulator. And I very much
    appreciate the work and the discussion and dialogue that has
    already taken place, the legislation submitted by Senator
    Corzine, the discussions that I have had with other Members of
    this Committee that have not necessarily signed on to
    legislation but are approaching this in, I think, a very, very
    thoughtful way.
        We have to be careful of a couple things: One, that we not
    allow politics to prevent us from doing the right thing for the
    GSE's themselves, for the taxpayers, and for the housing
    markets; and, second, that we not just accept a bill because we
    want to check it off our list and say we passed legislation
    dealing with the GSE regulation issue and now we can get on to
    something else.
        No bill would be far better than a poorly written bill. I
    believe this very strongly. If we pass legislation that is all
    form and no substance, we will be doing a disservice to the
    consumers, a disservice to investors, a disservice to
    taxpayers, and I think ultimately a disservice to the GSE's
    themselves, Fannie, Freddie, the Federal Home Loan Banks,
    because the employees at those important and fine institutions,
    their leadership, and their management want to operate in an
    environment of credibility, confidence, and certainty, just
    like any other participant in the private sector of the capital
    markets.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Stabenow.

                  COMMENTS OF SENATOR DEBBIE STABENOW

        Senator Stabenow. Thank you, Mr. Chairman. I would ask that
    my statement be included in the record.
        Chairman Shelby. Your statement will be made part of the
    record.
        Senator Stabenow. Thank you. I would like to offer a
    slightly different view than my colleague who just spoke in
    that, first of all, I think the secondary mortgage market is
    essential to our housing sector and that, in fact, there has
    been great success, and I welcome the opportunity to in the
    future submit for the record evidence as to why these very
    important GSE's have been so significant in terms of providing
    housing opportunities to people.
        We know that there is a growing interest in strengthening
    our housing finance regulators. I share that. We need a highly
    respected independent regulator for Fannie Mae and Freddie Mac,
    and that the Federal Home Loan Bank, of course, needs to be
    soundly regulated. But I appreciate the Chairman's comments at
    hearings in the past in terms of moving forward in a thoughtful
    manner, as the Chairman and the Ranking Member have done on
    other issues. And I am hopeful that we will move forward in a
    thoughtful manner and address what are legitimate concerns
    without, as they say, throwing the baby out with the bath
    water, because I believe that we have had many great successes
    for the American people through the systems that have been in
    place and providing housing which is so critical to all of us.
        I welcome the Secretaries to be with us today as well. I
    look forward to your testimony.
        Chairman Shelby. Senator Bunning.

                    STATEMENT OF SENATOR JIM BUNNING

        Senator Bunning. Thank you, Mr. Chairman, for holding this
    very important meeting. I would also like to thank all of our
    witnesses for testifying today.
        Everyone on this Committee was very troubled at what
    happened at Freddie Mac. Most troubling for me was the fact
    that OFHEO had no idea, until Freddie brought it to their
    attention, what was going on there. No idea.
        While I am happy that Freddie was able to self-police, I
    was astonished by OFHEO's attitude which seemed to come down to
    say, yes, we need more money, but the system worked. OFHEO's
    testimony reminded me of Kevin Bacon's character in ``Animal
    House,'' standing on the corner shouting, ``Remain calm. All is
    well,'' right before he is run over by the mob.
        [Laughter.]
        I am certainly happy that we have all come to the
    conclusion that Freddie and Fannie need to have a new
    regulator. But there are many pitfalls ahead of us. Nobody here
    wants to do anything that would harm our housing market, and
    this new regulatory structure could harm it if we do not do it
    right.
        We should not simply rearrange the deck chairs on the
    Titanic. We should not simply move OFHEO into Treasury and let
    it run the same way. But we also must remember who is affected
    by what we are doing.
        We have few large banks in Kentucky--few. We do not have
    the guys who compete with Fannie and Freddie. We have the guys
    who work with them. They use GSE products to make loans to
    underserved areas so they can bring the dream of homeownership
    to those who otherwise would not be able to afford it.
        They also use GSE products for CRA compliance. They are
    scared to death that this will be harmed by this legislation. I
    want to make sure that they are not.
        I have just one other major concern. On September 9 of this
    year, Assistant Secretary Abernathy was up here. I asked him if
    all GSE's, including the TVA, should have to register with the
    SEC. He said, ``That is our position, yes.'' I have the
    videotape if you would like to see it.
        I understand that someone above his pay grade, which I
    assume is you, Secretary Snow, has said that TVA is not a GSE,
    and so that the statement did not apply. This is very troubling
    to me. If TVA, which was established by the Federal Government,
    runs itself as a quasi-public enterprise and is not a GSE, what
    is it? If the TVA is not Government-sponsored, who sponsors it?
    If it is not an enterprise, what is it?
        Also help me comprehend why the Administration wants the
    Federal Home Loan Banks, which have a regulator and who do not
    sell public stock, to register with the SEC, while at the same
    time it does not call on TVA, which has over $26 billion in
    public traded debt and no regulator, to register with the SEC.
    I cannot comprehend the Administration's position on this.
        I do look forward to further discussions on this question
    very shortly, since I will have a chance to question you in the
    question and answer period. I want to thank you for coming. We
    deeply appreciate your appearance here.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Allard.

                   STATEMENT OF SENATOR WAYNE ALLARD

        Senator Allard. First of all, Mr. Chairman, I would like to
    thank you for holding this hearing.
        I would like to borrow a cliche from the medical community,
    and that is, ``An ounce of prevention is worth a pound of
    cure.'' And I think that my colleagues Senator Hagel as well as
    Senator Sununu hit upon the keyword, which is ``confidence.''
    We simply must have confidence in the secondary markets as well
    as the GSE's. The GSE's themselves will benefit with
    confidence. The investors will benefit with confidence. With
    good confidence, the users benefit. Homeowners certainly are
    beneficiaries as well as the taxpayers.
        So, I am delighted that we are having this hearing. Fannie
    Mae and Freddie Mac were chartered by Congress as Government
    Sponsored Enterprises to create a secondary mortgage market
    which has served us well. It is one of the things that has
    separated us from other parts of the world who are struggling
    with housing. We have housing now at an all-time high, and a
    lot of it is due to the fact that we have a very viable
    secondary mortgage market.
        Although they are private companies owned by shareholders,
    the GSE's retain certain Government ties. For example, they
    have access to a line of credit at the Treasury Department and
    are exempted from paying State and local income taxes. In
    exchange for these benefits, they are required to serve all
    markets and must meet certain affordable housing goals. Since
    their creation Fannie Mae and Freddie Mac have been an
    important source of homeownership for all Americans.
        Over the years, the GSE's have evolved into very large,
    very complex financial institutions. Because of their size,
    complexity, and importance to the financial markets, they
    demand the highest levels of oversight and scrutiny. Currently,
    the Office of Federal Housing Enterprise Oversight, referred to
    as OFHEO, is charged with ensuring the financial safety and
    soundness of the GSE's. But recent events have clearly
    demonstrated that OFHEO as currently structured is insufficient
    as a regulator. This causes me great concern due to the
    implications of homeownership, the markets, and because of the
    belief and implied Government backing of the GSE's.
        Accordingly, the Bush Administration proposed creating a
    new regulator for the housing GSE's. The new regulator would be
    an independent agency with the Department of the Treasury,
    similar to other Federal financial regulators, such as the
    Office of the Comptroller of the Currency and the Office of
    Thrift Supervision. I strongly support creation of a new
    regulator within the Treasury Department because they have
    better financial expertise to oversee the complex financial
    transactions in which the GSE's engage.
        In order to be an effective regulator, the new agency must
    have a broad set of powers comparable to other financial
    regulators, including additional enforcement powers and
    litigation authority. I also believe the regulator must have
    the ability to set capital standards for the GSE's. While we
    have found many areas of agreement, there are still many issues
    to be resolved, including mission regulation and inclusion of
    Federal Home Loan Banks. While I believe that we should move
    quickly in this debate, we must do so with care and
    deliberation. We must ensure any changes strengthen oversight
    of the GSE's and work to promote access to housing.
        I would like to welcome our witnesses today, particularly
    Secretary Snow and Secretary Martinez. I know this Committee
    will work closely with you as we continue to address the GSE
    reform.
        Thank you for being with us here today, and I look forward
    to your testimony.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Chafee.

                  COMMENT OF SENATOR LINCOLN D. CHAFEE

        Senator Chafee. I just want to thank you, Mr. Chairman for
    holding this important hearing.
        Chairman Shelby. Mr. Secretary, both of you, Secretaries
    Snow and Martinez, we welcome you again to the Committee. Your
    written testimony will be made part of the record in its
    entirety.
        Secretary Snow, you may proceed as you wish.

                       STATEMENT OF JOHN W. SNOW

               SECRETARY, U.S. DEPARTMENT OF THE TREASURY

        Secretary Snow. Thank you very much, Mr. Chairman, Ranking
    Member Sarbanes, and Members of the Committee. I greatly
    appreciate the opportunity to appear before you today with
    Secretary Martinez--can you hear me, Senator?
        Chairman Shelby. Bring it up closer to you.
        Secretary Snow. I greatly appreciate the opportunity to
    appear today before you with Secretary Martinez to address what
    is really a vitally important subject, a subject that raises
    complex and important issues and a subject that touches on
    something that has been mentioned in all of your statements a
    subject that is critically important, and that is homeownership
    in America. It is an important building block of individual
    financial security. It is also a building block for strong
    communities, as has been mentioned. So promoting housing
    opportunities, particularly for lower-income people, is a
    critically important national objective.
        Our national system of housing finance, as has been pointed
    out as well, plays a critical role in doing that. So we need a
    strong, resilient housing finance system. And to have that
    strong, resilient housing finance system, you need a regulator
    with credibility. A strong, credible regulator contributes
    importantly to having a strong, resilient housing finance
    market, which in turn promotes housing opportunities.
        But we have in the GSE's entities which are very large not
    just in terms of housing finance, but are very large in terms
    of the total U.S. financial system. And that is where we run
    into the fundamental issue we have to keep our eye on
    throughout these discussions. And it goes to the issue that
    Senator Hagel mentioned, that Senator Sununu mentioned, that
    others mentioned, of the so-called implied governmental
    guarantee. And that implied governmental guarantee can
    complicate the performance of the entire financial system of
    the United States.
        We need a world-class regulator to watch that issue, to
    watch the soundness and safety of housing finance and the
    relationship of housing finance to the resiliency of our
    financial markets.
        As Senator Allard said--and this is the situation we are
    dealing with here--an ounce of prevention. We do not face, in
    my view, any current crisis, but we never want to get close to
    the point where we would face that problem.
        The best insurance against ever getting there, at the same
    time the best insurance of having a strong, resilient finance
    market which promotes strong homeownership, is a sound
    regulator.
        In my extended testimony, I laid out what I think are the
    elements of a strong regulator. Some of you have mentioned
    them. Senator Hagel mentioned them. First, a sound regulator,
    in the context that I am talking about, a strong regulator who
    is focused both on soundness and safety of housing, but in the
    context of the soundness and resilience of the entire financial
    system, that regulator has to have a say on new products and
    new lines of business. Any strong financial regulator has that.
    Nowhere in the world is there a strong financial regulator who
    does not have an important say on the lines of business of the
    entities that it regulates.
        Second, that strong, effective regulator has to have an
    important say on capital standards, and it has to have the
    ability to adjust the capital standards to whatever the
    circumstances are that dictate a change in those standards. A
    good regulator has flexibility. A good regulator responds to
    the circumstances that that regulator finds call for action.
    And so a second element here would be flexible control over
    capital standards.
        Third, I think the regulator needs to have appropriate
    wind-down authorities; that is, if for some reason one of these
    entities got into difficulty, just like any other private
    sector entity, there needs to be the ability to pay the
    creditors. Wind-down authority, but wind-down authority
    recognizing that you, the Congress, have chartered these
    entities.
        Fourth, I would suggest that the proposal would be stronger
    and better if it did include the Federal Home Loan Banks. They,
    too, are part of this very large housing finance market. They,
    too, have implications for the resiliency and soundness of our
    entire financial system. They are engaged in activities that
    are very similar to those of the other housing GSE's. There are
    some important differences. They would need to be recognized in
    the legislation. I would acknowledge that. But I think if we
    are going to deal with this issue really effectively, we should
    also look at including the Federal Home Loan Banks.
        Finally, there is the question: Where should this new,
    strong regulator be? Our focus is with the strong regulator
    rather than its venue, and I have said in the House that if the
    Congress, if the Senate Banking Committee wants to consider
    Treasury, we are happy to have that discussion. But only if--
    and I need to be really clear on this because of the enormous
    problems that can develop otherwise for the financial system in
    the United States--only if the Treasury adds some value and
    avoids the implication that the implied guarantee is being
    reinforced, because in that lies real trouble.
        So we would say if the Congress, if the Banking Committee
    wishes to consider Treasury, we would suggest you only do so if
    you put Treasury in a position to have some real say with the
    new regulator, a real say so that if there is confusion about
    this entity's being in Treasury and thus creating a larger
    governmental hug, a reinforced implied guarantee, we can
    disabuse the markets of that impression.
        Now, how do we do that? We would say that Treasury should
    have a say on new regulations. It should have a say on
    testimony. And it should have a say on budget.
        But let me conclude simply by saying the important issue
    here is a strong regulator. There were suggestions to have that
    strong regulator be an independent body. Wherever you go on
    that path, I would suggest the important thing is to make sure
    the new regulator really has credibility, really can do the
    job, really has the tools that all world-class financial
    regulators have, a say over new products, a say over capital
    standards, and a clear say over wind-down authority.
        I thank you very much.
        Chairman Shelby. Secretary Martinez.

                       STATEMENT OF MEL MARTINEZ

                               SECRETARY

            U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

        Secretary Martinez. Mr. Chairman, thank you very much.
    Ranking Member Sarbanes and distinguished Members of the
    Committee, it is a pleasure to be here today, with my colleague
    Secretary Snow, to talk about this important set of proposals
    of regulations for the Government Sponsored Enterprises.
        Before proceeding to talk about that, I want to just take a
    brief moment to thank the Committee for your support yesterday
    of the American Dream Downpayment Initiative. The President and
    I were in Dinuba, California, yesterday talking about
    homeownership and the importance of downpayment assistance, and
    your move yesterday on that legislation is an important step in
    that direction of creating homeownership opportunities for more
    American families. So we thank the leadership of the Committee
    and all of the Committee Members for your support.
        We believe that Congress, at this point in time, has not
    only an opportunity, but also really an obligation to move
    forward in this area of reform of the regulatory oversight of
    the GSE's. Fannie Mae and Freddie Mac have a vital public role
    to play in providing homeownership opportunities to low- and
    moderate-income families. The fact that we are a Nation of
    homeowners reflects the beneficial impact of the role these
    companies were created to perform, has on American life. The
    Bush Administration is committed to creating opportunities for
    homeownership in America, and that is why we believe it is
    important that these companies fulfill their mission. The best
    way to ensure that they do so is through real and lasting
    reform that enhances their financial regulation, while
    preserving and expanding their commitment to affordable
    housing.
        The Administration is committed to a society where every
    individual has the opportunity to gain the independence and
    dignity that comes from homeownership. This commitment is
    embodied in the President's budget proposals which have
    consistently increased funding for successful initiatives, like
    the HOME Investment Partnership Program, housing counseling,
    and the Self-Help Homeownership Program. The commitment is
    embodied in the President's challenge to the housing industry
    to join with us in creating 5.5 million new minority homeowners
    by the end of the decade. It is embodied in the Blueprint for
    the American Dream Partnership, through which HUD has brought
    together the private, public sector and not-for-profit and the
    Government agencies to meet the President's challenges.
        Fannie Mae and Freddie Mac are founding members of the
    Blueprint Partnership, and we appreciate their pledge to invest
    billions of dollars to lift more families into homeownership.
        The Administration's commitment to homeownership
    opportunities is not confined to our activities at HUD. It
    begins with the President and stretches across the whole of the
    Federal Government, and our proposal today reaffirms that
    commitment.
        Our reform proposal is consistent with this
    Administration's commitment to do everything necessary to
    foster a healthy and vibrant housing industry, which today
    accounts for roughly 14 percent of the Nation's gross domestic
    product. The potential impact of Fannie Mae and Freddie Mac
    upon the economy and housing programs makes it critical that we
    ensure their safety and their soundness.
        To be effective, a regulator charged with overseeing
    prudential operations, including safety and soundness, needs
    the proper tools to do its job. Currently, safety and soundness
    regulation is divided with new program approval authority being
    at HUD and financial oversight of the Office of Federal
    Enterprise Oversight. It is clear to us that both elements of
    safety and soundness regulation need to be consolidated in a
    single regulator. Splitting this regulation between two
    regulators weakens each one.
        The decision of whether to approve or deny any new activity
    is based partly on its effect on the prudence of a company's
    operations. It makes little sense to have one entity deciding
    whether or not to approve a new activity while another
    determines whether that activity meets the prudential operation
    test.
        New activities oftentimes directly impact the housing and
    mortgage markets, and for that reason, the Administration
    believes that HUD should retain a consultative role. Other new
    activities do not involve housing or mortgage market issues and
    are therefore most appropriately addressed by a strengthened
    regulator. As part of its consultative role, HUD will provide
    the benefit of its regulatory experience in such issues, and I
    do not see establishing a new and stronger regulator,
    potentially at the Treasury Department, as something that will
    harm the housing market. I see the opposite result: A
    strengthened housing finance system continuing to provide
    homeownership opportunities for all Americans.
        We are not proposing to alter the Congressional charter of
    Fannie Mae and Freddie Mac, nor do we have any intention of
    stifling innovation in the marketplace. Just as other financial
    institutions are subject to new activity approval, yet have
    been leaders in mortgage innovation, so too can Fannie Mae and
    Freddie Mac thrive under the Administration's proposal. Any new
    business activity that Fannie Mae and Freddie Mac wish to
    undertake will be reviewed with respect to consistency with the
    charter act, with respect to whether it is in the public
    interest and with respect to safety and soundness. The Federal
    Housing Enterprise Financial Safety and Soundness Act
    recognizes the need to take all of these concerns into account
    in the review process.
        While prudential operations, regulation, including safety
    and soundness regulation, should be exercised by a single,
    independent regulator, the Administration strongly supports
    retaining and enhancing the housing goals at HUD.
        Congress established Fannie Mae and Freddie Mac to provide
    market liquidity and to facilitate the financing of affordable
    housing for low- and moderate-income families. Congress also
    mandated that the HUD Secretary set housing goals to ensure
    that those needs are met.
        The affordable housing goals require Fannie Mae and Freddie
    Mac to focus on individuals in those communities most in need.
    This includes very low-income families and low-income families
    in low-income areas, low- and moderate-income families and
    underserved areas, such as central cities and rural areas.
        Today, the low- and moderate-income housing goal requires
    that at least half of all Fannie Mae and Freddie Mac mortgage
    purchases benefit families in this income bracket. As the
    President's budget noted in February, numerous HUD studies and
    independent analyses have shown that the GSE's have
    historically lagged the primary market, instead of led it, with
    respect to funding mortgage loans for low-income and minority
    homebuyers. The GSE's have also accounted for a relatively
    small share of the first-time minority homebuyers.
        The national home purchase goal we have proposed is a tool
    to specifically promote affordable homeownership. As the
    Members know, low interest rates in recent years have led to a
    boom in refinancings. Although Fannie Mae and Freddie Mac
    provide liquidity in refinancing, the share of funding they
    provide for home purchases declines during years in which
    refinancings are high. Our intent is not to saddle Fannie Mae
    and Freddie Mac with a series of stifling mandates as the
    opponents of reform have suggested, but to ensure, through a
    national home purchase goal, that they do not overlook those to
    whom they owe their primary devotion. This goal will certainly
    not unduly limit the ability of Fannie Mae and Freddie Mac to
    serve the refinance market or the multifamily market.
        Allow me to also clarify this proposal for a new goal, as
    some confusion has arisen over it. HUD is not asking for the
    authority to set overall home purchase levels for Fannie Mae
    and Freddie Mac, but instead is asking for the authority to
    ensure that the home purchase activity that takes place be
    equitably distributed among central cities and rural ares, low-
    and moderate-income families, special affordable homebuyers,
    and first-time homebuyers, just as HUD does for the existing
    housing goals. That is why HUD has asked for the authority to
    establish home purchase subgoals corresponding to these four
    categories, similar to the subgoal authority it presently has
    under the three existing goals. HUD is not asking for the
    authority to set home purchase subgoals in individual
    metropolitan and regional markets. HUD seeks only to set
    national subgoals so that Fannie Mae and Freddie Mac's home
    purchase efforts are fairly spread among these four categories.
    HUD also asks that these subgoals be enforceable.
        HUD is the appropriate agency to develop and enforce the
    housing goals. Institutionally, our mission is devoted to
    furthering the goals of affordable housing and homeownership,
    and HUD has the most expertise of any Federal agency in this
    area. Furthermore, the housing industry looks to HUD as the
    agency in which this authority should reside.
        In the Administration's proposal, HUD will not only retain
    authority to set meaningful housing goals, but will also be
    better equipped to ensure that Fannie Mae and Freddie Mac meet
    them. There will be sufficient funding, more accountability for
    Fannie Mae and Freddie Mac, and strengthened housing goals.
        One of the ways in which the Administration proposal has
    proposed strengthening HUD's housing goal authority is by
    creating a new GSE Housing Office within HUD, funded by the
    GSE's, to establish, maintain, and enforce housing goals. We
    also need to improve the Secretary's enforcement authorities
    with respect to these goals and have proposed doing so.
        It is also very important, Mr. Chairman, that fair housing
    requirements and enforcement that pertain to Fannie and Freddie
    remain at HUD, given HUD's expertise in fighting housing
    discrimination. HUD will have full enforcement power for those
    authorities in the same way it enforces the Fair Housing Act.
        A strengthened regulator is in everyone's best interests,
    and we strongly encourage it. The importance of Fannie and
    Freddie in the housing financial system is undeniable, and real
    reform is necessary to ensure the public of the ability of the
    two companies to make low-cost mortgage financing available to
    low- and moderate-income families.
        We look forward to working with the Committee as we develop
    a set of new proposals to have a strong regulator for these
    very important institutions.
        Chairman Shelby. Mr. Secretary, thank you.
        Secretary Snow, assuming that the new GSE regulator were
    placed within the Treasury Department, in terms of
    independence, should the new regulator differ from the OCC or
    OTS model? And, if so, why?
        Secretary Snow. Mr. Chairman, I think there should be some
    differences.
        Chairman Shelby. Why?
        Secretary Snow. Basically, because the OCC regulates 2,000
    national banks and has little risk of what the economists and
    political scientists call regulatory capture. The size of few
    of these entities approaches the size of the two large GSE's.
        Chairman Shelby. But in aggregate, they are larger, are
    they not?
        Secretary Snow. And----
        Chairman Shelby. Wait a minute.
        Secretary Snow. Well, in the aggregate, but there are far
    more than one or two banks. But the more important point is
    they are not issuing debt that is treated as agency debt that
    has a perception of some Government guarantee.
        Now, we do not believe there is any Government guarantee,
    and we go out of our way to say there is not a Government
    guarantee, but yet the market has a perception. I think it is
    terribly important that if the entity is in Treasury, the
    Treasury Department be in a position to continuously avoid the
    confusion, as Treasury is issuing its own debt, that Treasury
    is also party to the debt of an entity which has no Government
    backing. That is the essential distinction here. We need to be
    on guard against this perception. It is a perception. It is
    not, in our view, a reality, but it is a perception of an
    implied guarantee.
        Chairman Shelby. But the trend in financial institutions
    generally dealing with regulation has been to insulate
    regulators from what we call political pressure; that is, like
    OCC and OTS. Why should we buck the trend?
        Secretary Snow. Well, in a number of ways we are doing
    that. We are suggesting that the President forego the ability
    to appoint members of the boards of Fannie and Freddie. We
    think that would be an important way to insulate.
        We are suggesting that the budgets not come before the
    Congress any more. They are not dependent on authorizations and
    appropriations. That insulates it. We are saying that with
    respect to day-to-day operations, supervision, investigations,
    proceedings, the regulator be entirely stand-alone. But with
    respect to policy, we think the Treasury needs to be in a
    position to have a say or else there could be this very
    dangerous thing of a widening of that perception of an implied
    guarantee.
        Chairman Shelby. Mr. Secretary, you also mention in your
    testimony that you would like the new regulator of the GSE's to
    have the same product review authorities as the banking
    regulators have today, but with respect to both OCC and the
    Fed, banks are only required to notify their respective
    regulator after they have engaged in new activity. There is no
    preapproval standard in the bank regulatory world that I know
    of. How do you rationalize that?
        Secretary Snow. Well, I do not think we are asking for a
    prior approval. We just need the ability to weigh in.
        One of the things I have learned about regulatees is if
    they know they are being watched by a regulator, they tend to
    talk to the regulator in advance of doing what they might
    otherwise do. So I think there would be good communications on
    new products and activities.
        Chairman Shelby. But you are not asking for prior approval.
        Secretary Snow. We are not asking for it and do not think
    we need it.
        Chairman Shelby. Secretary Martinez, since we have 13-14
    Senators, I am going to try to enforce the 5-minute rule
    starting with myself. So you will have to be quick.
        Secretary Martinez. All right, sir.
        Chairman Shelby. The mission of Fannie Mae and Freddie Mac
    is expanding homeownership and the housing goals are a
    barometer of that mission.
        Secretary Martinez. That is correct.
        Chairman Shelby. Do you believe that the current housing
    goals are sufficient to fulfill the GSE's mission here?
        Secretary Martinez. No, sir, I think we should have an
    expanded goal of home purchase goal, and that goal would allow
    us to not only have the underserved areas, rural and central
    city, the low- and moderate-income and special affordable
    housing, but also a home purchase goal to ensure that they are
    involved even in refinancing booms with first-time homebuyers.
        Chairman Shelby. How do you see the dividing line between
    encouraging affordable mortgage lending and credit allocation?
    How do we make sure the goals are insulated from the political
    process?
        Secretary Martinez. Well, I believe even now that they are,
    and I think they are set for a 3-year period of time. I think
    we can continue to do that, and I think it is important that we
    have the GSE's sticking to their charter. It is important that
    the mission for which they were chartered is being enforced.
        Chairman Shelby. Senator Sarbanes.
        Senator Sarbanes. Thank you, Mr. Chairman.
        Secretary Snow, I would like to pursue very quickly this
    implied guarantee issue.
        First of all, let me ask you this question. Is it your view
    that Treasury is immune from political pressure?
        [Laughter.]
        Secretary Snow. On a relative scale, absolutely.
        Senator Sarbanes. What does that mean?
        Secretary Snow. Just that; that we live in Washington, DC,
    and I get calls from members of this body and members of other
    bodies, and I listen to them, but basically the Department of
    the Treasury has a long tradition of standing for some very
    important ideas.
        Senator Sarbanes. Why are the OCC and the OTS, which are
    ``in the Treasury,'' independent on a whole range of things--
    regulation, budget, statements to the Congress? They do not go
    through the Treasury.
        Secretary Snow. You know, they did at one time.
        Senator Sarbanes. I am hearing you are arguing that this
    entity, whatever it is called, should go through the Treasury;
    is that correct?
        Secretary Snow. Yes, very strongly I am recommending that,
    very strongly--not meekly and quietly, but strongly, in full
    voice.
        Senator Sarbanes. What is the rationale on OCC and OTS?
        Secretary Snow. Well, as I suggested earlier in response to
    Chairman Shelby's question, Senator, there is really a very
    different set of circumstances here. One, this is a new
    regulator, and it regulates entities that are very large
    individually relative to the markets. They are entities that
    are perceived--perceived--to enjoy an implied guarantee of the
    full faith and credit of the United States, and the Treasury
    Department is in the business of making the market for the U.S.
    debt. It is important that the integrity of what Treasury does
    is fully protected and that there is no confusion on that
    score.
        Senator Sarbanes. Why would there not be more confusion?
    Why wouldn't locating this regulator in the Treasury, with the
    Treasury having the authority over the GSE's and all of these
    respective areas, heighten the perception that there is an
    implied guarantee? It would seem to me that it is, in fact,
    increasing the likelihood of that perception because of this
    extensive Treasury involvement, an involvement well beyond what
    Treasury has with respect to the OCC and the OTS.
        Secretary Snow. Senator, I think it would do precisely what
    you are saying, unless you establish that new entity in a
    relationship to the Treasury, where Treasury could disabuse the
    markets of that at any opportunity, whenever the risk of that
    misapprehension became visible.
        Senator Sarbanes. What does that mean?
        Secretary Snow. That means the Treasury needs to be in a
    position to articulate the fact that what the role of the GSE's
    is and avoid confusion in the marketplace if, in fact, there is
    a perception that we stand behind their debt instruments.
        Senator Sarbanes. Now, do you agree with Secretary Martinez
    that the goals for the GSE should be set by HUD?
        Secretary Snow. The overall housing goals?
        Senator Sarbanes. The goals, yes.
        Secretary Snow. Yes, absolutely.
        Senator Sarbanes. So, whether it is going to be 50 percent
    or 60 percent or 70 percent, HUD would decide; is that correct?
        Secretary Snow. Yes.
        Senator Sarbanes. Now, why wouldn't the program, the
    programmatic content of the GSE's activities be an appropriate
    thing for HUD to do?
        Secretary Snow. You mean the new lines of business, getting
    into----
        Senator Sarbanes. Yes, the programs that they are going to
    carry out.
        Secretary Snow. Programs, right. Well, I think the
    programs, as I understand what Secretary Martinez said, would
    be with the GSE regulator, they would have the primary say.
        But on the broad program activity that they are engaged in
    today, their goals, that remains under HUD.
        Senator Sarbanes. How about the narrow program activity?
        Secretary Snow. The new program activity, which will be
    narrower than the base they are operating on, should be under
    the strong new regulator, wherever, Senator, that new strong
    regulator is.
        Senator Sarbanes. And why is that?
        Secretary Snow. Why is that?
        Senator Sarbanes. It affects safety and soundness?
        Secretary Snow. It is prudential. It affects not only
    safety and soundness of the housing finance market----
        Senator Sarbanes. Does not the goal set--my time is
    running. That is why I am pushing here--does not the goal
    setting affect safety and soundness?
        Secretary Snow. Goal setting is related to safety and
    soundness, but it is----
        Senator Sarbanes. Well, suppose HUD increases the low- and
    moderate-income requirement from 50 percent to 60 percent, does
    that not have safety and soundness implications, significant
    ones?
        Secretary Snow. It certainly could, and they should be----
        Senator Sarbanes. And that is going to be left with HUD; is
    that correct?
        Secretary Snow. Yes, but then subsequently those would be
    taken into account, Senator, by the new regulator and
    appropriate adjustments made in the risk-based capital
    standards.
        Senator Sarbanes. Well, then the same thing could be done
    with program activity, could it not, if the program activity
    was left with HUD?
        There is considerable concern, and presumably we will have
    another hearing--
        Chairman Shelby. We are going to have another hearing.
        Senator Sarbanes. --to hear from those elements. There is
    considerable concern that Treasury is insensitive to the
    housing objectives, and indeed that there are some within
    Treasury that may be, in fact, antagonistic; that HUD has
    traditionally been the place where concerns for housing goals
    have been reflected, housing objectives, and that moving the
    program approval, which is, in effect, the subcategory to the
    goals, carries with it the possibility of undercutting the
    housing mission, which everyone here keeps saying is so
    important, and where such a good job has been done, and it is
    vital to the functioning of our economy, and we have the
    greatest homeownership rate, and so forth.
        Secretary Snow. Senator, I think everyone has said it is
    important. There have been some questions about how effectively
    it is being carried on, but the housing opportunities remain
    the broad objective, right? To achieve the housing objectives,
    you need a strong, resilient housing finance system. That is
    promoted by a strong regulator, as Senator Hagel was
    suggesting. But the strong resilient housing finance system is
    part of this much bigger thing, of which it is a large part,
    called the U.S. financial system, and we also need to get those
    relationships right and make sure there are not prudential
    risks to the soundness of the U.S. financial system.
        Chairman Shelby. Senator Bennett.
        Senator Bennett. Thank you, Mr. Chairman.
        I think Senator Sarbanes has gone directly to the issue
    that probably will cause the most controversy in the Committee
    as we try to draft this bill, and that is the relationship
    between the new regulator in Treasury and HUD. You made a
    statement that I think we would like to clarify. You said there
    will be no prior approval. There is prior approval now. HUD has
    prior approval, and presumably that will stay. The controversy,
    as I understand it, comes from the definition of what requires
    prior approval and the addition of the word ``activities,'' and
    there is a lot of heartburn as to what activities might be
    stretched to mean.
        Can we clarify that?
        Secretary Snow. What we have in mind when we talk about
    approval authority in the strong financial regulator is lines
    of business, is the GSE extending the lines of business that it
    is engaged in. The regulator needs to make sure that those
    extensions of its lines of business are consistent with its
    charter, consistent with the public interest, consistent with
    soundness and safety, and I would also say, Senator, consistent
    with this larger question of the resiliency of the financial
    system as a whole. So it is new lines of business is what I
    primarily have in mind.
        Senator Bennett. Is it not true that HUD currently requires
    prior approval for new lines of business?
        Secretary Martinez. The new lines of business, and I think
    partially going back to the very excellent point that Senator
    Sarbanes was getting at, I think I should add has only, it is a
    sporadic thing. I think in the last decade maybe only six times
    has a new product line been in the approval process, while
    goals are something that has to be followed on a daily basis,
    and I think that is a crucial difference and distinction
    between the two.
        HUD now will require prior approval, does not require prior
    approval, but they must come to us once a product is being
    launched. And so it is an ill-defined system as it currently is
    utilized, quite honestly.
        Senator Bennett. As I understand it, you must affirmatively
    stop the new program.
        Secretary Martinez. Correct. So that is not prior approval.
        Senator Bennett. In other words, if you do not take any
    action. Well, it is prior approval in a sense. You have the
    right to veto it.
        Secretary Martinez. I have the right to come back and say
    stop it. That does not mean that before it is launched they
    come to me and say, ``Here is a product. Please approve it
    before we launch it,'' although that has occurred in the past,
    also.
        Senator Bennett. Have you ever stopped it?
        Secretary Martinez. There has been one that was withdrawn
    and five that were not stopped. That, by the way, largely,
    precedes my time at HUD.
        Senator Bennett. You have said that the GSE's have lagged
    the market rather than led it, which is an interesting
    statement. Can you tell us why? Does anybody have any idea why
    that would be the case? And to the point, does it have anything
    to do with safety and soundness? Usually, people that are a
    little more conservative because they want to be absolutely
    sure they are not taking that much of a risk will lag a market,
    and it is the real risktakers who lead it. Is that an
    indication of what we are dealing with here that we need to pay
    attention to?
        Secretary Martinez. No, sir, I do not think it has to do
    with the market as such. I think part of it could be explained
    in that or is explained by suggesting that they do not deal in
    the subprime market. However, even when including subprime
    numbers, they would still lag the primary markets.
        So, in any event, no matter how you look at it, I am not
    sure I can answer the question of why, and I do not think it
    relates to safety and soundness, but I think it is a very well-
    known point that our research would back strongly.
        Senator, I have also been helped and have a little better
    answer for the prior question.
        Senator Bennett. Okay.
        Secretary Martinez. Programs require prior HUD approval;
    products do not.
        Senator Bennett. Okay.
        Secretary Martinez. The real problem comes in
    distinguishing between what is a program and what is a product,
    and the statute currently is too vague for that to make it
    really enforceable.
        Senator Bennett. That is the whole concern here, is the
    vagueness that we try to deal with.
        A final question. Have they ever missed their goals? You
    say they have lagged the market, but have they ever missed
    their goals?
        Secretary Martinez. Yes, they have. From 1993 to 1995, they
    missed their goals. In more recent history, they have met their
    goals.
        Senator Bennett. My time is up. Thank you.
        Chairman Shelby. Senator Reed.
        Senator Reed. Thank you very much, Mr. Chairman.
        As a preliminary point, Senator Stabenow asked me to submit
    to the record a letter from Fannie Mae.
        Chairman Shelby. Without objection, it is so ordered.
        Senator Reed. Thank you very much, Mr. Chairman.
        [The Fannie Mae letter follows:]
        Senator Reed. Secretary Martinez, you are proposing to put
    together an Oversight Office within HUD that is going to be
    presumably staffed with very skilled individuals with financial
    experience as well as detailed experience in housing. Why could
    not these individuals review the programmatic and product lines
    that are being offered?
        Secretary Martinez. They could. The question really is, is
    that the best way to do this or should safety, soundness, and
    new product lines all be combined in one regulator?
        Right now we have a divided house. OFHEO does certain
    things, HUD does the new program approval. We believe that a
    strong regulator would have all of the ability to do all of
    those particular items, not have it separated. By separating
    it, I think you weaken the regulator.
        Senator Reed. Well, it would seem to me that there has to
    be collaboration between the two entities. Otherwise you would
    be----
        Secretary Martinez. And the bill proposes that
    collaboration. It suggests that Treasury would consult with HUD
    in new program approval.
        Senator Reed. Why could HUD not consult with Treasury with
    respect to safety and soundness? Moreover, I would think, if
    Treasury has the safety and soundness responsibilities, that is
    the trump card in everything. They would be on a daily basis
    dealing with these different GSE's, where you would be dealing
    on a periodic basis, looking at products and programs.
        Secretary Martinez. We would be looking at their goals as
    well.
        Senator Reed. And goals.
        Secretary Martinez. And the Fair Housing goals, too.
        Senator, I believe that one thing that the Secretary and I
    are very firm and very strong in an opinion is that it all
    should be in one place. Again, as he said in his testimony, and
    I think in answer to a direct question, you might debate the
    way that could happen, but inevitably I think it should all be
    under one regulator.
        Senator Reed. Well, but it seems that we are saying that,
    but we are giving you responsibilities, in fact, you are asking
    for enhanced responsibilities with respect to goals----
        Secretary Martinez. Yes.
        Senator Reed. So right away it is not one-stop-shopping; it
    is you have a role, and then Treasury has a role. But, again, I
    do not think there is anything that is chiseled in concrete
    here, and I think we have to look going forward with respect to
    these hearings and evaluation as to whether these functions
    should be in one place or the other because there is going to
    be two centers of gravity for this regulation, both HUD and
    Treasury.
        Secretary Martinez. A regulator of financial institutions
    typically can also deal with their new product lines, and I
    think that is what makes that important distinction is that
    here we are dealing with very important financial institutions
    that from time to time, not on a continuing basis, but from
    time to time, may choose to go into a new product line. As they
    do that, then I think that new regulator should have the
    ability to examine that.
        Senator Reed. Well, this becomes an almost philosophical
    debate. I mean, the question is how do the goals relate to
    programs and products, how do the programs and products relate
    to financial safety and soundness, and that is something we
    will thrash through.
        Secretary Snow, do you believe that this new financial
    regulating entity should have sole discretion to set both the
    risk base and the minimal capital standards?
        Secretary Snow. Yes.
        Senator Reed. What about just simply allowing that entity
    to have responsibility for risk-based capital standards, which
    is usually the measure of the real test for safety and
    soundness?
        Secretary Snow. We think that the regulator should have
    broad flexibility with respect to capital standards, generally,
    the risk-based capital standards, as well as the minimum
    capital standards, and I think that is consistent with good
    regulatory practice.
        I am worried about ``hard-wiring'' capital requirements in
    a statute because of the fact that we just cannot perceive
    fully when we are passing a law the circumstances that the
    entities will find themselves in or the capital requirements
    that will be prudential, given those circumstances.
        So, I think it is better to have a strong, capable
    regulator, sophisticated in what it is doing, who uses good
    flexibility and discretion.
        Senator Reed. Well, I think the flexibility comes in with
    risk-based capital. That is why we have a risk-based capital
    measure and a basic static capital measure sometimes it is
    called. But have you evaluated the impact on the housing market
    and investor markets if you have a complete ability to change
    capital requirements at any time?
        Secretary Snow. Well, a good regulator approaches the
    capital--and we are talking about a good regulator here, a
    strong regulator, an intelligent regulator, a sophisticated
    regulator--that regulator will approach that issue with
    enormous sophistication and care knowing that it is the
    essential ingredient of a financial institution's regulatory
    system. So that strong regulator will approach it with prudence
    and care.
        Senator Reed. Well, we should just pass the statute calling
    for prudence and care.
        [Laughter.]
        Senator Sarbanes. But you would remove the capital standard
    that is now in statute enacted by the Congress; is that
    correct?
        Secretary Snow. That is right. I would. I would. I would
    give the new regulator broad authority over capital, both
    minimum capital and risk-based capital.
        Chairman Shelby. Mr. Secretary, but what if we had a
    regulator that wanted to kill the housing market, for various
    reasons? That could be a dangerous situation.
        Secretary Snow. Senator, it would be a very dangerous
    situation, just as it would be if you had a capital markets
    regulator that wanted to kill the capital markets or a bank
    regulator who wanted to kill banks. I hope we do not confirm
    those sorts of people.
        Chairman Shelby. I hope not too.
        Senator Hagel.
        Senator Hagel. Secretary Snow, following in line with the
    statutory capital structure conversation, you mentioned in your
    testimony I think, Secretary Martinez and others here this
    morning have referenced differences--I mentioned it in my
    statement--differences between the Federal Home Loan Bank
    capital structure versus Fannie and Freddie. You noted, of
    course, as we all are aware, that there are significant
    differences.
        Could you frame up for us, as we are working our way along
    this process, whether obviously one of the questions, once we
    get to a point where we can agree on a new regulator or a new
    process, a new home, all that we have been talking about, the
    question whether Federal Home Loan Banks should be included.
    Obviously, the capital structure is different.
        Secretary Snow. Right.
        Senator Hagel. What are your thoughts about how we could
    address that? Where should we be looking? Can you make this fit
    with one regulator? Would it be too bifurcated, complicated?
    Open it any way you want and take it where you want.
        Secretary Snow. Let me try and address it. I think, as a
    general proposition, it makes sense to have one regulator, but
    the regulator would have probably two divisions. It would have
    a division that, because of the differences that you are
    alluding to, specializes in Fannie and Freddie, and then a
    division which is the division for the Federal Home Loan Banks.
        And there are a lot of issues that would have to be dealt
    with in any legislation. One is the role of the Secretary of
    Housing and Urban Development, who is currently on the board, I
    believe, on the Federal Housing Finance Board. Also, one would
    have to deal with this important issue that under the Federal
    Housing Finance Board is the so-called Office of Finance. And
    the Office of Finance controls the issuance of the Federal Home
    Loan Banks' notes. That would have to be clarified because you
    would not want the new regulatory entity being seen as issuing
    the notes.
        So, I acknowledge there are a number of important issues
    that would have to get dealt with. There are a lot of details
    and policy issues, but I would see it having merit; that is,
    the inclusion in one entity having merit conceptually because
    they are so interrelated and similar in terms of the
    fundamental bottom line of what they do. They are issuing large
    amounts of debt to support the housing market, and they are
    doing so with some notion in a part of the market that maybe
    they are supported in some way by the Government, with a
    Government back stop.
        And that complicated set of issues I think is best dealt
    with in one place rather than bifurcated, but I would see the
    Agency needing to have a division that focused on Fannie and
    Freddie and another division focused on the Federal Home Loan
    Banks just to take into account these differences.
        Senator Hagel. Secretary Martinez, would you have an
    observation, comment, thought on any of this?
        Secretary Martinez. No, sir. I think Secretary Snow pretty
    well covered anything I would have to say on it.
        Senator Hagel. Let me address the obvious tension that is
    always connected, woven into the fabric of agencies like Fannie
    and Freddie, the two different commitments; one being the
    commitment to the affordable housing goals that Secretary
    Martinez referred to, Senator Sarbanes has referenced in his
    questions versus the other commitment of shareholders' equity,
    maximizing that shareholders' equity and profits.
        Do you see any dynamic here, other than a healthy tension
    between the two, any conflict, any issues that you think, as we
    are dealing with possible changes, and enforcement structures?
        Secretary Martinez. I think that is a tension that should
    be recognized, and when I hear commentary that suggests that
    somehow these are Government entities that almost are in the
    grant business or something like that, I mean that is really
    misplaced. These are investor-owned entities chartered by the
    Federal Government to achieve a certain purpose. And one of the
    things I think it is important to note, while recognizing the
    importance and the value of what they have done is the fact
    that they have lagged the market in some very important areas
    that are part of their charter.
        I just believe that should be recognized, there exists that
    tension and that they are investor-owned entities who have a
    fiduciary responsibility to their shareholders.
        Senator Hagel. Secretary Snow, I know my time is up, but if
    the Chairman would indulge me, if you had a comment, I would
    appreciate it.
        Secretary Snow. No, I will associate myself with the
    Secretary's comments.
        Senator Hagel. The Chairman likes that.
        [Laughter.]
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Corzine.
        That is what we do here in the Congress. It works very
    well.
        [Laughter.]
        Senator Corzine. Thank you. Let me start with a couple of
    perceptions. First of all, I concur with the line of
    questioning that I heard from the Chairman and the Ranking
    Member with regard to the implied guarantee. I have a hard time
    understanding how making clearance policy statements through
    the Secretary of the Treasury is a means to protect against the
    misperception in the marketplace that there is an implied
    guarantee.
        I think foregone board appointments or budgets coming to
    Congress is a long way from what I think really gets the market
    to believe that there may be something like an implied
    guarantee, like State taxation exemption, lines of credit, and
    other issues. I do not think this is the heart of the issue,
    and I think we are really talking about, I think you could have
    that independent regulator. I would presume that you would, if
    I asked you the question, Mr. Secretary, whether you think the
    SEC is a world-class regulator, you would, I would hope, come
    to the conclusion that it is and its independence is such
    that--I will not ask you that, so you do not have to answer
    it--but I think the perception issue is not on the subjects
    that we are talking about, and I am not sure exactly, and it
    needs to be explored.
        Second of all, I think all of us are confused--I am more
    confused today than I was when I sat down here--about these
    definitions of mission goal, programs, activities, and which
    ones will fall under the rubric of what the new regulator works
    on, and all of us need to bring real clarity to this so that
    there is not a misperception on that.
        And then I have, I will ask the question on this, I have
    this perception problem that there is not enough emphasis on
    disclosure with respect to the discussion we are having today.
    I actually do not think it should be voluntary that the 1934
    Act is in operation here. I think that there are some standards
    of disclosure that, given the whole arrangements we have seen
    on corporate governance and concerns that have evolved in
    recent days that should be as much a centerpiece of the new
    regimen that we are putting together, and I would be curious
    about that.
        And then I just have to ask the question on Federal Home
    Loan Bank. Do you foresee, under this new formulation, and I
    actually believe one regulator is fine, but are you visualizing
    a demutualization of the Federal Home Loan Bank System at some
    point in this process and more to a shareholder organization?
        Secretary Snow. Senator, let me try and respond quickly to
    each of those four points.
        On the demutualization, no, that is not what is
    contemplated. On the 1934 Act, we agree with you. We are
    pleased that Fannie has gone under it. Freddie has indicated it
    will--the sooner, the better. We are sorry it has gotten
    delayed. We think the Federal Home Loan Banks Board should be
    under the 1934 Act as well.
        Senator Corzine. Disclosure of interest rate risk, credit
    risk, a whole series of these issues.
        Secretary Snow. The whole 1934 Act--yes.
        Then, on the clarity of programs versus activities versus
    lines of business, that is really what we would see the statute
    doing, the new statute. That is our proposal, that the statute
    lay that out so that we know that the regulator has clear
    authority over this, and the HUD Secretary has clear authority
    over that. So we are seeking that clarity.
        And on the first one, the perception issue, I mean, I will
    grant my biggest concern in talking about Treasury as the
    entity where the new regulator is housed as a bureau is that we
    add to the confusion in the marketplace about this perceived or
    implied guarantee. That is troublesome, and it is why I am far
    less focused on having it in Treasury than I am in having that
    strong regulator. And there are some proposals that I have seen
    for an independent regulator like the Federal Reserve Board or
    something, a new regulator.
        My concern is much more with having that strong regulator
    than having it in Treasury, and my comments on Treasury were
    only to indicate the dangers really of putting it in Treasury.
    I think Treasury, because we have some expertise in financial
    markets generally, could bring something to bear on the
    regulator that could be helpful and integrate its activities
    with the overall financial markets, but I also perceive very
    much the risk you are talking about and that others have talked
    about.
        Chairman Shelby. Senator Dole.
        Senator Dole. Secretary Snow, Fannie and Freddie have both
    publicly stated that they want to see legislation with a
    stronger safety and soundness regulator. In your talks with
    them, what initiatives do they advocate that would make their
    regulator stronger?
        Secretary Snow. They seem to be, and they are going to be
    on later so the question may be better to them, but I think
    there is some real agreement that a new strong regulator would
    make sense, would remove some of this volatility in the market,
    and might actually help, in a real way, to improve housing
    finance. And in the discussions I have had, I have pretty much
    laid out, as I did today, what we think should be included in
    that, and I think they better respond as to what parts of that
    they can live with, rather than my trying to interpret it, if
    you do not mind.
        Senator Dole. Secretary Martinez, some have raised
    questions about how the consultative process on GSE programs,
    activities, and products between HUD and Treasury might work.
    Would you describe for the Committee how you believe the
    process would work and any concerns that you might have, would
    you raise those for us.
        Secretary Martinez. HUD must be consulted prior to any
    final determination as to whether the activity is permissible
    or not, and so this process will ensure that any review of a
    new GSE activity and the potential impact that it will have on
    affordable housing or housing goals will be fully considered;
    in other words, will be a participant in the decisionmaking.
    And I think the important considerations of meeting the housing
    goals and the impact on the housing market we think will be
    fully considered through that consultative process that is
    envisioned.
        Senator Dole. Secretary Snow, would you comment on the
    impact of increased capital authority on holders of Fannie and
    Freddie debt and also what capital controls do the major U.S.
    financial regulators have?
        Secretary Snow. All of the major U.S. financial regulators,
    to the best of my knowledge, have broad authority with respect
    to capital adequacy of the financial institutions and, in fact,
    capital adequacy is the principal regulatory tool in the tool
    kit of financial regulators.
        I do not have in mind any precise change in the capital
    adequacy numbers. That, I would leave to a regulator, and the
    regulator may find that the current capital standards are
    perfectly adequate. My only point on capital adequacy standards
    is the regulator should have broad flexibility. I do not enter
    that with any preconception as to what those capital standards
    should be.
        Senator Dole. As you know, our legislation gives the new
    regulator authority to limit nonmission-related assets. Your
    department supplied me with a copy of your suggested language
    to restrict investments if they fail to meet your 12
    operational and managerial standards. I take it that you are
    then in agreement with S. 1508 on this point.
        Secretary Snow. Yes. I would have to say before I give full
    assent, I would like to make sure I have read it, but if the
    Treasury staff gave it to you, and it is based on that, I am
    sure I do agree.
        Senator Dole. Would you share with the Committee the
    reasons why the Treasury believes this authority is necessary.
        Secretary Snow. Yes. This authority is necessary so that
    these entities do not abuse their charters, that they live
    within their charters. A regulator needs to be ever mindful of
    what the charter is, and what the limits of the charter are, so
    that the entities do not go beyond those charter limitations.
    That is the basic point I would make.
        Senator Dole. Secretary Snow, if the regulator is put under
    the Treasury Department and is completely independent, what is
    the advantage to having the regulator at Treasury?
        Secretary Snow. The advantage of having it at Treasury is
    that Treasury is involved in all of the financial markets and
    brings a deep knowledge of the U.S. and world financial
    markets, how they operate, their complexities, and their
    condition. And that would be the value that would be added by
    having this entity at Treasury, if the statute did not block us
    from providing hat value.
        Off-setting that is the risk that we have talked about,
    that being in Treasury might further signal to the market,
    improperly, that the Federal Government stands behind these
    entities, and that is the line we are walking here.
        Senator Dole. Thank you, Mr. Chairman.
        Chairman Shelby. Senator Schumer.
        Senator Schumer. Thank you, Mr. Chairman, and thank you for
    being here both, Mr. Secretaries.
        First, just a comment. I am concerned, obviously, about the
    legislation that the Administration has suggested, and I do not
    think there is any doubt that there are some in the
    Administration who do not believe in Fannie and Freddie
    altogether. Let the private sector do it. That would be an
    ideological position. And my worry is that we are using the
    recent safety and soundness concerns, particularly with Freddie
    and with a poor regulator, as an excuse or as a straw man to
    curtail Freddie and Fannie's mission.
        I do not see that safety and soundness, which is important
    to every one of us, necessarily requires a regulation by the
    safety and soundness regulator of what Fannie and Freddie does.
    After all, banks decide on their own products, and then it is
    the regulators that decide the capital standards and other
    types of regulation that keep them safe and sound.
        And I could see a Treasury regulator who does not like
    Fannie and Freddie saying you cannot do any new products as the
    marketplace changes and gradually strangling them. So, I worry
    about this. Now, I am not going to ask you to comment on that.
    You have made your point clear, but I think we are using safety
    and soundness or some may be using safety and soundness as an
    excuse to constrict Fannie and Freddie's goal and mission in
    housing because they do not like a GSE to begin with; that they
    would rather just have the private sector do it, but I have
    another question for you.
        It is on a different subject, but you are here, and it is
    an issue of great concern to me, and that is China's currency
    manipulation. I have three questions. I will ask them seriatim
    and ask you for your answers.
        First, I was very, very disturbed, as were many of us, that
    despite the legal requirement that Treasury issue its report on
    exchange policies yesterday, that such a policy was not issued.
    Now, I know we have said we are going to do it October 30, but
    what that leads me to believe is we were afraid to issue a
    report right before the President went to see the Chinese,
    Japanese, Taiwanese, and other leaders and an indication of
    soft-peddling this; that, oh, yes, we will tell the American
    public we care about this, but we do not want to embarrass our
    friends in Asia by issuing a report that says they manipulate
    the currency the day or the week before the President meets
    with them. It is very convenient that it is extended for 15
    days after the trip is over.
        And I just worry about that as an indication of fear, or
    reluctance is a better word, to confront the Chinese,
    particularly, but others as well, on currency manipulation.
        So my first question is why was there the delay?
        Second, let me ask you directly, do you and does Treasury
    now believe that China has engaged in currency manipulation?
    You have probably seen the report already because it was just
    delayed at the last minute.
        And, third, and maybe most importantly, what if China
    continues just to say, no, despite your entreaties? We all read
    how the Chinese said they were not going to change this before
    you even landed on their soil to talk with them. They refused
    the President's entreaties. What should we do? Should we just
    stand here and say, ``Shucks, the Chinese are not doing the
    right thing?''
        Some of us on this Committee, I think there are four of us
    on this Committee, and many others--five of us on this
    Committee, three Republicans, two Democrats--who believe we
    should impose a tariff on China's goods to make up for the
    currency manipulation.
        Yesterday, the Bipartisan Commission on U.S.-China Economic
    Security Review said the following: They said, The Commission
    found that China, in violation of both IMF and WTO obligations,
    is, in fact, manipulating its currency for trade advantage, and
    this is the important point, ``The Commission further urges the
    Congressional leadership to use its legislative powers to force
    action by the U.S. and Chinese Governments to address these
    unfair and mercantilist trade practice.''
        So, A, why was the report delayed; B, do you--yes or no--
    believe China manipulates the currency; and, C, what should we
    do if China continues to refuse to do anything in light of the
    thousands, the millions of jobs that we are losing all over
    this country?
        Thank you, and you can have the rest of the time.
        [Laughter.]
        Secretary Snow. I will just answer briefly and look forward
    to a fuller discussion on October 30 when I am up here with the
    report.
        The delay is just straightforward. The GSE legislation was
    scheduled, and I think the report and my testimony should go
    hand-in-hand, so there is no confusion about it. Whether we
    view China as manipulating their currency is the subject of the
    report, which will be released on October 30. In the meantime,
    I have had, as you know, and the President will be having,
    extensive conversations with the Chinese political and economic
    leadership on that question.
        And since my time is up, I will look forward to reviewing
    that with you in detail on October 30.
        Senator Schumer. What about the third question? What should
    we do if the Chinese continue to do nothing?
        Secretary Snow. Well, Senator, this is a discussion, a
    serious discussion that takes some time. We are making
    progress. We are making some real progress. And I think the
    best thing we can do is continue to press hard and come to that
    bridge if we ever come to it, but press hard now for the
    reforms that make sense, and that you have talked about and
    Senator Dole has talked about and other Members of this
    Committee have talked about, including the Chairman.
        Senator Schumer. Thank you, Mr. Chairman.
        Chairman Shelby. Mr. Secretary, I hope the President does
    better than we did, the two of us, when we went to China and
    Japan.
        Senator Schumer. I hope he does better than I did right
    now.
        [Laughter.]
        Chairman Shelby. Well, you have raised some questions.
        Senator Sununu.
        Senator Sununu. Thank you, Mr. Chairman.
        First, as Senator Sarbanes pointed out, we like to do in
    Congress, let me associate myself with the remarks of Senator
    Corzine. You raised some very important points about disclosure
    that he included in his legislation. I apologize to him for not
    delving into those now, but I do want to ensure that we deal
    with these as we move forward with legislation because
    disclosure is an important part of investor confidence, and I
    agree with him very much on those issues.
        Second, there is a lot of discussion about the question of
    affordable housing goals, product and program approval, and I
    want to get into this important issue a little bit more.
        It seems to me that the affordable housing goals and the
    affordable housing mission is extremely important. I believe
    under the Treasury proposal those goals would be set by HUD, as
    they should be. As I said in my opening statement, we should
    look at ways to strengthen and improve the way that those goals
    are set and whether or not HUD needs even more power in dealing
    with affordable housing issues.
        But housing goals are a matter of public policy. There is a
    public policy goal that could be set in statute, but it is a
    matter of public policy. The question of products, activities,
    and business lines are questions of means for attaining those
    public policy goals, and they absolutely do affect safety and
    soundness, in my opinion, and I want to explore some specifics
    of the ways that they might affect safety and soundness.
        I have a list of activities, products, programs, whatever
    we want to call them for the time being, that are offered by
    the GSE's, and I want to list them for you, Mr. Secretary, and
    get some comment here.
        A desktop originator, where a GSE can go directly through
    to mortgage brokers; HomeStore.com, where a GSE engages in a
    direct joint venture with realtors, which raises questions
    about mortgage origination, which is something that the GSE's
    are prohibited from; Home Stay, where a GSE offers, for
    borrowers, credit insurance, two-tiered insurance products,
    where GSE's can take a portion of mortgage insurance risk for a
    portion of the mortgage insurance premium; issuance of retail
    callable bonds; a product called Payment Power, where, in this
    case I believe it is Fannie Mae, can allow borrowers to skip a
    certain number of payments over the life of the mortgage.
        My question is do not these kinds of products, whether they
    are insurance related, consumer related, dealing with
    prepayment issues, do they not affect the risk profile of the
    entities that are engaged in these lines of business?
        Secretary Snow. Senator, I am not an authority on these
    products or the nature of them, but certainly a strong
    regulator would be in a position to evaluate whether extension
    into those products creates risks that require changes in
    capital standards. I am not in a position to do that, but
    certainly there is a relationship between the products you get
    into, the size of your exposures, and the amount of capital
    that is appropriate to those exposures, yes.
        Secretary Martinez. If I may comment, Senator, the proposal
    that we have proposed will do away with the distinction between
    program and product, and instead it would make all new
    activities subject to review by the financial regulator, which
    we think is an important consideration.
        Senator Sununu. I believe that is an important point, and I
    am not prepared to say--I agree with you wholeheartedly, but I
    think the more general point that definitions matter and
    language matter has already been revealed here as to what we
    are defining as a product, what we are defining as a program,
    and I hope, and I expect, that that is something that the
    legislation will try to deal with in a clearer way because it
    does not seem to have been written with the clarity we would
    want.
        To that end, Secretary Martinez, have any of the programs
    that I just read, and I hesitate to call them programs, but
    have any of these required or received clearance from HUD?
        Secretary Martinez. I am being told--I cannot firsthand
    tell you, but I am being told by Mr. Weicher of the Housing
    Commission that the answer is, yes.
        Senator Sununu. They have had to be approved, they have had
    to receive clearance?
        Secretary Martinez. Payment power and Homestay, payment
    power has been approved, and Homestay apparently is under
    review and will be.
        Senator Sununu. Those will be two of the five that you
    mentioned?
        Secretary Martinez. Yes.
        Senator Sununu. Thank you.
        Let me talk about another specific product and, again, one
    that certainly raises concern only in that it certainly seems
    to affect risk profile, and that is the approval for GSE's to
    acquire acquisition, development, and construction loans. This
    would be lending against development properties, perhaps
    against land that could certainly be used for housing, but
    could also be used for projects of a commercial nature.
        This would, one, seem to be a business line that can affect
    the underlying risk profile of the company or the entity that
    is involved in it; and, two, would seem to at least raise
    questions about whether or not it is in keeping with the
    mission.
        I would like each of you to comment on, again, whether this
    is a product line, a program, an activity that affects risk
    profile and issues regarding mission.
        Secretary Martinez. I think it affects risk profile, and I
    think it clearly also affects mission. I think it also should
    be noted this product was approved by HUD in 1992 as a pilot
    program, and then last summer it was approved as a permanent
    program, but I do believe that both areas are affected by the
    product.
        Senator Sununu. I appreciate that, and what we need to get
    at with the legislation is simply to make sure that business
    lines, activities, products, programs, as we hope would be
    clearly defined, the ability to look at these, to consider
    these, as they affect safety and soundness, are included in
    that strong regulator. I cannot think of any other regulator
    that would not have the authority over decisions that so
    directly affect safety and soundness.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Bunning.
        Senator Bunning. Thank you, Mr. Chairman.
        I want to take Secretary Snow back to, even though this is
    a hearing on GSE's relating to housing, but we have got to talk
    about GSE's that are unregulated completely. What would it take
    for this current Administration to call for some regulation of
    the Tennessee Valley Authority--gouging their customers,
    raising rates without any approval? Because they do that if
    they have no regulator whatsoever--they do not have one; having
    $26 billion in debt, publicly traded debt--this is publicly
    traded--which is AAA rated, and guess why it is AAA rated--
    because everybody thinks that the Federal Government is backing
    the debt; or are we going to have to wait until something like
    Enron happens in the Tennessee Valley?
        Secretary Snow. Well, Senator, I must confess to you I am
    not an authority on TVA. It is different from Fannie and
    Freddie in the sense that it is wholly owned by the U.S.
    Government.
        Senator Bunning. We own it.
        Secretary Snow. Yes, we own it. We do not own Freddie and
    Fannie. They are publicly owned.
        Senator Bunning. We do not own the Federal Home Loan Banks
    either.
        Secretary Snow. No, we do not. They have a different
    ownership structure, but they are not owned by the Federal
    Government.
        Senator Bunning. They are owned by stockholders, which are
    the banks themselves.
        Secretary Snow. The banks, exactly. So the first
    distinction is TVA is a wholly owned agency, instrumentality of
    the U.S. Government. I agree with you, it sells debt into the
    public markets. The borrowing authority of TVA, if my
    recollection serves me, and I want to confirm this, is treated
    by OMB as budget authority for purposes of the Federal budget.
    So there is that element of oversight on it. It is governed I
    think by three----
        Senator Bunning. Commissioners.
        Secretary Snow. Yes sir, commissioners appointed by the
    President----
        Senator Bunning. The President of the United States.
        Secretary Snow. --confirmed by the Senate, I think.
        Senator Bunning. Yes, but there is a big, big problem here
    because, when OMB tells them to reduce their debt, the $10 or
    $12 billion, they do not pay any attention to OMB.
        So the need for regulator, a regulator, if we are making a
    new regulator to take care of Freddie, and Fannie, and the
    Federal Home Loan Bank, which I do not agree with, but we
    should take a look at some that are totally and completely
    unregulated.
        Secretary Snow. Senator, you have me at an enormous
    intellectual and knowledge-based disadvantage here. Could I
    bone up on this subject and come and talk to you, so I would
    know what I am talking about when I have that discussion?
        Senator Bunning. Yes, you can.
        Secretary Snow. Thank you.
        Senator Bunning. I would be more than happy.
        Let me ask you one more question, then, since my time is
    not up. Why does Treasury call on the Federal Home Loan Banks
    to register with the SEC? Which I agree with, by the way.
        Secretary Snow. We do because there are investors who buy
    their securities; the Federal Home Loan Banks do issue debt,
    and it is important to have disclosure. So you are asking me
    why not TVA, and I told you I am going to get into that.
        Senator Bunning. I am asking you----
        [Laughter.]
        You have answered my question, and I appreciate that very
    much.
        Thank you, Mr. Chairman.
        Chairman Shelby. Since I come from a State where TVA is
    partly represented, I have a lot of questions about it, too,
    but I will save them for another day, though, and probably for
    another Committee.
        Senator Allard.
        Senator Allard. Thank you, Mr. Chairman.
        I am not sure that I agree entirely with your statement
    that transferring the regulatory provisions from HUD over to
    Treasury implies that there is a greater backing by the Federal
    Government on these loans.
        It seems to me that the issue comes right down to too big
    to fail. Fannie and Freddie have taken over so much of the
    market and have become such big entities, that I think the
    thought is, is that because they have such an impact on our
    economy, the Congress could not allow them to fail. I would be
    interested in hearing your comments on this.
        Secretary Snow. I agree, Senator. It is that if they
    failed, there is a perception that the full faith and credit of
    the United States stands behind them, and that means the U.S.
    Treasury. And the concern would be that if Fannie and Freddie
    came to the U.S. Government, with the perception of ``too big
    to fail,'' or the belief of an implied guarantee or the sense
    that the Federal backing was there, or that the Federal
    Government was a back stop, that perception would be
    heightened. That is what I am saying.
        It is not as large a perception when the entities are in
    HUD because HUD does not have the responsibility of the U.S.
    Treasury to go into the credit markets, with the full faith and
    credit that lies behind it, so that is precisely the issue.
        Senator Allard. Mr. Chairman, I also would now like to
    pursue this idea that you are going to have the expertise there
    to have a top-flight regulatory----
        Secretary Snow. Right.
        Senator Allard. I see Fannie Mae and Freddie Mac standing
    out and using derivatives and some rather unusual financial
    instruments to manage the dollars that they have. When
    regulators manage derivatives, many of them have Ph.D.'s. My
    understanding is that these qualified individuals are sometimes
    difficult to find in Government agencies because there is such
    a demand for them in the private sector.
        Secretary Snow. That is right.
        Senator Allard. Would you explain to me how you are going
    to put together a highly qualified regulatory agency? I think
    OFHEO has the same problem in hiring personnel with the
    expertise necessary to properly regulate Fannie and Freddie,
    whether they can do it top flight. How is Treasury's situation
    different from current OFHEO?
        Secretary Snow. Senator, you put your finger on a very,
    very good issue. What I was talking about is the fact that the
    Treasury Department has people who are deeply knowledgeable
    about the condition of the credit markets, directly involved in
    making the $2-trillion-a-year debt market for U.S. Treasuries,
    and have an awful lot of expertise about financial matters.
        The regulatory agency in Treasury would draw on that
    broader expertise about the condition of financial markets here
    and abroad to address, the whole question of systemic risks.
    But the agency would need to be augmented, with its own
    experts, just as the Fed has a number of experts on
    derivatives. Really, you need people trained in options theory,
    and Black-sholes, and derivative mathematics. You would have to
    attract those people there, clearly. The new regulator would
    need, as the Fed does, to have the authority to attract people
    who are high-powered and financially knowledgeable people. I
    agree with you.
        Senator Allard. How are you going to attract these
    qualified individuals and maybe Secretary Martinez would like
    to comment.
        Secretary Martinez. I just wanted to comment, also, because
    whether the regulator, the Treasury, or the office that we
    envision at HUD for the portion of regulating the HUD will
    continue to have, we also believe that it should be financed,
    as most regulated entities are, by the regulated entity, which
    will give us a little more flexibility in terms of salary,
    compensation packages, and the way in which we could attract a
    competent staff to do this very, very important job, which
    right now what HUD does in this arena, we are not properly
    staffed to do.
        Senator Allard. I have another ``nuts and bolts'' question.
    How are you going to transfer these dollars budgetwise? In
    other words, how are you going to handle the transfer of the
    Agency? Are you going to retain the money that is allocated to
    HUD or will this be transferred over to Treasury? If the
    Director is going to increase his regulatory ability, it seems
    that he will need to request an increased amount of dollars.
    Have you discussed that?
        Secretary Martinez. There is no question that OFHEO, and
    all that goes with it, including its budget, would go to
    Treasury, and there is no dispute or discussion about that. So
    they would have the wherewithal of current OFHEO, to begin
    with.
        In addition to the added authority now from the new law,
    which would permit us to seek, for the regulated entities, to
    finance in fact the regulation.
        Senator Allard. Any comment, Secretary Snow?
        Secretary Snow. No, I agree, Senator. You are putting your
    finger on a very important issue. You have to have
    sophisticated, knowledgeable people. Those people have
    alternatives, and high-paying alternatives. We have to be able
    to attract them. And as Secretary Martinez said, I think taking
    this off the budget and making the Agency self-financing, as we
    have suggested, would give us much greater latitude to attract
    the people that are needed.
        Senator Allard. Thank you, Mr. Chairman.
        Chairman Shelby. I have some questions, but since we have a
    second panel, I am going to submit my questions for the record.
        Senator Sarbanes.
        Senator Sarbanes. Mr. Chairman, I will forbear, as well,
    because I know we have people who have been waiting.
        Chairman Shelby. I want to thank both Secretaries for being
    here----
        Senator Carper. Mr. Chairman, I do have just a couple of
    questions I would like to ask. I have not had a chance to ask
    anything, if I could. Thank you.
        I am not going to be here for the second panel. I
    understand that Fannie Mae and Freddie Mac may have a different
    take on whether the GSE's lagged the market on affordable
    housing. I hope, when they speak, that we will hear from them
    about whether they are going to, how they want to respond to
    this charge, and I would look forward to what they have to say
    on that.
        Two questions. Two quick ones.
        Secretary Martinez. Could I comment on that issue, Senator?
        Senator Carper. Sure.
        Secretary Martinez. Business there is one thing that I
    think should be on the record, which is that our research would
    indicate that the GSE's have 42 percent of all loans in the
    mortgage market, of which only 15 to 17 percent go to first-
    time minority homebuyers.
        FHA, by contrast, has only 16 percent of loans, of which 34
    percent are for minority and first-time homebuyers.
        Senator Carper. Good. Thanks for that point.
        I know this has been raised, at least indirectly, by
    others, and I want to come back. I have heard from constituents
    in my State, as have my colleagues. They include the home
    builders, they include realtors, they include other affordable
    housing groups, and they are, for the most part, in opposition
    to transferring program approval from HUD to Treasury.
        And I am just going to ask you to take a minute and speak
    to the concerns that have been expressed to us by these groups
    which were that the Treasury would be less sympathetic to
    housing needs than HUD. What do we say to them? How do you go
    about reassuring these people, these constituents, that moving
    program approval to a new agency would not impact Fannie Mae or
    Freddie Mac's ability to design new products, new initiatives,
    to meet unique housing needs in Delaware or in other States.
        Secretary Snow. Well, Senator, I would start----
        Senator Carper. What reassurance can you offer?
        Secretary Snow. Maybe Secretary Martinez should lead on
    this, since this is his area.
        Secretary Martinez. I believe, Senator, that new product
    approval is not essential to the function, day-to-day, of the
    GSE's. It is something that, from time to time, comes up, and
    as it does, it has a very, very direct impact on their safety
    and soundness.
        When those issues would arise, and it is sporadic, it is
    not daily, and they are on very specific market areas that they
    wish to go into, that are new, that they are not today doing,
    so, if they are doing a great job today, only for expansion,
    growth and continued ability to provide a return to their
    investors is a new product necessary. So, for those sporadic
    instances when that will come up, the Treasury is the perfect
    place or the new regulator is the perfect place for that to
    take place.
        HUD would be consulted in that process. So we would have
    our input as it relates to housing needs and, secondarily, as
    it relates to housing goals, we will ensure that they continue
    that vital part of their charter, which has to do with meeting
    low-income, minority homebuyers, first-time homebuyers, and
    underserved areas.
        Secretary Snow. Senator, I work, as Secretary Martinez
    does, for the President of the United States, who is as deeply
    committed to housing, as any President I am aware of. It is a
    matter that comes up regularly. I have heard him say to the
    Secretary, ``How are we doing on those housing goals? Why
    cannot we get there faster?'' And he would not countenance for
    a moment the Treasury Department playing a role which was not
    entirely consistent with his objectives for strengthening
    homeownership in the United States. It is a goal I share.
        You say, well, Administrations come and go, how do you know
    the next one will be that way? I think the Secretary said it
    well. Getting the soundness and safety of the finances of the
    GSE's and the housing markets right helps, not hinders, the
    homeownership objectives. So having a strong regulator in place
    will reassure the markets and should make the markets more
    favorable to housing finance, not less favorable, which should
    help the spreads, help the costs, and help ownership,
    ultimately.
        Senator Carper. Secretary Snow, one last quick question.
    Under the regulatory structure that I understand you are
    proposing, could there be some potential for a conflict of
    interest for Treasury, if Treasury participates in the debt
    markets as a participant, and this potential role as regulator
    of GSE's, who would also be participating in the debt market?
        Secretary Snow. Well, today, there is a consultative
    process. I do not think there would be a serious problem along
    those lines, but today we recognize the need for a consultative
    process, and that consultative process works well.
        Senator Carper. All right. Thanks very much.
        Thanks, Mr. Chairman.
        Chairman Shelby. Thank you.
        I thank both of you, again.
        Our second panel will be Franklin Raines, Chairman and CEO
    of Fannie Mae; George Gould, Director of Freddie Mac; Norman
    Rice, President and Chief Executive Officer, Federal Home Loan
    Bank of Seattle.
        Gentlemen, your written testimony will be made part of the
    record in its entirety. We will start with Mr. Raines. Welcome
    back to the Committee. You have spent a lot of time here, and
    we appreciate it. If you could sum up. I know the day is moving
    on, and we appreciate your patience. This is a very important
    hearing. We are going to have another hearing. We think we
    should hear from the housing people and others and have a
    balanced approach to what we are doing, and perhaps we will
    learn a lot.
        Mr. Raines.

                    STATEMENT OF FRANKLIN D. RAINES

            CHAIRMAN AND CHIEF EXECUTIVE OFFICER, FANNIE MAE

        Mr. Raines. Thank you very much, Mr. Chairman, Senator
    Sarbanes, and Members of the Committee, for this opportunity to
    speak with you today. I am delighted to have the chance to
    share my views on strengthening the financial regulation of
    Government-sponsored housing enterprise which Fannie Mae
    supports.
        Fannie Mae supports legislation to create a safety and
    soundness regulator as a bureau in the Treasury Department. I
    believe there is a broad consensus that having a strong,
    credible, well-funded financial regulator is in the best
    interests of the housing finance system, the financial markets,
    and homeowners.
        First, there is a broad consensus that the American housing
    finance system is the best in history and the envy of the
    world, that the housing finance system is critical to the
    economy, that the secondary mortgage market is the backbone of
    the system and that Fannie Mae plays an essential role in the
    system.
        Second, I think there is a broad consensus that the housing
    finance system is, and will continue to be, strong, stable and
    operating at peak performance and that regulatory reform
    efforts do not arise from a need, urgent or otherwise, to ``fix
    the system.''
        Third, there is a broad consensus that thanks to the
    performance of the housing finance system, housing helped to
    boost the economy when the economy needed boosting the most.
    Last year alone, homeowners withdrew about $140 billion of
    their growing equity wealth and plowed $80 billion of it back
    into the economy, boosting consumer confidence and spending.
        All together, housing-related activities accounted for 9.4
    million jobs and contributed $2.3 trillion to gross domestic
    product, which was nearly 22 percent of GDP.
        And, finally, given that the housing finance system is so
    strong, efficient, and essential to the economy, there is also
    broad consensus that any legislation that would affect the
    system should begin and end with two critical goals in mind:
    First, do no harm to housing and homeowners; and, second,
    ensure that any legislation that goes forward serves to
    strengthen the housing finance system.
        We are prepared, and look forward, to working with the
    Congress and the Administration to achieve a broad consensus on
    legislation to ensure that we have a strong, credible, well-
    funded financial regulator. But, today, as the Committee
    requested, I wanted to focus these few oral remarks on a couple
    of key issues pertaining to the legislation to move our
    financial regulator to the Treasury.
        First, I believe that a safety and soundness regulator at
    Treasury must have the powers and resources necessary to ensure
    effective oversight. To ensure adequate resources, I believe
    the new Treasury bureau should be funded independent of the
    appropriations process. We do believe, for the sake of funding
    accountability, that Congress should also include some
    transparent review mechanism or process, such as notice and
    comment, to ensure that the assessments levied are reasonable.
        As for the review of regulations and testimony, I believe
    those are questions for the Congress and the Administration to
    resolve.
        Regarding our capital requirements, Fannie Mae supports
    maintaining our minimum capital at the current statutory level,
    but giving the new regulator more flexibility in setting risk-
    based capital. The minimum capital requirement established by
    Congress in 1992 is appropriate for a low-risk business model,
    and requiring capital in excess of our risk would reduce the
    flow of mortgage finance to homebuyers and undermine our
    mission.
        That said, we agree with Treasury that our financial
    regulator, like others, should have the authority to
    continuously evaluate the risk we face and adjust our risk-
    based capital requirements accordingly.
        Today, our financial regulator has this flexibility through
    the risk-based capital requirement that Congress enacted in
    1992, which is determined by a statutory stress test. This
    test, administered every quarter, computes how much capital we
    would need to survive a severe economic shock and a prolonged
    economic crisis, and Fannie Mae has met this stress test every
    quarter.
        While recognizing the need for stability in capital
    standards, we support Treasury's proposal to provide our
    financial regulator with fuller and more flexible authority to
    ensure that our risk-based capital requirement remains
    consistent with our risk profile.
        On the matter of prompt corrective authority, I believe the
    authority Congress provided in 1992 is appropriate for Fannie
    Mae and Freddie Mac, but at the same time, we would support
    enhancing the enforcement authorities of the new financial
    regulator at Treasury beyond those available to OFHEO. We would
    support granting the new regulator cease and desist powers, the
    ability to levy civil money penalties, and the authority to
    suspend and remove company officers and directors comparable to
    what bank regulators have.
        We also believe that a clear distinction of the separate
    rule and authority of HUD and Treasury would be in the best
    interests of housing and Fannie Mae. Currently, HUD regulates
    our housing mission. OFHEO, an independent bureau of HUD,
    regulates our safety and soundness. These separate regimes are
    mutually supportive and neither undermines the other.
        For example, HUD has the authority to ensure that new
    mortgage programs are consistent with our charter and housing
    mission, and OFHEO has the authority to ensure that new
    mortgage programs do not harm our safety and soundness. This is
    an appropriate distinction and one we believe can, and should,
    continue as our financial regulator moves to become a bureau in
    the Treasury.
        Thus, we agree with most of the housing industry
    organizations that HUD should continue to oversee our housing
    mission and, at the same time, it is critical that a world-
    class regulator at Treasury has the authority to review all
    aspects of our operations, including new and ongoing
    activities, and disallow anything that poses a safety and
    soundness risk.
        Whether the Committee chooses to house the mortgage
    approval authority with Treasury or HUD, the standard of
    program approval I believe is crucial. The current standard has
    fostered an unprecedented era of innovation in the mortgage
    industry, and under this authority, HUD is authorized to review
    major new programs to determine whether they come within our
    charter and mission.
        Indeed, on several occasions since 1992, Fannie Mae has
    presented new programs for HUD to review and approve. For
    example, at the urging of Congress, we sought and received
    HUD's approval to invest in energy efficient home loans. The
    current regime does not require HUD to review each and every
    mortgage innovation. This tacit support for innovation has
    allowed us to work with lenders and housing partners to create
    mortgage initiatives, options, and features, all of which are
    consistent with our charter, to fulfill our mission and respond
    to the market and to lender and consumer needs in a timely way.
        In this way, Fannie Mae has led the market in mortgage
    innovation, such as automated underwriting, low downpayment
    mortgages, and creative mortgage initiatives, but we rarely, if
    ever,
    innovate a loan. Behind virtually every new innovation we
    introduce, there is a lender or a housing partner who has asked
    for our investment, and we have responded to them. And we work
    with mortgage bankers, nonprofits and community organizations,
    local housing agencies, minority outreach groups, faith-based
    institutions, and others to help create creative new ways for
    lenders to reach and serve more families.
        Our ability to innovate is crucial to many mortgage
    lenders. They feel free to develop new products to reach
    underserved communities because they know that Fannie Mae will
    purchase their innovative loans in a secondary market, and
    smaller lenders, such as independent community banks, depend on
    our innovations to access the secondary mortgage market and
    build up a competitive mortgage business to serve their unique
    markets.
        With the freedom to innovate, we have been able to respond
    to specific challenges. President Bush challenged the private
    sector to help achieve this minority homeownership initiative,
    to create 5.5 million new homeowners. And Fannie Mae responded
    instantly by boosting our commitment of capital to minority
    families from $420 billion to $700 billion. We have also
    included new initiatives for new Americans and links to
    immigration programs and faith-based organizations.
        As American continues to grow and change, the housing
    industry lenders and homebuyers will need a new generation of
    innovation. We believe the appropriate standard for mortgage
    program review, wherever housed, is that there should be a bias
    for allowing innovation, unless it is clearly contrary to our
    charter.
        One last comment I would make relates to the housing goals.
    Under the 1992 Act, HUD has assigned regulatory affordable
    housing goals for Fannie Mae and has created goals that are
    more
    ambitious than those that are required of most other financial
    companies. They require us to devote a fixed percentage of our
    business in three distinct areas: low- and moderate-income
    families, underserved communities, and special affordable
    housing for very low-income families.
        HUD has considerable flexibility in setting the goals. And
    over the years, they have consistently raised these goals, and
    we have met all of the current goals every year that they have
    been in place. HUD can also use its authority to focus our
    efforts on specific high-priority items, which they have, in
    fact, done.
        In conclusion, as Congress considers legislation to ensure
    a world-class financial regulator for Fannie Mae, I believe
    there is a lot at stake. The U.S. housing finance system is
    indisputably the best in the world, but we have an opportunity
    to make it better.
        There is widespread consensus that housing is crucial to
    the economy and that Fannie Mae is crucial to housing. There is
    also widespread consensus for moving our financial regulator to
    Treasury and providing our regulator with the authority and
    powers to ensure our financial safety and soundness, and Fannie
    Mae stands ready to work with the Congress and the
    Administration to achieve this goal.
        Chairman Shelby. Mr. Gould.

                      STATEMENT OF GEORGE D. GOULD

                    PRESIDING DIRECTOR, FREDDIE MAC

        Mr. Gould. Thank you, Mr. Chairman.
        Chairman Shelby, Ranking Member Sarbanes, and Members of
    the Committee, my name is George Gould. I have served on
    Freddie Mac's board since 1990 and am currently the Presiding
    Director and Chairman of the Governance and Finance Committees.
    From 1985 through 1988, I served as Undersecretary for Finance
    at the Department of the Treasury.
        Freddie Mac plays a central role in financing homeownership
    and rental housing for the Nation's families. Given the
    importance of housing to the economy, it is critical that our
    regulatory structure provide world-class supervision. Before
    expressing our views on specific proposals, I just would like
    to say a few words about Freddie Mac.
        The deficiencies in the company's previous accounting and
    disclosure are unacceptable, plain and simple. While the board
    has taken many steps to address these weaknesses, I will be the
    first to acknowledge that more can be done and will be done.
        First, the board is extremely ``hands on'' with regard to
    getting the restatement done and done right. Since March, the
    committee responsible for the restatement has met on a weekly
    basis, and as we announced last month, we expect to release
    restated earnings for prior years in November.
        Second, we are moving aggressively to ensure these problems
    never occur again. We have added highly qualified accounting
    personnel and strengthened our control infrastructure, and we
    have brought in independent experts to review best practices
    and proposed remediation. For example, we have engaged former
    SEC Division of Corporation Finance Chief David Martin to help
    us with disclosure. The board is fully committed to
    implementing the recommendations of independent experts.
        Now, I would like to comment on key aspects of regulatory
    restructuring. I would like to recognize Senators Hagel,
    Corzine, Sununu, and Dole for helping to get these important
    discussions underway.
        Freddie Mac strongly supports the creation of a strong,
    effective regulatory structure. It is good for the GSE's, it is
    good for markets, and it is good for consumers. Difficulties in
    moving legislation forward are regrettable, but not
    insurmountable. We are committed to doing whatever it takes to
    get an effective regulatory structure in place.
        The Committee has requested our views on a number of issues
    starting with regulatory structure and independence. Freddie
    Mac supports the creation of a new regulatory office within
    Treasury. We also support providing both the new regulator and
    HUD authority to assess the GSE's outside of the annual
    appropriations process.
        With regard to independence, we support applying the same
    operational controls as apply to the relationships between
    Treasury, and the OCC and the OTS.
        With regard to capital, we strongly believe the new
    regulatory structure continue to tie its capital to risk. The
    GSE's are subject to both the traditional leverage ratio--our
    so-called regulatory or minimum capital--and a dynamic risk-
    based capital stress test that requires us to hold enough
    capital to survive 10 years of severe economic stress. Few
    other institutions could meet such a high standard.
        To ensure that the GSE's remain at the forefront of risk
    and capital management, the new GSE regulator should have
    greater discretion with regard to the risk-based capital
    standard.
        Additional discretion is not needed with regard to GSE
    minimum capital, however. Bank regulators need discretion to
    change capital requirements, given the diversity of the
    business lines banks are engaged in. In contrast, GSE's are
    restricted to one line of business, residential mortgages.
    Compared to commercial lending or loans to foreign governments,
    long-term, fixed-rate mortgages are one of the safest financial
    assets around. Even comparing mortgages alone, Freddie Mac's
    mortgage credit losses are consistently lower than those for
    banks.
        Given this low-risk profile, regulatory discretion to
    change minimum capital is unwarranted. Raising minimum capital
    would not increase the safety of the housing finance system;
    rather, it would hamper our ability to serve housing markets
    and raise costs for homeowners.
        With regard to new program approval, we believe HUD should
    retain its authority to approve new programs in keeping with
    its housing mission. At the same time, however, we believe the
    new regulator within Treasury should have authority to review
    and veto any new program that raises safety and soundness
    concerns.
        We also urge the Committee to maintain a new program
    standard, not a new activity standard. In saying that, based on
    earlier discussion, I note that there seems to be a little
    confusion about the definition of those terms, but I think
    there is some precedent to indicate what programs HUD dealt
    with in the past. Requiring the regulator to provide advance
    approval of each and every new activity significantly exceeds
    the standard required of banks and could chill innovation and
    mortgage lending.
        Freddie Mac supports parity of supervisory and enforcement
    powers among financial institutions. Although an array of
    powers currently exist, we would support providing the new
    regulator additional authority, such as new removal and
    suspension authority and new authority to assist civil money
    and criminal penalties.
        Now, let me say a few words about mission oversight. In
    1992, Congress established three GSE affordable housing goals:
    An income goal, a geographic goal, and a special goal for unmet
    needs as determined by HUD.
        HUD has significant discretion to establish and adjust
    these goals and has raised them markedly over the years. Today,
    50 percent of our mortgage purchases must be dedicated to
    meeting these needs. The GSE affordable housing goals are the
    toughest of any financial institution. Additional statutory
    goals could simply balkanize the mortgage market.
        And I may say, departing slightly from my written and oral
    comments, that within Freddie Mac, at least, our Economic
    Department would disagree with Secretary Martinez' conclusion
    that we are lagging the market. If you compare apples-to-apples
    and oranges-to-oranges, we do not believe we are. FHA has a
    different mission. Therefore, its percentage would obviously be
    different from ours, and we are limited statutorily, and by
    safety and soundness standards, to certain parts of the market
    which, when you put it all together, makes us look like we are
    lagging, but within our universe, we do not feel we are.
        HUD also has significant enforcement powers. Not only can
    HUD require the submission of a housing plan should we ever
    fail to meet one of our goals, but it can also require a
    housing plan if it determines there is a good chance that we
    might miss a goal. By contrast, bank regulators cannot bring
    enforcement proceedings against an institution failing to meet
    its CRA obligations.
        Considering that we consistently have met the goals since
    they have become permanent, and that existing powers already
    are the industry's toughest, we respectfully suggest no
    additional powers are needed.
        In summary, Freddie Mac is prepared to embrace significant
    enhancements which will make our regulatory structure stronger.
    Building these enhancements into existing law would give the
    new regulator supervisory and enforcement powers comparable to
    those of bank regulators. The new structure would also maintain
    the tougher GSE regulatory requirements, including program
    approval standards and a risk-based capital stress test.
        Our mission regulator would continue to oversee the most
    challenging, quantitatively affordable housing goals in the
    industry, with more than adequate powers to enforce them. Taken
    together, this enhanced GSE regulatory structure would be
    strong, solid, and credible. It is essential to maintaining the
    confidence of the Congress and the public.
        I would look forward to working with Chairman Shelby,
    Ranking Member Sarbanes, and other Members of this Committee as
    you move forward to address these issues, and I will be
    obviously happy to answer any questions the Committee may have.
        Chairman Shelby. Thank you.
        Mr. Rice.

                      STATEMENT OF NORMAN B. RICE

                 PRESIDENT AND CHIEF EXECUTIVE OFFICER

                   FEDERAL HOME LOAN BANK OF SEATTLE

        Mr. Rice. Thank you. Good afternoon, Chairman Shelby, and
    Ranking Member Sarbanes, and Members of the Committee. I am
    Norman Rice, President and Chief Executive Officer of the
    Federal Home Loan Bank of Seattle, and I would like to thank
    you for the opportunity to speak today on behalf of the Council
    of Federal Home Loan Banks.
        I will just start this afternoon by commending Congress for
    the process now underway regarding regulatory restructuring of
    the housing GSE's. It is also important to note that the Bank
    System continues to work toward voluntary SEC registration,
    pending resolution of some critical accounting and reporting
    accommodations. For example, the Seattle Bank's Board of
    Directors, at our September 2003 meeting, adopted a resolution
    calling for SEC registration, and we are now moving to make
    that happen. The bottom-line goal for our 12 banks is to
    provide complete and transparent financial disclosures that are
    considered no less than best in class.
        While there remain differences of opinion within our system
    on the matter of regulatory reform, we have reached consensus
    on four principles that we believe must serve as a framework
    for specific action and represent our bottom-line concerns as
    Congress moves forward on legislation.
        Principle No. 1: Preserve and reaffirm our mission. We
    strongly believe any legislation should accomplish the
    following regarding the mission of the Bank System: Provide
    cost-effective funding to members for use in housing finance
    and community development; preserve our regional affordable
    housing programs; support housing finance through advances and
    mortgage programs; and allow for innovative new business
    activities that advance our mission.
        Principle No. 2: Create a strong and independent regulator.
    Safety and soundness of the Bank System is our number one
    concern. This is neither a partisan nor an ideologically driven
    endeavor. It is for this reason we ask that Congress protect
    the Bank System through the creation of a strong and
    independent regulator. This is absolutely consistent with the
    role of other bank regulatory agencies in which the regulator
    responsible for safety and soundness has free and unfettered
    authority to determine policy, rulemaking, adjudicative, and
    budget matters.
        We strongly believe that a regulator lacking true
    independence may eventually find itself pursuing other agendas,
    not the will of Congress, nor what is demanded to ensure safety
    and soundness.
        Principle No. 3: Preserve the Bank System funding. It is
    critical that we ensure that nothing is done to any of the
    housing GSE's that would increase their cost of funds and,
    correspondingly, increase costs for financial institutions and
    consumers. Therefore, any legislation must: Preserve the role
    and function of the Office of Finance, which issues our
    system's debt; It must ensure that neither the U.S. Treasury,
    nor the independent GSE regulatory unit, has the ability to
    impede or limit our access to the capital markets without
    cause; And it must not limit the financial management tools
    available to the GSE's to prudently manage risk.
        Principle No. 4: Recognize and reaffirm the unique nature
    of the Bank System. We believe any legislation must preserve
    the cooperative ownership of the Bank System, joint and several
    liability, and the regional structure that assures we are
    locally controlled and responsive to the needs of our
    communities.
        Regardless of the regulatory structure established by
    Congress, we believe these principles must be considered as you
    move forward in your policymaking. So, in closing, I would like
    to put forward some ideas that reflect my own thinking on these
    matters.
        I believe there are two threshold issues that could help
    Congress attain its goal of protecting the public interest in
    the housing GSE's.
        First, there is much that separates the Federal Home Loan
    Banks from the two other housing GSE's: Our mission is broader,
    incorporating economic and community development. We have
    different capital requirements; The Bank System is
    cooperatively owned and capitalized by our members, while the
    other housing GSE's must meet the earnings expectations of Wall
    Street; The other two housing GSE's pay Federal income tax, but
    the Federal Home Loan Banks pay special taxes, equivalent to a
    Federal corporate income tax rate of 26 percent.
        These are not inconsequential differences. Yet, despite
    these differences, we increasingly have more in common. All
    three housing GSE's are managing increasingly complex sets of
    financial, operating, and accounting risks. And in my view, all
    three would benefit from more rigorous oversight of these
    activities.
        Second, the choices you make on regulatory reform must be
    based on the underlying philosophy about the housing GSE's. In
    your judgment, is the public interest best advanced by
    encouraging competition or encouraging market domination? In
    the end, I believe the Nation's home lenders will better serve
    the Nation's homebuyers if there are choices and competition in
    the secondary mortgage market. Full-fledged competition among
    GSE's is a way to more prudently manage growth and disburse
    risk among more investors.
        As one of 12 Federal Home Loan Bank presidents, my
    responsibility is to protect and enhance this cooperative and
    the overall public interests invested in our Bank System--the
    same process that each of you bring to this process.
        I would like to thank you for your time this afternoon, and
    I would be also happy to answer any of your questions you may
    have regarding my testimony.
        Chairman Shelby. Thank you very much.
        Mr. Raines, the minimum capital threshold of 2.5 percent
    that Fannie Mae and Freddie Mac are subject to is often
    compared, as we know, to the 4-percent-minimum capital standard
    the banks and thrifts must meet. Do you believe that is a fair
    comparison?
        Mr. Raines. I do not believe it is a fair comparison, for
    several reasons.
        First, the minimum capital requirement that we have applies
    not just the 2.5-percent on-balance sheet, but also there is a
    45 basis for off-balance sheet items, which banks do no count
    off-balance sheet items in the calculation of their so-called
    minimum capital.
        But more importantly, banks are in a far more risky
    business than we are.
        Chairman Shelby. Elaborate on that for the record. We
    basically know that a first mortgage on a home is probably one
    of the safe investments. I mean, it is not perfect, but it is
    pretty safe. Would you compare it to some of the other risks
    that banks take.
        Mr. Raines. Yes, sir. I think the simple comparison is to
    compare capital to losses. If you compare our capital to our
    losses on an annual basis, we have 450 times more in minimum
    capital than in our annual losses. A typical bank has 15 times.
        Chairman Shelby. Four hundred fifty times?
        Mr. Raines. Four hundred and fifty times as much minimum
    capital as our losses, a typical bank 15 times, a typical large
    bank, 12 times.
        Chairman Shelby. And how long is this 450? Is this this
    year or what about the last----
        Mr. Raines. It has been maintained for many, many years.
        Chairman Shelby. It remains constant.
        Mr. Raines. And, indeed, even if you just look at banks'
    residential mortgages, banks lose 30 times as much on their
    residential mortgages as we do. So, even if we do not count
    their investments overseas, their investments in leases, their
    investments in a wide range of riskier things, if we just look
    at residential mortgages, they have 30 times the losses that
    Fannie Mae has.
        Chairman Shelby. You do not make credit card loans, do you?
        Mr. Raines. We do not do that. Indeed, if we were to turn
    the equation around and say maybe banks should have the same
    level of capital that we have compared to losses, it gives you
    an idea of how high bank capital would have to go, even on
    their mortgages, if they had to have 30 times the capital that
    they have today.
        So that is why it is very important to relate capital to
    risk. The most dangerous thing I think you can do in the
    financial system is require excess capital for the risk that is
    being taken because what that does is it diminishes the flow of
    capital into the marketplace. And so what you need to do, I
    believe, is to match capital with risk, and Fannie Mae and
    Freddie Mac, throughout our entire history, have had far lower
    risk profiles than comparable banks.
        Chairman Shelby. Both you and Mr. Gould have expressed your
    opposition clearly to a change in statutory minimum capital
    guidelines, but at the same time, you have generally expressed
    support for strengthening the authority of the new regulator
    using bank regulators as a model.
        Why would it not make sense to allow the new regulator, if
    we create one, to have more discretion over the minimum capital
    standard?
        Mr. Raines. The major reason, I believe, is that the
    minimum capital standard is this capital standard relates to
    our mission, and it is saying how much it is that you think
    Fannie Mae should do. If you double the minimum capital
    standard, without any change in risk, you are saying Fannie Mae
    can do half as much, and I believe that should stay with
    Congress.
        But where it comes to risk, we believe that a regulator
    should have extensive ability to change the capital standard.
    Indeed, I have to say to you, and I am a very trusting person,
    but I have to say to you I wonder what would be the reason to
    raise our minimum capital standard if our risk has not gone up?
    What would be the reason? And the only reason I can think of is
    that the regulator will just have a different view of how
    active we should be in the housing market.
        Chairman Shelby. But, on the contrary, if the risk were not
    there, could a regulator not lower the risk capital?
        Mr. Raines. In theory, the regulator could lower it. We are
    not asking for it to be increased, and we are not asking for it
    to decrease. We are asking for our capital to be related to
    risk.
        Chairman Shelby. And if you could quantify your capital,
    just Fannie Mae, and I will ask Mr. Gould, what is this 2.5
    percent? How many billions of dollars are you talking about?
        Mr. Raines. It is about $30 billion currently.
        Chairman Shelby. This is Fannie Mae.
        Mr. Raines. This is Fannie Mae. But on top of that, we have
    also pledged to issue another 1.5 percent against our assets in
    subordinated debt. So, if you calculate all of the capital, all
    of the risk-bearing capital that we have, we have 4 percent
    capital--2.5 percent that is equity and another 1.5 percent
    which is subordinated debt, which if we were a bank would be
    counted as part of the overall capital calculation.
        We have 4-percent capital if you are talking about risk
    bearing.
        Chairman Shelby. For a lot less risk, you are saying.
        Mr. Raines. For a lot less risk, and it is important to
    remember that, when everyone talks about the risk to others,
    remember the first people who lose their money are the Fannie
    Mae shareholders. They have $30 billion as the first line----
        Chairman Shelby. Well, that is the way it should be, is it
    not?
        Mr. Raines. Exactly. That is why they keep me on my toes.
        Chairman Shelby. Mr. Rice, uniform capital standards for
    housing GSE's. You state that it is your view the capital
    requirements be standardized for all three housing GSE's. Are
    you proposing a 4-percent minimum, a 2.5-percent or regulatory
    discretion? What are you really saying?
        Mr. Rice. I believe in regulatory discretion, but I do want
    to state that the Federal Home Loan Banks have had zero credit
    losses--zero--ever, and we are required to hold 4 percent
    minimum capital.
        So, I would hope, with the discretion of an independent
    regulator, they would understand that there is some imbalance
    in the minimum capital standards, and maybe they would lower it
    to a level closer to the other housing GSE's.
        Chairman Shelby. On the other hand, the Federal Home Loan
    Banks can make advances based on collateral beyond mortgage-
    related assets; is that correct?
        Mr. Rice. That is correct.
        Chairman Shelby. Would that not argue that the capital
    standard for the Federal Home Loan Banks should be different
    and perhaps more rigorous? In other words, you have got more
    risk than----
        Mr. Rice. Well, Congress allowed us to have expanded
    collateral for other loans to be made to rural farmers and the
    like.
        Chairman Shelby. But that does not mean you do not have
    more risk.
        Mr. Rice. No, I am not saying that, but I am saying that
    the collateral standards and the management of that credit is
    as important in managing that risk.
        All I am saying is that we have a different minimum
    standard, and I think it would be important for the new
    regulator to evaluate those standards and make some
    determination rather than the status quo.
        Chairman Shelby. Mr. Rice, your written statement notes
    that the Bank System is working toward voluntary SEC
    registration, pending resolution of critical accounting and
    reporting issues.
        I am also familiar with the study completed by First
    Manhattan which indicates that there may be significant costs
    associated with registration, and I want to enter that study
    into the record and share it with my colleagues.
        [The First Manhattan study follows:]
        Mr. Rice. I would appreciate it.
        Chairman Shelby. What factors do you believe that we need
    to consider, if we agree with the need for disclosure, which I
    think we do, yet want to be mindful of any structural factors
    unique to the Federal Home Loan Bank System?
        Mr. Rice. The Federal Home Loan Banks have always, by
    statute, been jointly and severally liable for each other's
    debt. Under SEC registration, it appears that this situation
    could give rise to the need for each Federal Home Loan Bank to
    create an additional on-balance sheet liability. Additionally,
    Federal Home Loan Bank stock would be characterized, under
    current regulations, as being mandatory or redeemable. Those
    have real consequences on our balance sheet for our members,
    and we want to get clarification of those issues.
        So the issue is not about not disclosing, it is how we
    disclose, and then the impact of those disclosures on our
    members. Our board has directed us to move quickly on this
    issue, but we do think there are areas of differences we would
    like to resolve with the SEC.
        Chairman Shelby. But the key to disclosure is how you
    disclose.
        Mr. Rice. Exactly.
        Chairman Shelby. So, in other words, what do you disclose,
    and if you have transparency, that is going to be better for
    the regulator, it is going to be better for your members, is it
    not?
        Because you are looking for the truth of your financial
    condition.
        Mr. Rice. Well, transparency is what we all believe in.
        Chairman Shelby. And disclosure.
        Mr. Rice. And disclosure, and there is no doubt about it.
    There are unintended consequences for the way we are structured
    from other publicly held corporations, and all we want to do is
    to talk to SEC about those differences and recognize them.
        Chairman Shelby. Thank you for your indulgence.
        Mr. Gould. Mr. Chairman, might I comment on capital from a
    slightly different point of view, but I think an important one
    for what this Committee is considering?
        Chairman Shelby. Yes.
        Mr. Gould. I think capital has often been a shorthand way
    of looking at protecting the overall risk which Secretary Snow
    commented on to the financial system a number of times when he
    was here, and that is of course true. That is the first capital
    to be lost if there is a problem, and risk-based capital,
    trying to relate it to the risk nature of where you are buying
    loans or holding assets, but I think there is another very
    important aspect of it, a subtlety to the risk aspect, which
    is, to me, the most important thing the regulator must look at
    is how well the companies themselves control the risk of what
    they are doing, how well does Freddie Mac control its interest
    rate risk exposure in terms of its retained portfolio and how
    well do we evaluate and monitor the credit risk of our
    securitized portfolio because there the numbers are very large.
        This is a very important factor, as we go forward and try
    to provide more minority housing and fulfill our low-income
    mission, so a strong regulator, in my mind, is defined in other
    ways, besides other ways, as someone who is able to evaluate
    the risks of how we manage ourselves internally because that,
    in the end to me, involves much larger numbers than merely the
    amount of capital.
        Chairman Shelby. How much of our portfolio do you keep and
    you do not secure? Do you securitize everything?
        Mr. Gould. No, sir.
        Chairman Shelby. I thought you kept a lot of stuff.
        Mr. Gould. Yes, we do.
        Chairman Shelby. That is where the risk comes, is it not?
        Mr. Gould. Well, a different type of risk.
        Chairman Shelby. It is risk.
        Mr. Gould. They are the same securities. Yes, sir, it is
    risk, but the retained mortgages and the ones we securitize are
    the same product. In securitizing them, we have taken the risk
    in our guarantee of those securities that they are good in a
    credit sense. For the same type of mortgage that we retain, our
    risk is that we do not finance properly or do not hedge
    properly the interest rate risk of having to finance those
    retained mortgages in the market and yet have those mortgages a
    fixed rate of return financed in a fluctuating or volatile
    public market, which we do, and we believe very successfully
    and safely, with a certain amount of derivatives.
        Chairman Shelby. Senator Sarbanes.
        Senator Sarbanes. Mr. Gould, your comment just now about a
    strong regulator evaluating the internal controls of the
    entities that he is regulating, that is the point you are
    making.
        Mr. Gould. Yes, the economic controls within the company.
        Senator Sarbanes. I take it that is, in effect, a fairly
    strong criticism of OFHEO in terms of its oversight over
    Freddie Mac.
        We would not be here today, I do not think, but for the
    Freddie Mac experience.
        Mr. Gould. I would not, personally, characterize it as a
    strong criticism because their prime mission is safety and
    soundness, and there is no question, before or during the
    accounting problem or now, of Freddie Mac's safety and
    soundness. Indeed, I think anyone will testify that our safety
    and soundness, in terms of economic risk, and hedging and
    credit risk, is first rate, best in class.
        Senator Sarbanes. If you are not reporting accurately, does
    that not carry with it a huge potential to impact on the
    perception of your safety and soundness?
        Mr. Gould. Certainly, the perception I would not argue with
    you, Senator, and perceptions in markets are extremely
    important. And Freddie Mac, what the Freddie Mac issue is
    really about is the timing of the recognition of income. When
    you get right down to the core issue, that is what it is.
    Should these earnings have been recognized in earlier years or
    should they have been amortized over certain assets into future
    years? And basically that is what you are getting to.
        And the answer of our new auditor, in particular, is we
    should have recognized that income in earlier years, but that
    is a long way from safety and soundness and a long way from the
    systems we built to control our economic risk. And, very
    frankly, Freddie Mac simply did not build its accounting, both
    its accounting abilities, both in a technical sense and in a
    personnel sense, in the same way that fortunately it built all
    of its economic risk organization.
        Senator Sarbanes. Mr. Rice, if a new regulator is developed
    for Fannie and Freddie that carries with it the message that
    they are under enhanced safety and soundness regime, and the
    Federal Home Loan Banks are not part of that new regime, with I
    think a growing perception that the regulator of the Federal
    Home Loan Banks is really not up to standard, what would the
    impact of that be on the Federal Home Loan Banks?
        Mr. Rice. You started your question with ``perception,''
    and if that perception moves to the Street, then it could have
    consequences on the cost of funds. There could be a difference,
    and you might be able to feel it.
        I think that is one of the reasons why a large number of
    banks have said, if you are going to move in this direction,
    here are the principles we want, and we would like to be
    included based on that framework.
        Senator Sarbanes. I guess it is the concern about that
    development that has led at least some of Federal Home Loan
    Banks to now be in favor, on certain terms, of being included
    with the other GSE's in this regulatory arrangement; is that
    correct?
        Mr. Rice. There are those concerns, yes.
        Senator Sarbanes. So from the point of view of the Federal
    Home Loan Banks, or at least some of them as they analyze it,
    being left out has a potential of a significant downside to it;
    is that correct?
        Mr. Rice. The more people talk that way the more momentum
    is create but there is nothing quantifiable at this point.
        Senator Sarbanes. I am not talking that way. I am just
    asking.
        Mr. Rice. There is nothing quantifiable that could show you
    those kind of metrics. But I do believe that the cost of funds
    might be affected, but I have no proof or empirical data to
    show you that.
        Senator Sarbanes. Then let me ask this question of all of
    the panel members. Fannie and Freddie have been under the same
    regulator. They do the same line of work. The issues are all
    co-terminus, so to speak. The Federal Home Loan Banks are
    somewhat different. They do some things that Fannie and Freddie
    do, and they do other things that Fannie and Freddie do not do.
    Fannie and Freddie would not be permitted to do some of those
    activities.
        Now if you are all brought in under one regulatory
    structure, it seems to me you confront a problem of how do you
    harmonize this situation. So, I would be interested in hearing
    from each of you what you think the problems of harmonization
    would be and how they might be resolved. Mr. Rice, why don't I
    start with you and we will just go across the panel?
        Mr. Rice. I think the best way was the one that was
    articulated by Secretary Snow, even though I would like an
    independent regulator--he said, have two deputies to view the
    functions of the two structures, because they are different. I
    think to recognize the difference within the organization and
    let the regulator then lead would be the best way to do it.
        Senator Sarbanes. Mr. Gould.
        Mr. Gould. I think you would have to have a pretty good-
    sized staff in order to harmonize it because you are, as you
    suggest, Senator, looking at certain different activities and a
    regulator would have to come to conclusions as to the safety
    and soundness of each of those different missions. I think,
    however, there is a common denominator which is the safety and
    soundness of how they finance themselves and how they manage
    risk; interest rate risk or core credit risk. So the Treasury
    does have, certainly, expertise in that area, but I think it
    would have to be staffed more broadly than just the two GSE's
    because of the different level of opportunities they have to
    make loans.
        Senator Sarbanes. Mr. Raines.
        Mr. Raines. Senator, I think the problem is broader than
    that of my compatriots here. I think that there would need to
    be a very clear standard that similar activities would be
    regulated in a similar way. Otherwise it raises the question,
    which regulatory scheme is really the best one? That raises a
    number of issues I think would have to be resolved.
        First of all, the question of mission. If you look back in
    1992, Fannie Mae had 87 percent of its assets were owning
    single family mortgages and the rest were liquidity primarily.
    If you look today, 90 percent of our assets are owning single
    family mortgages but we have had an extensive debate about
    whether Fannie Mae has been in new businesses or not.
        If you look at the same thing with the Federal Home Loan
    Banks, for some of the Federal Home Loan Banks in 1992, 100
    percent of their assets were either advances or investment
    securities. Today, in at least one of the banks, advances are a
    minority of what they do. So there would have to be a question
    first on mission. What do we mean by mission? And could Fannie
    Mae, if we were to harmonize, does that mean Fannie Mae could
    go wholly into an entirely new business that is completely
    different from the holding of mortgages, if the harmonization
    were to go that way? I would think that would not be the
    interest because there has been so much concern that we have
    already gone into things that are far beyond our charter.
        The second point that comes up is on capital. We had a
    discussion on capital, and I have to correct myself. We only
    have 357 times as much capital as our losses, not 450.
        But on the question that Norm Rice brought up on capital.
    The capital that the Federal Home Loan Banks have today would
    not count as capital for Fannie Mae because it would be
    considered a kind of puttable preferred. It would not count at
    all as being acceptable capital for Fannie Mae. That is a big
    difference. The Federal Home Loan Banks believe they have an
    enormous amount of capital but under our capital standard it
    would count for zero. Someone would have to resolve, what does
    that mean?
        Similarly with regard to housing goals. Today, Fannie Mae
    has housing goals which are percentage of business goals and we
    invest more money in low-income housing tax credits than the
    entire Federal Home Loan Bank System invests in their
    affordable housing program. And we pay Federal income taxes. So
    we do all three and the Federal Home Loan Banks do one. Now
    which way are you going to harmonize?
        Mr. Rice. That is why you need two.
        Mr. Raines. I think the problem is, if we are both going to
    be in the business of providing a secondary market and owning
    and guaranteeing the mortgages, then presumably we would have
    the same standards apply. I think these are tough questions. I
    think that before we embark on this you would want to either
    have the Congress answer them, or certainly empower the
    regulator to insist that the same standards be applied if you
    are in the same business. Certainly within this small group of
    GSE's that should not be too much to ask for.
        So, I think there are some very profound issues and I do
    not want to presume to say, doing it our way is the best way or
    their way is the best way. But there are very different
    standards that are being applied now and I would think that we
    would want to pick one to apply to all these entities, at least
    as far as it goes to the owning of mortgages.
        Mr. Rice. I would just come back to the whole question that
    because we are a cooperative and because our members are on our
    board and we service our members, if our members are desirous
    of a product, we have that product approved by our regulator
    and we are providing the type of product that our members want.
        I would call it mission leap rather than mission creep and
    I do believe we can do it and we have managed it well. In the
    short term, $1.75 million from this new activity has gone to
    our affordable housing programs and created almost 385 units of
    housing. So we are still providing the mission that we were
    chartered, and I think we are moving in a way that really makes
    a difference.
        Advances are a product. I have no problem if Fannie Mae
    wants to move into advances. I just think that the regulator
    ought not to be so overburdened with restrictions at the
    beginning. These are things that I think an independent
    regulator has to come to grips with. But I do think that there
    is a way to manage this in a way that maintains the character
    of the system that we have and recognizes the differences,
    because that is what is at risk is the differences. So by
    having a single regulator with maybe two divisions under it
    still maintains the integrity of what the Federal Home Loan
    Banks is and allows I think for good regulation.
        Chairman Shelby. Senator Bennett.
        Senator Bennett. Thank you very much, Mr. Chairman. The
    more I sit here, the more I realize I need to sit here.
        [Laughter.]
        First, I asked a question of the previous panel, have they
    ever missed their goals? Mr. Gould, you came back fairly
    strongly and said you disagree and that you have not missed
    your goals. Mr. Raines, do you also disagree that you have not
    missed your goals?
        Mr. Gould. I have said that there is disagreement with the
    study that Mr. Martinez was citing as to our not leading, but
    lagging. In terms of meeting our goals, as my testimony says,
    since those goals have been permanent we have met them every
    time. There were some temporary goals in the early to mid-
    1990's that we did not meet.
        Senator Bennett. That was the period of time that he cited,
    1993 to 1995.
        Mr. Gould. Yes, sir, that is correct.
        Senator Bennett. Mr. Raines, do you have a comment on that?
        Mr. Raines. Yes. The current goal structure we have met
    every year. In the first year that they established the goals,
    they had a different goal called a central cities goal, in the
    very first year, which we did not meet nor, I believe, did
    Freddie Mac meet. But that goal was then eliminated. So when we
    are talking about, have we met our goals, if you look at the
    goals that we have had over this period we have met them every
    year.
        But I agree with George Gould on the question of leading
    the market, that we believe the data clearly shows that we do
    lead the market. But let us be clear of what that means.
        Senator Bennett. I wanted to get more clarification on
    that.
        Mr. Raines. What leading the market means is that we are
    acquiring a greater share of a type of loan than the market
    creates. Now that may sound like an easy thing to do, but we
    are in the business of buying loans that other people have
    originated and which they have voluntarily decided to sell. So
    leading the market is not just simply our opening up the doors
    and saying, give us the loans you have. Indeed, if you look at
    our major lenders, if we only relied on our single family
    lenders we could not even meet the HUD goals, let alone lead
    the market.
        But also, this Committee has instructed other lenders,
    particularly depositories, that they are to lead the market. So
    when they acquire loans that may fit our goals, if they decide
    to hold them then they are leading the market and we are unable
    to lead the market. So the fact that we lead the market is a
    big deal. It is not a small thing.
        This debate, I hope you understand, between us and HUD on
    the statistics, which we can go over with your staff with the
    statistics, is a question of, they believe we might be behind
    the market by 1 percent, and we believe we might be ahead of
    the market by 1 percent. So this is not a question of wholly
    failing. This is a difference between 41 percent and 42
    percent.
        But the important thing is the fact that Fannie Mae and
    Freddie Mac can even come close to the market on this kind of a
    detail is an indication of the kind of effort we make because
    we can only buy loans that people voluntarily want to sell to
    us. We cannot make them sell them to us. Indeed, we have to
    induce them to originate the loans. Then we have to induce them
    to sell them. And then we have to induce them to sell them to
    us. All of which goes into leading the market.
        So when we say we lead the market, it is not as though we
    just opened up the doors and business came in. It is a very
    hard thing to do when you do not originate the loans yourself.
        Senator Bennett. So everybody has to lead the market. It is
    a little like Lake Woebegone where everybody is above average.
        Mr. Raines. Yes.
        Senator Bennett. Let me ask about the cost of funding.
    GSE's are successful largely due to their access to relatively
    low-cost funding. So how would the different issues relating to
    creating a new regulator and possibly moving program
    authority--these are the two fundamental issues I keep hearing
    over and over again; what role is HUD going to have? What role
    is the regulator going to have? I think there is general
    agreement agreeing with Senator Carper, here is the list of
    things that we all agree on, and there is general agreement
    that there needs to be stronger regulation; a higher class,
    world class--whatever that means--regulator for everybody. And
    there is general agreement that that, for the GSE's at least,
    should be in Treasury. Mr. Rice is not quite sure he is ready
    to move in that direction yet. I can understand that.
        But how would the different issues related to creating a
    new regulator and then moving the program authority out of HUD
    affect your access to low-cost funding?
        Mr. Raines. I think the impact on funding is not nearly
    what has been spoken about. I think that is an issue of
    mission. I think it is far more important, in terms of the
    balance between safety and soundness and mission, to get the
    program approval right. Because if you freeze Fannie Mae or if
    you had frozen us 10 years ago and said that innovation is now
    going to be subject to a bureaucratic procedure, we never could
    have done all the refinances that were done last year when 10
    million loans went through our automated underwriting system,
    and giving people loan approvals in two minutes rather than 2
    weeks. We could never have done what we have done in the last
    couple of years. It just would not have happened.
        I think it goes to the mission and our capability to serve
    the market. But I do not believe that moving our regulator to
    Treasury is going to increase our access to the market. I do
    not believe it will harden in any sense the implied guarantee,
    which I never quite understood what an implied guarantee is.
    Nor do I think it would be harmful, whether or not the Federal
    Home Loan Banks were in or out of the Treasury apparatus. I
    think the most important thing is that we have a strong and
    safe and sound--strong regulator so that the investors believe
    that their interests are being taken care of.
        I view this as a continuum. Before 1992, we essentially did
    not have a safety and soundness regulator. In 1992, this
    Committee led the way in creating one. Now here we are 11 years
    later to improve on it. So, I view this as more of a continuum
    than an abrupt change that is going to change the market's
    perception of Fannie Mae, Freddie Mac or of the Federal Home
    Loan Banks.
        Senator Bennett. Mr. Rice, do you want to comment?
        Mr. Rice. The only thing I would add is that the System has
    had zero credit losses--and we are regulated for safety and
    soundness by the Finance Board, we have had an exemplary
    activity and a record in this whole area because we have had a
    very good safety and soundness regulator. I do believe that I
    share some of the same opinions that Mr. Raines has, and that
    is that it is the performance and the examination and the
    supervision of our activities that really does resonate with
    the Street.
        The Street does not really ask you, who is your regulator?
    They really look at your financial statements and the condition
    of how you run your operations and that is the measure of your
    success. We think we have a good success record as we exist
    today. I think that is the reason some of the banks are
    questioning whether this new configuration as something that is
    necessary.
        But I do think that all of us are realists. If you are
    going to create a new regulatory structure, we would like to
    see if maybe there could be some consistency. But I do not
    believe we all need to be the same. One size does not fit all,
    especially for the Federal Home Loan Banks, and especially for
    the cooperative nature in which it operates. So when you try to
    make these distinctions to bring this all together in one lump
    sum, I think that is not something that legislation can really
    do. You are going to have to rely on the independent regulator,
    who should be outside of Treasury, making those determinations
    which will allow you to get the accountability that Congress
    needs.
        Senator Bennett. Thank you. Thank you very much.
        Chairman Shelby. Senator Sununu.
        Senator Sununu. Thank you, Mr. Chairman. Welcome to each of
    you. Mr. Raines, I very much appreciate, one, the time you have
    spent on this issue. You have spent time with me. Your staff
    has been very generous with my staff and that is very helpful.
    I think everyone on the Committee understands how important
    these issues are to you as businessmen and your employees, but
    also how important they are to the capital markets. So thank
    you for that.
        I also very much appreciate the emphasis you place on the
    definition and the language that is going to be used by any
    regulator regarding products, programs, and activities. I very
    much agree with that. We want to be, first and foremost, as
    clear as possible. We may end up with language that is not
    exactly the way you would write the statute. No surprise. But I
    very much agree that language is important, more important than
    exactly where the regulator overseeing those new business lines
    are. We want to get that right so that you can innovate, so
    that you can respond to changes in the market and new
    technologies. So, I want to emphasize that I very much agree
    with you there.
        Certainly, as you well know, the legislation that Senator
    Hagel, Senator Dole, and I have introduced I think largely
    agrees with the perspective that you place on enforcement--you
    talked about that in your testimony--on independence, which you
    have talked about and emphasized in your testimony, and a
    number of other issues. So, I think we can all appreciate that
    there is a good deal of consensus here.
        Mr. Gould, I think you suggested that the accounting issues
    do not affect safety and soundness. The misstatements of
    accounting, profits, do not affect safety and soundness; is
    that correct?
        Mr. Gould. I have said the accounting issues we have had do
    not affect safety and soundness. I am not making a
    generalization of that statement.
        Senator Sununu. Sure. I want to explore that a little bit
    because I think a $3 billion misstatement of profit does affect
    safety and soundness. I would imagine it affects your access to
    the capital markets, and it certainly affects the interest rate
    at which you can borrow and the expectation of investors. Would
    that not be part and parcel of affecting safety and soundness?
        Mr. Gould. It might ultimately. I do not think it has
    affected our safety and soundness now. I do not know what tense
    we are speaking in, Senator. Are we talking about present
    tense, future tense, or past tense?
        Senator Sununu. We are talking about past tense in terms of
    accounting misstatements that have occurred, a $3 or $4 billion
    misstatement of the timing of profits earned by Freddie Mac----
        Mr. Gould. Have not affected our safety and soundness.
        Senator Sununu. And whether or not that accounting issue in
    particular or that type of accounting issue would affect safety
    and soundness.
        Mr. Gould. It has not affected our safety and soundness in
    a past tense or in a current tense. Could it affect our safety
    and soundness in a future tense? Absolutely. That is why we
    have a number of steps of remediation to try to prevent
    anything like that happening again. In a sense this is, as
    someone said earlier, a high class problem. It happens to be
    more earnings. But it is also possible, in theory, if steps
    were not taken to correct it, that it might go the other way
    sometime and that certainly affect the perception and the
    reality of safety and soundness. So it is something that must
    be corrected.
        Senator Sununu. I appreciate that, although I will qualify
    my own reaction as I did earlier, the fact that it was an
    understatement of earnings does not make it any better, any
    more acceptable, does not denigrate the fundamental problems
    than if it were an overstatement.
        Mr. Gould. I agree with you totally. I might say though,
    since you are on that subject and we are talking about
    accounting, and I think that this is very important for this
    Committee to understand. I am not passing judgment on whether
    it is good or bad, the new accounting rules under GAAP, but the
    fact is it introduces, particularly for someone like Freddie
    and Fannie, a high degree of volatility in earnings, quarterly
    earnings and yearly earnings, high degree compared to the past
    which, again since we have discussed perceptions, is something
    that we are both going to have to work on trying to explain the
    realities of the underlying economics of our companies rather
    than merely GAAP.
        Because Freddie's transgression here has been not following
    GAAP. Part of the problem has been the fact that we do not
    think GAAP is the best explanation of the nature of our
    economics. But we must follow GAAP. Those are the rules. But in
    an accounting sense, the future will look different from the
    past even with all the accounting corrected.
        Senator Sununu. I appreciate your concern with the
    accounting standards and I understand in concept, in principle,
    your concern. But this is usually the part of the hearing when
    we all run for cover behind Senator Enzi. If we start getting
    into FASB and GAAP standards then most all of us are out of our
    element. But your points are very well taken. Also I want to be
    clear, I very much understand that you are more sensitive than
    anyone else in this room to the issues created by the past
    misstatements.
        Mr. Raines, you stated that you, Fannie Mae, or the GSE's,
    are asking for capital to be related to risk. I totally agree.
    But I do not see how moving regulatory authority for a minimum
    capital standard to be inconsistent with ensuring that capital
    is related to risk. Those are not mutually exclusive, are they?
        Mr. Raines. I think that there is a concern that if you
    have a risk-based capital standard that you are setting gauged
    risk; why did you move the minimum capital standard? Our
    minimum capital serves a very different purpose than minimum
    capital in banks. Banks do not have an effective risk-based
    capital standard. What they call risk-based capital is simply a
    leverage requirement applied asset class by asset class. But it
    does not go up and down with changes in the economy. It does
    not go up and down with changes in interest rates. It has no
    stress test involved in it. So in their case, the only lever
    they have to move is the minimum capital in order to be able to
    affect the bank.
        Senator Sununu. I appreciate that. I appreciate the
    differences between banks, and your testimony about the
    differences in portfolios and business activities; very
    important and very well taken. But it just would seem to me,
    and I suppose most people looking at this from a common sense
    perspective would say, whatever capital standards exist in
    order to ensure and match with safety and soundness should be
    the responsibility of whatever new regulator is envisioned by
    this Committee.
        Again, I can understand your point that there are
    differences between banks and that banks may not have the risk-
    based capital standard. But whether we are talking about
    minimum capital or risk-based capital, it would seem to me to
    make sense that the new regulator have responsibility.
        Mr. Raines. Then, Senator, if that is the Committee's view
    then my recommendation would be, abolish the minimum capital
    standard and simply have a risk-based capital standard, which
    would be entirely based on risk and we would not have to have
    the discussion about whether minimum goes up or down. Because
    in our case, minimum capital is in some ways an anomaly, as to
    why you even have a minimum capital standard if you have got a
    risk-based capital standard. So there is another way to avoid
    the confusion, which is to eliminate the minimum capital
    standard.
        Senator Sununu. Are you recommending that?
        Mr. Raines. No. My recommendation is to leave the capital
    standard that Congress has created in law and leave it the way
    it is and allow the regulator great flexibility in changing
    risk-based capital. I am not proposing a big change. I am
    trying to have as few changes as possible so we can actually
    get something done. But based on your logic, there is an
    alternative solution. Rather than giving the regulator
    authority to move it around, get rid of it and have the entire
    focus based on risk-based capital.
        Senator Sununu. My logic is that whatever capital standards
    exist should be the responsibility of the new regulator. Your
    logic is that nobody else has a minimum capital standard, and
    therefore, we ought not to deal with it.
        With regard to the Federal Home Loan Banks, if they are
    included in the legislation, are you recommending that we
    include your proposal to tax them?
        Mr. Raines. What I recommend is that if the Committee is
    going to include the Federal Home Loan Banks, that the
    Committee address these substantive issues as to whether or not
    they should be--as it relates to their mortgage programs, not
    to their advances, but as it relates to their mortgage
    programs--operating under the same rules that we do.
        Senator Sununu. Which would be a significant change to
    their charter.
        Mr. Raines. Absolutely. But they have moved into a
    significantly new business. Just as if we moved into a
    significantly new business I think you would want to revisit
    our charter.
        Senator Sununu. But moving them to a new regulatory
    authority does not mean they are moving into a new business.
        Mr. Raines. Some of them have already moved----
        Senator Sununu. The question is, if we move them into a new
    regulatory authority, should we tax them? You seem to say, yes,
    because we should revisit the charter issues associated with
    the Federal Home Loan Banks because we are moving them into
    this new regulatory authority.
        Mr. Raines. No, because the Congress of the United States,
    I do not believe, is going to take up this issue again any time
    soon. If you move them into a new regulator you are essentially
    saying that you are comfortable with the Federal Home Loan
    Banks having $100 billion today, and potentially $500 billion
    in a few years, owning of mortgages under an entirely different
    scheme than you have established for Fannie and Freddie.
        Senator Sununu. So by extension, should we revisit the
    issue of the tax status with regard to State and local taxes
    for the GSE's, and the Treasury line of credit as well?
        Mr. Raines. If we move into a different business.
        Senator Sununu. If we move Fannie and Freddie into a new
    regulator?
        Mr. Raines. No. If we moved into a new business I think you
    should revisit our charter. But we cannot move into a new
    business under our charter. They have moved into a new business
    that is entirely different from the business that they were in
    the last time Congress reviewed their charter.
        Senator Sununu. So your point seems to be that you want to
    revisit these issues of charter and taxation because they have
    moved into new businesses, not because we are considering
    including them in a new regulator.
        Mr. Raines. Both.
        Senator Sununu. There is an important distinction to be
    made here.
        Mr. Raines. It is both of those. But I agree with you. If
    the Congress was not taking up this issue, then I would not
    come up here and say, I would like you to take up the issue.
    But if Congress does take up the issue of the Federal Home Loan
    Banks, I think this is the one time you are going to deal with
    it for the next 5 or 10 years, and I think if you do not deal
    with it now it will never be dealt with.
        Senator Sununu. But this same exact argument could be made,
    by someone that wanted to make it, that for those very reasons,
    because we are talking about these issues, that we should have
    on the table Treasury line of credit for the GSE's, that we
    should have on the table applicability of State and local
    taxes. As you well know, in approaching this I think many
    people, including me, have said that maybe those ought not to
    be addressed specifically in this legislation.
        Mr. Raines. There has been no hesitancy in this town for
    people to raise those issues about Fannie Mae and Freddie Mac.
    If we were to move into a new business I would expect them to
    raise them, and I would expect Congress to address them. But
    nothing has changed in terms of our business since 1992.
    Congress addressed that issue in 1992. There has been no new
    argument made with regard to them since 1992. That is why I am
    saying, I do not see a need for Congress to go into that.
        A lot has changed with the Federal Home Loan Banks since
    1992; a lot has changed. And a lot has changed since the last
    time Congress legislated a few years ago with regard to this
    issue. And the Banks are proud of the change. So this is not
    hidden. The only question I am raising, a change has occurred.
    If you are going to now legislate on the Federal Home Loan
    Banks, it seems to me that change should be addressed.
        Senator Sununu. I want to salute Mr. Rice for his
    discipline at the other end of the table and make note that----
        [Laughter.]
        Mr. Raines. It is a Seattle characteristic.
        Senator Sununu. I do not think the Chairman would have
    moved on without giving you an opportunity to respond.
        Mr. Gould. And you noticed, I tried to stay out of the
    argument.
        Mr. Rice. I was trying to. I have a hole in my tongue.
        The Fifth Circuit Court of Appeals confirmed the System
    moving into this mortgage purchase area. They said it was
    consistent with the mission, and the System's housing mission.
    And the Finance Board authorized us to move into this area. So
    it was not as if somehow we just moved into this area. We had a
    lot of people giving us scrutiny, and that precedent is there.
        As a matter of fact, it is interesting, this is the hard
    part with the regulatory structure. Some people want things
    left as they are as we move forward into the new regulatory
    structure and some people want them changed. I do not think
    that you can have it both ways.
        I think at the end of the day we are in a business that our
    members wanted and that is what we respond to.
        I would just say that we do have taxes, we pay RefCorp,
    which is a percentage of our income. And we have AHP, our
    Affordable Housing Program, 10 percent of our net income that
    is mandatory. And we have no tax shelters.
        Chairman Shelby. I think you used the phrase earlier
    creeping mission or something like that.
        Mr. Rice. Mission leap.
        Chairman Shelby. Mission leap. Well, we hope you are not
    leaping, any of you leaping toward the taxpayers. That is what
    we worry about, as you know, and that is why we need strong
    regulators and strong standards.
        Mr. Raines, you have indicated that you support such a
    change, but there is a need for stability in capital standards.
    How would you define stability in capital standards?
        Mr. Raines. I think the stability that we would look for is
    to simply leave it to the regulator to decide when it would be
    necessary to change the risk-based capital standards. They just
    became effective this year. I would hate to see the Committee,
    or the Congress, mandate that the regulator make a change. And
    so I would leave it to the judgment of the regulator as to how
    rapidly they would want to make a future change.
        But there was some discussion at some points about
    mandating, that they throw out the existing standard and create
    a wholly new one. And having just gotten it, after 10 years, we
    think that would be precipitous.
        Chairman Shelby. You would have to be careful in doing
    that.
        Mr. Raines. You would have to be careful, but we are not
    looking for any limitation on the ability of the regulator to
    make a change. We just do not want there to be a mandate that
    by some date they have to come up with a brand new standard
    that we would then have to adjust to.
        Chairman Shelby. So basically, would you be comfortable,
    whatever that comfort level might be, with language on risk-
    based capital similar to that accorded to the bank regulators?
        Mr. Raines. In terms of how they set the risk-based
    capital?
        Chairman Shelby. Yes.
        Mr. Raines. We are comfortable--I hesitate on the bank
    regulator because we have some many examples. But we are
    comfortable that they have broad authority to do that.
        Chairman Shelby. We know you are different, your mission is
    different.
        Mr. Raines. Yes, we believe that they should have broad
    authority, keeping in mind the best practices that have been
    developed over time, and that they apply their best judgment to
    that. So we are in favor of a lot of latitude on risk-based
    capital because it has to evolve and change as the risk posture
    changes.
        Chairman Shelby. Senator Bennett, would you like to ask any
    more questions?
        Senator Bennett. Thank you, Mr. Chairman, and I thank
    Senator Sununu for his diligence and his penetration in his
    questioning. I just have one quick comment, more or less to get
    it off my chest than to discover anything.
        Mr. Gould, I believe that accounting is an art, not a
    science. I believe accounting is a philosophy, not an exact
    procedure. And the assumption everywhere is exactly the
    reverse. The assumption is that you count the number of beans
    in the jar and they are what they are, and any statement of a
    different number of beans in the jar is dishonest. And
    accounting is very, very clear and straightforward.
        What people who have not run businesses do not realize is
    that there are a whole bunch of jars sitting on the shelf and
    you put a bean in the wrong jar, many times because your
    auditor tells you the second jar is where that bean belongs
    even though you want to put it in the first jar.
        And my understanding of what happened at Freddie Mac was
    that your auditor, who was Arthur Andersen that no longer
    exists, was telling you that proper accounting required you to
    report what you reported. And then when Arthur Andersen, who
    made some very, very serious accounting mistakes in their
    advice to Enron, ceased to exist, your new accountant said no,
    they are in the wrong and let us put it here. And this is not a
    matter of misleading anybody. It is simply a matter of making a
    philosophical choice as to which jar the bean goes into that
    turned out to be the wrong choice.
        Now I do not want to lead you, but is that----
        Mr. Gould. Well, that would apply to a good bit of all that
    is wrong, Senator. I can say that with absolute certainty.
        There are probably some other instances of transactions
    where on reflection, with the help of our new auditor, our
    people internally would say gosh, we were following the wrong
    policy, albeit that a number of those may have been passed upon
    by Arthur Andersen. I am not trying to exonerate everything or
    whitewash what had been done. But I will just give you one
    example.
        We changed auditors and Price Waterhouse comes in and looks
    at 140 accounting policies and decides to change 130 of them.
    Now that is not saying that 130 of them are necessarily dead
    wrong. That is saying they felt best practice and the proper
    way to do it was to change 130, and that is one of the reasons
    this restatement has taken so long.
        But you are absolutely correct, there is subjectivity in
    accounting rules. There is no bright line, often. Sometimes
    there is a bright line and sometimes Freddie Mac went over that
    bright line.
        But the fact is that there was a lot of subjectivity to it,
    a lot of art form. In fact, sometime if we had a lot of time,
    perhaps you and I could have a philosophical discussion of what
    are earnings? What reflects the underlying economics of a
    business best? And that is not an easy question to answer. So
    you are correct certainly, sir, in that respect.
        Senator Bennett. Well, I just simply, in this discussion,
    want to make it very clear that there is a difference, and it
    is a very significant difference, between the Enrons where
    people are greedy and stupid--and usually those two go
    together--and deliberately cooked the books to achieve a result
    that was not sustainable from the economics. And then
    accounting challenges that come because of philosophical
    differences between accountants.
        And this is one of the challenges that a regulator is going
    to have to deal with, because the regulator is going to have to
    decide how the books should be kept, in many instances.
        Mr. Gould. Again, I want to be very careful that I am not
    exaggerating here. Freddie Mac made some errors and that is
    undeniable, particularly as to whether or not certain things
    conformed with GAAP or the business purpose of certain things.
    A lot of it was, as suggested, differences of opinions. But
    there were some mistakes made and those mistakes have been
    corrected and the remediation has included not only correcting
    those mistakes but also ensuring it will not happen again by
    changes in personnel and systems.
        Senator Bennett. That is why I raised the question, because
    I wanted to be clear to what extent it was just you were
    following the advice of your auditor, and what extent you made
    mistakes. And you have made it clear that there was both.
        Mr. Gould. I wish I could say it was entirely someone
    else's fault, but that would not be an honest statement.
        Senator Bennett. Thank you. I appreciate that.
        Chairman Shelby. Mr. Gould, is that restatement date, is
    that in November now?
        Mr. Gould. Yes, sir.
        Chairman Shelby. I know it slipped.
        Mr. Gould. It has been a moving target, but it is now
    November.
        Chairman Shelby. Are you going to make it? I think the
    world would like to know.
        Mr. Gould. I certainly do not want to perjure myself in any
    way here. No, yes. I feel a very high degree of confidence that
    we will have it completed. The last glitch has been largely a
    systems----
        Chairman Shelby. Sure, we know you have to go back and do a
    lot of things.
        Mr. Gould. Yes, we had to go back to 1998 and review some
    numbers because of a systems glitch. But the fact is that I am
    quite confident that it will be November, yes, sir.
        Chairman Shelby. Thank you.
        Senator Bennett. If I could just interject, Mr. Chairman,
    you have announced your intention to register with the SEC, as
    Fannie Mae has already done. Is your registration with the SEC
    delayed by your ability or inability to meet these deadlines?
        Mr. Gould. Yes, sir. Our ability to register with the SEC
    is contingent upon having current financials and we do not have
    those, and will not have current financials for probably the
    middle of next year.
        Senator Bennett. So your registration is not a lack of will
    or a dragging of the feet, it is simply the mechanics of
    getting numbers.
        Mr. Gould. Precisely. We thought we would have been there
    by now.
        Senator Bennett. I see. Thank you.
        Chairman Shelby. Sir, do you anticipate November, if you
    meet the deadline, the news is going to be upward and out and
    good news as far as----
        Mr. Gould. Well, I expect it will be really----
        Chairman Shelby. I know you are not going to say what.
        Mr. Gould. The news that we have already tried to announce
    to the public in several releases, we have given a range of our
    expectations.
        Chairman Shelby. It is going to be a gain, not a loss?
        Mr. Gould. Oh, yes. It is going to be----
        Chairman Shelby. It is going to be a substantial----
        Mr. Gould. There are few things I am totally sure of, but I
    am totally sure of that.
        Chairman Shelby. Would it be a substantial one?
        Mr. Gould. Yes, sir. I think we have said it would be
    something, a $4.5 billion after tax number, or maybe somewhat
    higher, I believe, was the nature of our public announcements.
        Chairman Shelby. Senator Crapo, I know you have been gone
    and busy.
        Senator Crapo. Since I have not been here, maybe you should
    let Senator Sununu go ahead.
        Senator Sununu. Thank you. If we were to extend Senator
    Bennett's line of questioning, I am afraid the next question
    would be when is an economic hedge not an economic hedge? And I
    think my friend Peter would be the only person who would enjoy
    that discussion. So, I am going to change the subject.
        Mr. Gould, is the prepayment rate in the mortgage-backed
    security portfolio that Freddie Mac holds different than the
    prepayment rate associated with the mortgage-backed securities
    that are sold into the secondary market?
        Mr. Gould. Not intentionally, but there has been a period
    here, which I believe has now been almost entirely corrected,
    when it appeared that that actually occurred. And to the best
    of my knowledge, the research internally that we undertook to
    see why that was happening, it had to do in particular with a
    number--or several, not a number, several people who were very
    large sellers of mortgages to us. And we happened to securitize
    those. And it would appear that, for whatever reasons in their
    initiation of those mortgages, they had a population that
    prepaid earlier. But there was a differential, that is correct.
        Senator Sununu. There were unusual demographics in two
    distinct blocks of mortgages that were rolled into a mortgage-
    backed security? Is that correct?
        Mr. Gould. There were.
        Senator Sununu. Was it coincidence that you had this type
    of a prepayment demographic rolled into one security? Or was it
    good fortune?
        Mr. Gould. You have to look at, to answer that question
    properly, our pattern of mortgages purchases. We have steady
    customers who sell us mortgages on a regular basis. And
    occasionally we have large financial institutions who originate
    mortgages that will sell us a large bundle of mortgages.
        You can get as technical as you wish, but the fact is that
    in a very steep yield curve, a lot of these banks find it more
    profitable to hold mortgages than they did with a flatter
    curve, so they accumulate mortgages and hold for a while
    because it is economic to them. And then they might crawl up
    and say how would you like $20 billion of mortgages?
        So there are periods when you buy a large pool of mortgages
    and then you turn around with those mortgages and either retain
    some of them for your own portfolio, or you securitize some of
    them. So it is not a steady, even pattern. So once in a while
    you can have instances where there may be difference of
    demographics or geography that particular affects some issue of
    mortgage-backed securities. Yes, sir.
        Senator Sununu. A final question. Mr. Raines, you talked
    about in your testimony the assessment fees or the fees that
    are used to finance a new regulator. I did not see in your
    testimony a final number. How much? How much do you think we
    should provide for the new regulator? How much is enough for
    them to do a good job?
        Mr. Raines. I think that should be left up to the
    regulator, with some supervision by some outside entity that
    would simply have a reasonableness test or simply have them
    announce publicly what it is going to be and give an
    opportunity for people to comment.
        But I do not think that there should be any artificial
    limitation on their resources, but I just worry. Having been a
    former budget director, I worry a little bit about when you
    have an unlimited source of money, that you have an unlimited
    need.
        Senator Sununu. Fannie Mae does not represent an unlimited
    source of money. That is a slight exaggeration.
        Mr. Raines. I think that some believe that to be true, and
    I just hope it is not our regulator who has that belief.
        Senator Sununu. Let me ask it a slightly different way. The
    $30 million that is currently appropriated for OFHEO, is that
    enough?
        Mr. Raines. Well, they have asked for more. And we have had
    a policy of never commenting in the appropriations process on
    what their appropriations should be. So we have never taken a
    position one way or another. We have left it up to the
    appropriators to pick the right number.
        Senator Sununu. Thank you. Thank you, Mr. Chairman.
        Chairman Shelby. Senator Crapo.
        Senator Crapo. Thank you very much, Mr. Chairman.
        Let me first apologize to the members of the panel. I had
    other obligations that took me away, and so I was not able to
    be here when you made your presentations, although I have read
    your testimony and am familiar with it.
        I want to use my time here talking to Mr. Rice about the
    Federal Home Loan Bank issue. You thought you were going to get
    off the seat.
        Mr. Rice. I sure did.
        Senator Crapo. I apologize if these things have already
    been addressed by others, but it is my understanding that there
    is not consensus among the Federal Home Loan Banks as to
    whether they support the establishment of a new independent
    regulator, as you do. Could you tell me why there is that lack
    of consensus?
        Mr. Rice. First of all, as I said earlier in my testimony,
    there is consensus around the four principles that I laid out.
    And that is clear. Three banks have no desire to be under
    Treasury and believe that the status quo is fine.
        I think if you asked any individual bank president, no one
    would say that we have something broke that needs to be fixed.
    But if we are talking about the future and where we are going
    to go, I think there are more presidents who say if you are
    going to make a change this is the way you should do it. And
    that is where we are moving.
        I think that if Congress were to create an independent
    regulatory agency outside of Treasury, there may be more banks
    who would work to be supportive. I think the big issue is to
    get consensus over the idea of whether it is an independent
    regulatory agent under Treasury.
        Senator Crapo. So independence really is the critical
    issue?
        Mr. Rice. Yes, it is. And I think it is important, no
    matter how you shape it, regulator should have independence.
    And I think also having the flexibility to make changes to
    consider who we are and move in that direction. Because you are
    going to have a strong regulator.
        Senator Crapo. We have had some testimony, or actually some
    comments that were made earlier by some of the members of the
    panel, of the Senate panel here, to the effect that there are
    differences between Fannie and Freddie and the Federal Home
    Loan Banks. How would you--and I know you probably went into
    this some--but how would you propose that this independent
    regulator approach those differences?
        Mr. Rice. Well, one of the things I believe is, first of
    all, to recognize that there are differences and therefore
    shape the organization of the agency in a way that recognizes
    how we do our business and how we move forward.
        There are some people who want to say that maybe we could
    have consistency across all the housing GSE's. I do not think
    you can because the cooperative nature of the Federal Home Loan
    Banks lends itself to a different type of structure. And I
    think that we want to have a regulator who understands that.
        So, I would see something along the lines of where there
    would be a regulator with divisions. One would deal with the
    Federal Home Loan Bank and the other would deal with the Fannie
    and Freddie. I think there will be some things that they will
    have to look at across those three GSE's, but I still think it
    is the regulator that would have to shape that.
        Senator Crapo. So there would be a benefit to having the
    single regulator, but that there should be divisions among that
    regulator's focus?
        Mr. Rice. I think so.
        Senator Crapo. Can you just tell me briefly, for a minute,
    how the Federal Home Loan Banks accomplish their affordable
    housing mission?
        Mr. Rice. By statute, 10 percent of our net income goes
    toward affordable housing. And that was crafted by Congress, to
    achieve those objectives. We use our affordable housing
    allocation to target households and neighborhoods with incomes
    lower than those that qualify even under the housing goals for
    HUD.
        Each bank has an advisory committee that sets standards and
    objectives within that 10 percent affordable housing goal and
    then we allocate along those lines. We have about 50 percent of
    our affordable grants go for multifamily and 50 percent go for
    single family, but under those guidelines.
        Basically, the banks are collectively the largest source of
    private funding for affordable housing, and we probably are the
    largest contributor to Habitat for Humanity.
        So we are consistent in this area and we like the 10
    percent that we have. I do not know what would happen if you
    move us into a new regulatory agency. Would we go under HUD's
    goal? Or would you keep the 10 percent affordable housing goal
    that we have? I think it is cleaner and easier to manage with
    our 10 percent.
        Senator Crapo. All right. Thank you very much.
        I have other questions for each member of the panel, and
    perhaps the Chairman would allow us to submit questions.
        Chairman Shelby. We will. We are going to keep the record
    open. Senator Sarbanes and I have a number of questions.
        Senator Crapo. And again, Mr. Chairman, I appreciate your
    cooperation here. I had to leave for an extended period of time
    and I appreciate the fact that you were still going when I got
    back so I could ask some of my questions.
        Chairman Shelby. Important hearings.
        Senator Crapo. Thank you.
        Chairman Shelby. Thank you.
        As I said earlier, we are going to continue some hearings.
    We want to hear from the housing end of this because I think
    the mission of Fannie Mae and Freddie Mac and the Federal Home
    Loan Bank are very important. We know they are different. We
    believe, I think most people believe here, that a strong
    regulator is important, a regulator that knows what is going
    on, that has the means to know what is going on.
        But I think we have to balance this. I think Senator Reed
    said it fairly well earlier. We might have two centers of
    gravity here. We are all interested in housing, from the
    President of the United States to every Member of Congress. And
    we realize how important that is, not only socially but also to
    our economy. So we have to balance this.
        I think we can do this. We know it is difficult to do but
    we are trying to make sure that we are not part of the problem
    down the road. I think all of you recognize this.
        We thank you for your patience, and the hearing is
    adjourned.
        [Whereupon, at 2:03 p.m., the hearing was adjourned.]
        [Prepared statements, response to written questions, and
    additional material supplied for the record follow:]
                PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER
        Thank you Mr. Chairman, Ranking Member Sarbanes, and our
    distinguished panel. Thank you for coming. This is an important
    subject, one of the most important topics before our Committee in some
    time. I have only a brief statement to make.
        You know there is an old expression, ``if it ain't broke, don't fix
    it.'' I think some of us here in the Senate believe that when we try to
    fix things that are not really broken, we can end up doing more harm
    than good.
        In today's hearing we are considering potential large-scale changes
    in one of the few areas that is working in our economy--housing. It is
    a critical area to get right for the country, and it is an area where
    Fannie Mae and Freddie Mac play a vital role.
        We had an accounting issue at Freddie Mac--but we should note that
    it was a problem some of us would love to have, they had understated
    their earnings! I agree we need to address the issue of the best
    regulation of Fannie Mae and Freddie Mac for all the stakeholders
    involved. But I have not heard why that should lead us down the path of
    potentially changing capital standards or changing the method and
    authority for approving the kinds of business Fannie and Freddie can
    engage in or potentially politicizing the management of the GSE's. That
    seems to be going too far--to run the risk of fixing what is not
    broken.
        It seems that instead of treading carefully, if we rush to
    judgement now we could be opening the door to all sorts of changes
    unrelated to the specific problem at hand, and going down a path that
    may not be where we want to head.
        So, I will be very interested to hear Treasury's specific evidence
    that the capital standards at the GSE's--minimum and risk based
    capital--are too low or too high. I hope they will share that data with
    us today or in the future. I did not see it in Secretary Snow's
    testimony.
        I am also very interested in whether Treasury can give us a report
    or findings that show where the current ``new program approval''
    authority, which is today at HUD, has consistently broken down or hurt
    the economy.
        I am also curious to hear the level of capital that Fannie or
    Freddie would be required to hold under the Basel I and the proposed
    Basel II Accords. Are their current capital amounts too high or too low
    versus these standards? I am assuming Treasury has done that analysis
    or will do that analysis shortly.
        We are all also very sensitive to the impact of that a change in
    capital could have to the GSE's ability to fulfill their vital housing
    mission and to their stock prices. They are after all publicly held
    companies.
        So, I hope Treasury will walk us through an analysis of what a
    potential change in minimum capital standards, some have suggested
    these levels should double, would mean in terms of Fannie's and
    Freddie's ability to fulfill their housing mission.
        For example, how many units of housing could be impacted if they
    need to hold funds in reserve and not put them into the housing market?
    And what would be the impact on the stock prices, since any capital
    reserves would come out of the companies earnings?
        Again, I am assuming Treasury has done all this analysis--it seems
    critical to the decisions we need to make. But to date I have not seen
    it.
        Mr. Chairman, if we do not have that data and have fully aired
    those findings--and they are but a few examples of the consideration
    needed to carefully address these issues--I wonder how we can know
    whether or not we have a problem or whether or not we should make
    changes. If we do not have any data to look at--if it is all simply
    conjecture--one opinion versus another--do we risk making some enormous
    and potentially damaging mistakes?
        It seems like a dangerous way to make public policy in one of the
    few areas that is working in the economy.
        Mr. Chairman, you and Ranking Member Sarbanes, have always chosen a
    careful and considered approach, and I trust you will lead us in that
    direction again. I look forward to future hearings on this important
    subject.
                                   ----------
                 PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
        Thank you, Mr. Chairman. Today's hearing is an important
    opportunity to re-examine the regulatory structure in place for Fannie
    Mae, Freddie Mac, and the Federal Home Loan Bank System.
        Ever since accounting problems were reported at Freddie Mac earlier
    this year, there has been a growing interest in strengthening our
    housing finance regulators. I agree that there is room for improvement,
    but I also think that it is extremely important that we move
    deliberatively and cautiously. The secondary mortgage market is so
    essential to our housing sector and to our greater economy that it
    would be inappropriate to make sweeping changes without extensive study
    and broad consensus.
        Mr. Chairman, when I raised this caution at our first hearing on
    accounting at Freddie Mac, you were quick to agree that we must move
    cautiously and judiciously and I very much appreciate that we are of
    the same mind on this.
        I want to see Fannie Mae and Freddie Mac with a highly respected,
    independent regulator. I want the Federal Home Loan Banks to be soundly
    regulated, too. And, I think there are several things that we can do to
    achieve that end. And, that is part of what today's hearing is all
    about.
        I appreciate that Secretary Martinez and Secretary Snow have agreed
    to come up and share their thoughts on this issue. And, I appreciate
    our second panel for appearing before us today as well.
        I want to work with all of my colleagues to come to a bipartisan
    consensus on what legislative changes if any are needed in the housing
    finance regulatory system.
        The Chairman, from FCRA to the American Dream Downpayment Act, has
    shown that he is a consensus-builder and that he listens to everyone on
    this panel. I know that he will want to move forward on regulatory
    reform in the same way we have on so many other important issues under
    his leadership.
        While we may not be able to move on legislation this year, it is
    more important that we begin a discussion and a debate. And, we let the
    GSE's, the regulators, the markets, and the public know that while
    there is no explosive financial disaster before us today, this
    Committee is working together to ensure that our GSE's and the Federal
    Home Loan Banks will always be safe and sound and fulfill the missions
    with which they are tasked. Thank you, Mr. Chairman.
                                   ----------
                       PREPARED STATEMENT OF JOHN W. SNOW
                   Secretary, U.S. Department of the Treasury
                                October 16, 2003
        Thank you Chairman Shelby, Ranking Member Sarbanes, and Members of
    the Committee for inviting Secretary Martinez and me to appear before
    you today.
        Homeownership is an important building block of individual
    financial security as well as strong communities. Our national system
    of housing finance plays a key role in promoting homeownership. We
    might call it one of the economic wonders of the world. Playing a
    prominent role in the vitality of our housing finance system are the
    Government Sponsored Enterprises (GSE's): Fannie Mae, Freddie Mac, and
    the Federal Home Loan Banks. They need to be strong and healthy so that
    they can play that important role today and be here to continue that
    important role in the future. That is why Secretary Martinez and I are
    here today.
        As the President has made clear, one of the great strengths of
    America is that everyone has an opportunity to gain the independence
    and dignity that come from homeownership. And, Secretary Martinez and I
    share the commitment made by the President to expand homeownership to
    5.5 million more minority homeowners by the end of the decade.
        There is a general recognition that the existing supervisory system
    for these enterprises does not have the tools, stature, authority, or
    resources to reach that goal. The regulatory structure is ill-equipped
    to deal effectively with the current size, complexity, and importance
    of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. As we
    attempt to remedy this situation, we must be mindful that we have two
    core objectives that should guide us: A sound and resilient financial
    system, and increased homeownership opportunities for less advantaged
    Americans.
        To serve both of these objectives we need to devote careful
    attention to the resilience of our system of housing finance. These
    enterprises play such a major role in our housing finance system and
    housing finance is so important to our national economy that we need a
    strong, world-class regulatory agency to oversee their prudential
    operations, including safety and soundness, consistent with maintaining
    healthy national markets for housing finance.
        On September 10, in testimony before the House Financial Services
    Committee, we called upon Congress to create a new and stronger
    regulatory system for Fannie Mae, Freddie Mac, and ideally the Federal
    Home Loan Banks. At that time, I outlined the Administration's
    recommendations for the essential, minimum requirements for a credible
    regulator for these enterprises. At that same hearing, Secretary
    Martinez outlined measures that the Administration would desire to
    increase homeownership opportunities. Today, I renew that request, and
    I will highlight some of the key elements that the Administration
    believes are essential to reform of the supervision of these important
    housing Government Sponsored Enterprises. Without these reforms, any
    new regulatory system would be little improved from the inadequate
    system we have today. In doing so, I must emphasize that we are not
    presenting a wish list of reforms that we would like to see enacted. We
    are presenting the minimum elements that are needed in a credible
    regulatory structure, a structure that can ensure that our housing
    finance system remains a strong and vibrant source of funding for
    expanding homeownership opportunities in America. There may be
    additional reforms worthy of consideration, and I look forward to
    discussing them, but the reforms that Secretary Martinez and I are
    presenting today are the foundation for an enduring program of housing
    finance to help provide an effective regulatory system for Fannie Mae,
    Freddie Mac, and the Federal Home Loan Banks.
    Essential Elements of Regulatory Reform
        To begin with, we must make sure that we keep our eye on the
    crucial task of getting the regulatory structure right. In general, the
    legislative objective should be to create a strong, credible, and well-
    resourced regulator with all of the powers, authority, and stature
    needed to do its job. In this regard, the new agency's powers should be
    comparable in scope and force to those of other world-class financial
    regulators, fully sufficient to carry out the agency' mandate, with
    accountability to avoid dominance by the entities it regulates. This
    means that the new agency should have general regulatory, supervisory,
    and enforcement powers with respect to the Enterprises. In my September
    10 testimony, I outlined the broad parameters of the new agency's
    powers and presented a list of specific items that should be included.
        Each of these reforms should be placed in context. The
    Administration wants Fannie Mae, Freddie Mac, and the Federal Home Loan
    Banks to be models of the highest corporate governance standards,
    rather than exceptions to the rule. The Administration is committed to
    make sure that corporate governance and oversight remain strong and
    effective. That requires that there be great clarity that the people
    running large companies are there to serve the interests of the
    shareholders and that their incentives and loyalties be clearly aligned
    in this way. One man cannot serve two masters. Fannie Mae and Freddie
    Mac are large, experienced, publicly traded enterprises that have grown
    significantly and taken important places in our capital markets. The
    Administration is committed to make sure that the directors of publicly
    traded corporations like Fannie Mae and Freddie Mac are elected by
    their shareholders, rather than selected by the President.
    Location of the Agency
        While in my statement on September 10, the Administration did not
    make a request that the new regulatory agency be made a bureau of the
    Treasury Department, I did say that such a recommendation could be
    contemplated and would be supportable if the new agency were
    established with adequate elements of policy accountability to the
    Secretary of the Treasury. The necessary arrangement would allow the
    agency to draw upon the resources of the department for depth of policy
    guidance, stature, and authority, assuring that the regulated
    enterprises remain focused on their important housing duties, operating
    within prudent bounds that will ensure sustained financial vigor to
    continue to fulfill their housing finance roles.
        To allow the Treasury Department to provide real value to the new
    regulatory agency, at a minimum, the new agency should be required to
    clear new regulations through the Department. The existing independent
    regulator for Fannie Mae and Freddie Mac currently clears its new
    regulations through the Office of Management and Budget (OMB), so it
    would not be novel for the new agency as a bureau of the Treasury to
    clear its new regulations with the Treasury Secretary as well as OMB.
    The Treasury Department should also have review authority over the new
    agency's budget to ensure that resources are being properly allocated.
    And to ensure policy consistency, a new Treasury bureau should clear
    its policy statements to the Congress through the Department.
    Nevertheless, in any such arrangement, the new
    supervisory agency should have independent responsibility over specific
    matters of supervision, enforcement, and access to the Federal courts.
        The direct involvement of the Treasury Department in providing
    policy guidance to the new regulatory agency is important for a number
    of reasons.
        First, unlike the Treasury Department's other financial institution
    regulatory bureaus, the new regulatory agency would only be responsible
    for regulating a very limited number of very large financial
    institutions, ranging in size from more than $30 billion in assets to
    more than $700 billion in assets. This increases the possibility of
    regulatory capture, and makes the oversight of overall policy
    development by the Treasury Department vital.
        Second, even though the obligations of Fannie Mae, Freddie Mac, and
    the Federal Home Loan Banks are not backed by the full faith and credit
    of the U.S. Government, market participants have come to believe that
    some sort of implied guarantee exists, weakening market discipline of
    the Enterprises. Market discipline is an essential element of any
    regulatory oversight regime, the first line of regulation of commercial
    banks and thrifts. A weakening of market discipline is inconsistent
    with our goal of a resilient housing finance system, particularly if it
    weakens the sensitivity of Fannie Mae, Freddie Mac, and the Federal
    Home Loan Banks to the demands of the housing markets. Therefore, it is
    vitally important that the Treasury Department be able to monitor the
    new regulator's policies to ensure that such policies are not
    reinforcing any such market misperception of an implied guarantee.
        The Administration's proposal strengthens the Department of Housing
    and Urban Development's oversight of the GSE's' housing goals. However,
    we need a credible, single regulator to do the important job of overall
    prudential supervision of Fannie Mae, Freddie Mac, and the Federal Home
    Loan Banks, one that will help ensure that the Enterprises are healthy
    today and strong tomorrow. We need a regulator that has all of the
    tools and stature and resources to do the job, that is independent with
    regard to supervision and enforcement, but that has accountability in
    the formulation of policy.
    New Activities Approval
        The Administration has proposed that the authority for approving
    new activities of the housing enterprises be transferred from HUD to
    the new regulatory agency. This proposal is consistent with
    availability of one of the central tools that every effective financial
    regulator has--the ability to say ``no'' to new activities that are
    inconsistent with the charter of the regulated institutions,
    inconsistent with their prudential operation, or inconsistent with the
    public interest.
        The Federal Reserve has this kind of authority for bank holding
    companies, the Comptroller of the Currency has comparable authority for
    national banks, and the Office of Thrift Supervision has similar
    authority for savings associations. The current financial regulator for
    Fannie Mae and Freddie Mac lacks that authority, one of its most
    serious weaknesses. If we are serious about creating an effective,
    credible financial regulator, it must have the authority, in
    consultation with the Secretary of HUD, to review new activities as
    well as to review their ongoing activities.
        Innovation has been fostered and encouraged under the review
    authorities that our Nation's banking regulators have, and we see no
    reason why providing similar authority to the new regulatory agency
    would stifle innovation by Fannie Mae, Freddie Mac, and the Federal
    Home Loan Banks.
    Capital Requirements
        While we are not recommending a statutory change to the current
    capital requirements, we believe that the regulator should have broad
    authority with regard to setting the capital requirements of the
    Enterprises, both with respect to risk-based
    capital and minimum capital. Authority for setting capital standards
    needs to be flexible enough to employ the best regulatory thinking,
    conscious of the Enterprises' own measures of risk, so that the
    regulator can direct Fannie Mae, Freddie Mac, and the Federal Home Loan
    Banks to each maintain capital and reserves sufficient to support the
    risks that arise or exist in its business. We want the regulator to
    have the authority to increase minimum and risk-based capital
    requirements if warranted. Providing the new regulatory agency
    flexibility in regard to setting risk-based capital requirements would
    be an important and necessary improvement over the current awkward
    risk-based capital regime that applies to Fannie Mae and Freddie Mac.
    Receivership/Conservatorship
        Should sufficiently troubling circumstances require it, the new
    regulatory agency should have more than the powers associated with
    conservatorship. It should have all receivership authority necessary to
    direct the orderly liquidation of assets and otherwise to direct an
    orderly wind down of an enterprise, in full recognition that Congress
    has retained to itself, in the case of Fannie Mae and Freddie Mac, the
    power to revoke a charter. Providing the new regulatory agency the
    ability to complete an orderly wind down of a troubled regulated entity
    also encourages greater market discipline, which is consistent with our
    goal of a resilient housing finance system that responds to the needs
    of customers in the housing markets.
    Federal Home Loan Bank System
        The importance of our housing finance markets requires that all of
    the housing enterprises be included in a single program of world-class
    supervision. We see the need for this for the Federal Home Loan Banks
    just as we see it for Fannie Mae and Freddie Mac. While including the
    Federal Home Loan Banks in a program of world-class supervision
    presents some significant issues of policy and important details that
    must not be glossed over, that does not mean that their inclusion
    should be avoided at this time. This does not require that the
    supervisory structure of the housing GSE's be identical in all
    respects, but it does require that the new regulator have the same
    caliber of authorities, stature, powers, and resources for enforcement
    and supervision of all of its regulated entities.
        Since September 10, when Secretary Martinez and I testified on this
    subject before the House Financial Services Committee, tremendous
    progress has occurred in developing a consensus. There now appears to
    be an emerging consensus for providing a new supervisory structure for
    the Federal Home Loan Banks. Today, we are very encouraged that this
    can be achieved, as part of a new regulatory system for Fannie Mae and
    Freddie Mac.
    Conclusion
        In conclusion, let us consider once again our purpose here this
    morning. It is to consider how best to promote the strength and
    resilience of our housing finance markets, in order to continue our
    progress in advancing homeownership throughout the Nation. The housing-
    related Government Sponsored Enterprises were created by Congress to
    assist in achieving that goal. Our aim must be to give them the first
    class quality of supervision that the importance of their charge
    requires. To accomplish that purpose, the fundamental elements that the
    Administration has proposed are essential.
                                  ------------
                    PREPARED STATEMENT OF FRANKLIN D. RAINES
                          Chairman and CEO, Fannie Mae
                                October 16, 2003
        Chairman Shelby, Senator Sarbanes, and Members of the Committee,
    thank you for inviting me here today to share my views on legislation
    to strengthen the safety and soundness regulation of Fannie Mae.
        A strong safety and soundness regulator is in the best interest of
    Fannie Mae, homeowners, and the financial system. I am here to voice
    support for legislation that creates a new world-class safety and
    soundness regulator within the Department of the Treasury. There is a
    strong and growing community of support for legislation that focuses on
    strengthened financial regulation and does not directly or
    indirectly change our mission, status, or charter.
        The impact of what you do here can be enormous, for the economy as
    a whole and for expanding affordable homeownership and affordable
    rental housing in particular. First, as you know, the home mortgage
    refinance wave of the last 2 years has allowed millions of families to
    increase their savings or raise their standard of living. Federal
    Reserve Chairman Alan Greenspan has noted that last year close to 10
    million households ``cashed out'' almost $200 billion of their
    accumulated home equity, using as much as half of that amount for
    consumption. Home mortgage refinance provided the single largest
    stimulus to the economy last year, and it made difficult economic times
    more manageable for families across the Nation. Our ability to use
    technology and to draw private capital into the home mortgage market
    was critical to ensuring that lenders were able to meet refinance
    demands effectively and efficiently.
        Second, we as a society have a long-held commitment to
    homeownership. Congress has reflected that commitment by making
    homeownership a public policy priority, in tax policy, in policy
    affecting Government Sponsored Enterprises, and in the commitment to
    FHA and other Government programs. Recent public policy commitments
    have reaffirmed the importance of homeownership. Just this month, the
    House of Representatives overwhelmingly passed legislation to provide
    downpayment assistance to cash-strapped families.
        President Bush has made expanding homeownership a priority for his
    Administration. Last summer, he called on the private sector to partner
    with Government to create 5.5 million new minority homeowners this
    decade. Fannie Mae stepped up to the plate to meet that challenge. We
    committed $700 billion in financing for minority borrowers, and are
    forming partnerships in communities across the Nation to bring mortgage
    financing to underserved minority communities.
        Enacting legislation that will strengthen safety and soundness
    regulation of Fannie Mae and Freddie Mac can enhance our role in
    promoting a smooth functioning mortgage finance industry. Ultimately
    that leads to more homeownership opportunities for more Americans.
        Since I testified before the House Financial Services Committee on
    this issue on September 25, the debate over changing our regulatory
    framework has moved on from general principles to specific issues.
    Rather than repeat my recent testimony, I would like to specifically
    address the questions posed by the Committee in its invitation
    requesting my appearance here today.
    The Structure and Mission of the New Regulator
        Safety and soundness regulation of privately capitalized, privately
    managed companies has a singular mission. That mission is to ensure
    that institutions have the ability to manage the risks they face. As
    long as a company is managing risk properly, safety and soundness
    regulation should not dictate day-to-day business
    operations or routine management decisions. Private companies thrive
    when management is allowed to innovate and experiment, and even to see
    a new innovation fail, as long as that failure does not put the
    Enterprise at risk. Companies that take no risks and do not innovate
    cannot evolve to meet the demands of consumers and improve living
    standards for all Americans.
        This distinction between supervision and management is the
    foundation of commercial regulation throughout the marketplace. In the
    financial services sector, our public policy has found the right
    balance between private management and public supervision. And the
    Federal Housing Enterprises Financial Safety and Soundness Act of 1992
    struck the right balance between private management of Fannie Mae and
    Freddie Mac and public supervision to ensure that management does not
    put the companies at risk of failure.
        The financial services industry has evolved dramatically over the
    last 11 years, as financial institutions have merged and broadened
    their lines of business. The housing finance industry has evolved as
    well, developing products and technology that have given both
    homebuyers and mortgage investors more choices at lower costs. It is
    appropriate that, 11 years later, Congress reexamine the safety and
    soundness regime it built in 1992 to see if that balance is still
    correct.
        Striking the right balance between appropriate and effective safety
    and soundness oversight and avoidance of micromanagement is important
    when considering the powers of the new regulator. The new Treasury
    bureau should be charged with the full authority to ensure that the
    Enterprises are operating in a safe and sound manner, and that they
    remain adequately capitalized. World-class safety and soundness
    regulation is designed to help ensure that financial institutions do
    not mismanage the risks they face in a way that threaten the financial
    viability of the companies.
        At the same time, Congress should not open the door for the
    regulator to prescribe, outside the necessities of safety and soundness
    oversight, how the Enterprises conduct their businesses--whether it be
    the management of credit and counterparty risk, management of interest
    rate exposure, issuance of subordinated debt, or adequacy of liquidity
    and reserves, to name just some of the issues the Enterprises must
    manage. The modern best-practices regulatory approach to these issues,
    as reflected in the practices of the OCC and OTS, for example, is for
    the regulator to issue guidelines ensuring that the regulated financial
    institutions have adequate policies and procedures addressing these
    prudential matters. The regulated entities are then examined against
    these standards. This approach not only avoids micromanagement, but
    also ensures necessary flexibility for examination staff. In fashioning
    the new regulator's duties and responsibilities, Congress should follow
    the evolving best practices used by regulators for the rest of the
    industry.
    Funding
        To ensure adequate resources, a new Treasury bureau should be
    funded independent of the appropriations process. Over the last 11
    years, OFHEO has steadily increased its budget and grown its
    examination staff. Today, OFHEO has a staff of 40 examiners, or 20 per
    institution. This is comparable to the size of the typical on-site OCC
    exam team dedicated to any of the largest OCC-regulated banks. OFHEO's
    current budget includes a plan to expand to 66 examiners over the next
    year.
        While independent funding will ensure that the new regulator has
    the necessary resources to do its job, there must be some review of
    that independent assessment, to ensure that the regulator does not
    assess the companies in an arbitrary way. In the banking system, the
    ability of any bank at any time to change charters engenders a
    regulatory competition that prevents excessive assessments. Fannie Mae
    and Freddie Mac will not have an option to move to a different charter,
    and therefore some other mechanism must be developed.
        There are many different ways to achieve this objective.
    Fundamentally, it should involve some wider review within the
    Administration of the new agency's budget. Congress could mandate
    transparency for the new agency's funding by requiring it to release
    for notice and comment a proposed budget and resulting assessment. This
    would be similar to the approach used by the National Credit Union
    Administration. Or the increase from year to year could be based on an
    objective index. Of course, we would support the agency's ability to
    obtain additional funding mid-year if necessary.
        Currently, OMB authority to apportion agency funds is an important
    check in ensuring the most effective and economical use of resources.
    Their authority covers agencies funded both through the appropriations
    process and outside of it, and we believe it would be an important
    level of review that should be adopted for the new safety and soundness
    regulator.
        A new regulator must not only have necessary resources, but those
    resources must also be spent appropriately. Today, the OCC and the OTS
    devote more than three quarters of their budgets to examination and
    supervision. This emphasis in their budgets is evidence of these
    agencies' focus on examination and supervision to monitor continuously
    the safety and soundness of the regulated enterprises. A new regulator
    for the Fannie Mae and Freddie Mac should have a similarly clear focus
    on examination and supervision, with a similar division of resources to
    ensure the regulator's priority remains on on-site, daily oversight of
    the safety and soundness of the operations of the regulated companies.
    Independence
        The independence of the new regulator is also an issue of
    discussion in the current legislative debate. In particular,
    policymakers today differ over the independence of the new regulator
    with respect to funding, testimony, and regulation. As I stated
    earlier, we do believe that there must be some review of the
    assessments the regulator levies on the company, to ensure the budget
    fully funds the regulatory mission of the agency but does not include
    arbitrary assessments. Because we cannot change regulators the way
    banks can, we favor outside review of the new regulator's budget.
        With regard to the issuance of regulations, currently OFHEO's
    regulations are reviewed by OMB. That practice does afford broader
    policy input into any proposed regulation, and we believe that broader
    input has value. The third issue, review of testimony, raises important
    questions that Congress and the Administration will have to address
    directly and resolve.
    The Powers of a New Regulator
        The new regulator must have the powers necessary to carry out its
    role. The current debate over these powers has focused on capital,
    prompt corrective action, and new program approval. Let me take up each
    of those issues separately.
    The Appropriate Capital Regime
        Capital requirements are a fundamental part of financial
    regulation. The approach Treasury put forward in testimony before the
    House Financial Services Committee focuses on ways to give the
    regulator more flexibility in aligning capital
    requirements with the risks Fannie Mae takes on, while ensuring that we
    can continue to fulfill our mission. It is this balance that Congress
    struck in 1992, and it is a balance Congress should maintain in any
    proposed legislation.
        As you know, Fannie Mae has two capital standards, a minimum
    capital (or leverage) requirement, and a risk-based capital
    requirement. The minimum capital requirement sets a floor and also
    incorporates the indefinable, non-quantifiable risk present with any
    institution. Fannie Mae must hold the greater of the minimum capital
    requirement or the risk-based capital requirement.
        Minimum capital is defined as the sum of 2.50 percent of on-balance
    sheet assets and 0.45 percent of mortgage-backed securities guaranteed
    by, but not owned by, Fannie Mae. Including capital for off-balance
    sheet obligations distinguishes Fannie Mae's minimum standard from the
    bank leverage ratio, which requires that banks hold capital only
    against on-balance sheet assets.
        Calculated in the same manner as the bank leverage ratio, Fannie
    Mae's core capital was 3.3 percent of on-balance sheet assets, or $30.7
    billion, as of June 30, 2003. Furthermore, beginning in 2001, Fannie
    Mae has issued subordinated debt as a supplement to our equity capital.
    Subordinated debt can act as a risk-absorbing layer on top of core
    capital and can serve as a market signal of a corporation's credit
    risk. Fannie Mae's subordinated debt outstanding totaled $11.5 billion
    at June 30, 2003, or 1.2 percent of on-balance sheet assets. Thus the
    sum of core capital and outstanding subordinated debt represented 4.5
    percent of on-balance sheet assets at the end of the second quarter, or
    $42.2 billion.
        Fannie Mae's minimum capital requirement should be viewed in the
    context of the limited business in which we operate. By law, we invest
    only in residential mortgages, which are less risky than many bank
    investments such as consumer debt, commercial real estate, or foreign
    debt. Furthermore, our book of business is more geographically diverse
    than most banks, and we are required to have loss-sharing agreements on
    higher-risk loans.
        As a result, Fannie Mae has far lower losses than other lenders.
    For instance, Fannie Mae's credit losses in 2002 were 0.5 basis points
    of our total single-family mortgages. That compares with bank credit
    losses on mortgages of 15 basis points in 2002. Furthermore, while
    Fannie Mae's losses have trended sharply lower in the last 5 years,
    banks' losses on mortgages have not followed a similar pattern.
        The further an institution moves away from specialization in
    mortgages, the greater the level of losses relative to capital.
    Reflective of our low level of risk, Fannie Mae's capital was 357 times
    its credit losses for the first two quarters of 2003. The thrift
    industry, which also specializes in mortgages, had a comparable ratio
    of 47:1, less than one-seventh the capital coverage that Fannie Mae
    had. Large commercial banks, on the other hand, had a capital coverage
    ratio of only 15:1, with the entire banking industry at 18:1.
        The question for policymakers is not how to eliminate credit risk
    from the system. That is not possible. The question is how do
    institutions manage this risk, and what capital is necessary to cover
    the risk. In the event of a credit crisis, Fannie Mae is in a much
    stronger position to survive than are the other potential holders of
    mortgage credit risk. If credit losses were to increase by a factor of
    20, Fannie Mae would have sufficient capital to cover the resulting
    losses. The average bank wouldn't.
        For these reasons, Fannie Mae's minimum capital requirement should
    remain set in statute at 2.5 percent for on-balance-sheet assets and
    0.45 percent for off-balance-sheet assets. Doing so supports Fannie
    Mae's mission of bringing low-cost capital to housing. Increasing
    minimum capital absent any increase in risk raises the cost of capital
    to housing and undercuts our ability to fulfill our mission of
    constantly providing liquidity in all markets and through all economic
    conditions. Quite simply, if you raise capital requirements for the
    same level of risk, you will substantially reduce the impact Fannie Mae
    can have in fulfilling its mission.
        Of course, a key responsibility of a safety and soundness regulator
    is to evaluate continuously the risks the company faces and adjust
    capital requirements accordingly. Financial regulators achieve this
    goal through a risk-based capital standard. In Fannie Mae's case, this
    requirement is determined by a statutory ``stress test,'' computing the
    capital needed to survive a prolonged adverse economic environment,
    assuming no new business and adding a 30 percent capital cushion for
    operations risk. The regulation that implements this standard has been
    in place for one year, after 10 years of development. Fannie Mae has
    met the requirements of that rule every quarter.
        A world-class regulator must have the ability to adjust this risk-
    based capital requirement to reflect both changes in the economy and in
    the risks facing an institution. Under the current statute, our
    regulator has considerable flexibility to adjust the standard. The
    Administration has asked for additional flexibility in this area. We
    support giving the regulator more flexible authority in this area,
    while recognizing that there is a need for stability in capital
    standards, which should not be subject to frequent change. Additional
    flexibility in altering the risk-based capital standard will ensure
    that the regulator can require the companies to hold appropriate levels
    of capital consistent with the risks they take.
    Location and Standard for New Program Approval
        To carry out our mission effectively, Fannie Mae must be able to
    harness the innovation and efficiency of the private sector to promote
    affordable housing as a clearly articulated public policy goal. The
    standard Congress created in 1992 has fostered an environment of
    unprecedented innovation in the mortgage industry over the last 10
    years.
        In a constantly changing interest rate environment and faced with
    unprecedented volumes of business, Fannie Mae and the mortgage finance
    industry have created a revolution in underwriting, product innovation,
    and streamlined technology processes, to produce significant gains in
    lending to low- and moderate-income and other traditionally underserved
    borrowers. We have automated our underwriting, reducing mortgage
    origination costs by an average of $800, and enabling applicants to get
    an answer from a mortgage lender in minutes rather than weeks. Our
    improved credit analysis has helped us to develop mortgage products for
    credit-impaired borrowers who previously had little access to
    conventional mortgages. We have worked with lenders to develop low-
    downpayment loans, bringing homeownership within reach of Americans who
    can afford a monthly mortgage payment but do not have savings for a 20
    percent downpayment. Much of this innovation is driven by our lender
    customers, who routinely challenge us to add features to match their
    offerings, and to partner with them to increase access and efficiency.
        Some of our competitors have decried innovation as somehow outside
    our charter. But the facts are these: In 1992, when our charter was
    last revised, mortgages made up 86 percent of Fannie Mae's total
    assets. Another 11 percent was devoted to maintaining necessary
    liquidity and the remaining 3 percent consisted of other assets. In
    2002, mortgages made up 90 percent of Fannie Mae's total assets.
    Another 7 percent was devoted to our liquidity portfolio and--just as
    in 1992--only 3 percent consisted of other assets. Clearly, our
    devotion to our mission has not changed. The
    innovations we have pioneered or adopted from others are not only
    within our charter; but they are also necessary to meet our charter
    obligations. We cannot serve our mission of making homeownership more
    affordable unless we can innovate continuously to create products and
    processes that better serve the industry and homebuyers.
        The mortgage market today provides consumers with a wider variety
    of products than ever before, and therefore is better poised to meet
    the individual financing needs of a broader range of homebuyers. This
    has been possible because the program approval requirements in the 1992
    law respect the need for innovation. Lenders have felt free to innovate
    and develop new products to reach underserved
    communities because we have been able to review the products and,
    whenever possible, assure them that we will purchase these loans in the
    secondary market. Without that secondary market outlet, lenders would
    have to assume more risk and expense in developing innovative mortgage
    products that are vital for reaching new markets.
        There is a consensus in the housing industry that innovation is
    best protected by maintaining HUD's role as mission regulator for
    Fannie Mae and Freddie Mac. Many of our lender partners and leaders in
    the housing industry, such as the National Association of Home
    Builders, the National Association of Realtors, the Independent
    Community Bankers of America, the Enterprise Foundation, LISC, and
    Self-Help Credit Union, fear that moving program approval authority
    away from HUD could diminish housing as a public policy priority, and
    create a barrier to innovation that hinders us from achieving our
    mission within our charter. We share those concerns, and as a result we
    support maintaining HUD's authority to review new programs.
        The current debate over whether program approval authority should
    be housed at HUD or at the new Treasury bureau misses a critical point.
    Maintaining HUD's role as mission regulator to review new programs does
    not diminish the power and authority of the safety and soundness
    regulator on matters of financial risk. In our view, a world-class
    financial regulator must have the ability to address any issues that
    pose a risk to safety and soundness. The new regulator will have on-
    site examination staffs continually reviewing and assessing programs,
    products and business processes at Fannie Mae. Just like a bank
    regulator, the new bureau could examine any activity in detail at any
    time, and address any activity it found to pose a safety and soundness
    risk, even if it has been approved by HUD for charter compliance.
        Wherever Congress decides to locate the program approval authority,
    our greatest concern is that the process and standard allow Fannie Mae
    the freedom to work with lenders to create innovative mortgage products
    that meet consumers' needs. Lenders eager to reach underserved
    communities have developed mortgage features that make homeownership
    more affordable to these communities. Before they make these innovative
    mortgages available, they want to know that Fannie Mae will purchase
    them in the secondary market.
        If new legislation creates a bureaucratic process in which every
    new mortgage ``product'' or ``activity'' must be formally approved
    before we can tell a lender we will buy it, or every process innovation
    to improve efficiency must first be vetted by some third party, then
    innovation to address tough housing problems will come to a screeching
    halt. Without a secondary market partner, lenders will be less able to
    pursue the creative partnerships that are critical to meeting Congress'
    public policy goal of bringing homeownership opportunities to
    underserved communities. Any new program approval regulatory regime
    must ensure Fannie Mae's continued freedom to work with lenders, non-
    profits, community organizations and local governments to develop new
    products and new business processes without intrusive regulation that
    seeks to replace business judgment with the government's judgment.
    Prompt Corrective Action Authority
        In determining the appropriate and necessary powers to ensure a
    world-class regulator for Fannie Mae, there has also been some debate
    over what prompt corrective action, or PCA, powers a new regulator
    should have.
        Congress created a PCA regime for OFHEO one year after creating a
    PCA regime for bank regulators, purposely altering the bank regime to
    make it appropriate to Fannie Mae and Freddie Mac. Because Fannie Mae
    and Freddie Mac differ from banks, Congress crafted a prompt corrective
    action regime for OFHEO that focuses specifically on how Fannie Mae and
    Freddie Mac operate in the secondary market without importing those
    wholly inapplicable aspects of the bank-like PCA regime.
        Interestingly, prompt corrective action is not the preferred method
    of supervisory enforcement by banking regulators. In fact, capital
    deterioration is seen as a lagging indicator of problems at banks.
    Thus, bank regulators often take action pursuant to their cease and
    desist, civil money penalty, and suspension and removal authority long
    before a bank would be subject to PCA. As reflected in its enforcement
    regulations and as we have seen by the recent actions it has taken,
    OFHEO has considerable enforcement authority. Fannie Mae supports the
    enhancement of these authorities by giving the new regulator cease and
    desist and civil money penalty authority consistent with the authority
    of bank regulators. Fannie Mae also supports the addition of express
    authority for the new regulator to suspend and remove personnel from
    the Enterprise for violations of laws, regulations, final cease and
    desist orders and written agreements.
        As part of our PCA regime, Congress specifically provided for the
    authority of our regulator to appoint a conservator should an
    enterprise become significantly or critically undercapitalized. By
    providing for a conservatorship process in the 1992 Act, Congress, and
    in particular this Committee, made clear its preference that an
    enterprise be privately recapitalized rather than liquidated in order
    for the important mission of the Enterprise to be protected. Moreover,
    Congress reserved, as Fannie Mae and Freddie Mac's chartering body, the
    right to extinguish those charters.
        We welcome Congress' discussion of potential enhancement of the
    conservatorship powers enumerated in the 1992 Act. Certainly, we
    believe a conservator for an enterprise should be able to take such
    actions as may be necessary to put the Enterprise in a sound and
    solvent condition as well as those that are appropriate to carry on the
    business of the Enterprise and preserve and conserve the Enterprise's
    assets and property.
    HUD's Continuing Oversight Role
        Finally, the Committee has asked for our thoughts on HUD's role in
    the oversight of the Fannie Mae and Freddie Mac. As I stated earlier, I
    support maintaining HUD's authority to review new programs for charter
    compliance, and I share the concerns of the housing industry that
    moving this authority from HUD to the Treasury Department could
    diminish the overall public policy commitment to homeownership as a
    national priority.
        Let me comment on legislative proposals regarding HUD's authority
    with regard to housing goals. HUD sets housing goals as a regulatory
    requirement to ensure that Fannie Mae focuses particular attention on
    low- and moderate-income borrowers and underserved areas. We have
    consistently exceeded those goals every year since 1994. The agency is
    currently developing proposed goals for next year and beyond.
        Over the years, HUD has sought to establish goals that require the
    company to stretch beyond levels we might otherwise achieve, without
    threatening our safety and soundness or jeopardizing the liquidity of
    the mortgage finance system. HUD relies on predictions of market size
    to establish these goals. This kind of forecasting is not easy and
    predictions are likely to be inexact. The record-breaking refinance
    boom of the last 2 years, for instance, has resulted in a dramatically
    different mortgage market from the one envisioned when the current
    goals were set in 2000, substantially increasing the difficulty we face
    in meeting them.
        Setting goals in the midst of changing markets requires
    flexibility--for HUD in setting the goals and for Fannie Mae in meeting
    them. HUD's recasting of the goals in 2000 is an example of the
    flexibility it has under current law. The Department increased all
    three housing goals. The goal for Fannie Mae's purchase of loans to
    low- and moderate-income borrowers, for instance, was increased from 42
    percent in 1999 to 50 percent in 2001. In addition, the new goals
    created bonuses that gave Fannie Mae the incentive to pay special
    attention to financing small multi-family properties and owner-occupied
    2-4 unit properties, which HUD identified as having particular value to
    underserved groups and which it believed would benefit from increased
    participation by Fannie Mae and Freddie Mac.
        Fannie Mae also has flexibility under the current structure. We
    must meet three national goals through a combination of our single-
    family and multi-family businesses, including all types of business--
    both refinances and purchase money mortgages--that we engage in. And we
    must pursue this focus on affordable lending while serving the broader
    market. Under the current framework, Fannie Mae has been able to
    achieve both objectives, though it has been very difficult in some
    years.
        Going forward, it is critical that Congress not change the
    structure of housing goals in a way that would fragment the market
    Fannie Mae serves. The mortgage market in the United States is a
    national market, with mortgage rates essentially the same in every
    community in America. Indeed, Fannie Mae and Freddie Mac were founded
    to, among other things, provide stability in the secondary market for
    residential mortgages and promote access to capital throughout the
    Nation by increasing the liquidity of mortgage investment and improving
    the distribution of investment capital. A series of regional goals, as
    some have suggested, could disrupt the free flow of capital into
    certain areas in favor of others and place these founding principles at
    risk. In addition, the proliferation of national goals would similarly
    begin to fragment the market among a number of competing credit
    priorities and weaken our ability to bring efficiencies to the market.
        Therefore, it is essential that our affordable housing requirements
    drive us to expand access to underserved communities without
    undermining our support for the broader market. The Administration's
    proposal, which appears to establish a series of home purchase goals
    and give the Secretary open-ended authority to set or amend additional
    national goals would, we believe, undermine our ability to support the
    broader market.
    Conclusion
        I have tried to respond to the specific issues that have been at
    the center of the legislative debate over the last few weeks. I am sure
    there are other issues I have not addressed, and I look forward to
    discussing these topics with you as well.
        We as a society have long made homeownership a national policy
    priority. And the work of the Congress to address that priority has
    been an unprecedented success. We have the most effective and efficient
    home mortgage market in the world, continually working to make
    homeownership affordable to an ever larger number of Americans.
        I have attached the testimony delivered to the House Financial
    Services Committee last month, which lays out the steps Congress has
    taken and the steps we have taken that together have expanded
    homeownership opportunities for millions of America's families. I
    believe Congress has an opportunity this year to build on this success,
    by creating a new financial regulator that will ensure the continued
    health of the mortgage finance market and enable us to continue
    bringing low-cost financing to millions of American homeowners.
                                   ----------
                     PREPARED STATEMENT OF GEORGE D. GOULD
                        Presiding Director, Freddie Mac
                                October 16, 2003
        Thank you, Chairman Shelby, Ranking Member Sarbanes, and Members of
    the Committee. Good morning. It is a pleasure to be here today. My name
    is George Gould.
        I have served on Freddie Mac's board since 1990 and am currently
    the Presiding Director and Chairman of the Governance and Finance
    Committees. I am also Vice Chairman of Klingenstein, Fields & Company,
    a firm that manages individual assets and estates. Prior to joining
    this firm, I served as Undersecretary for Finance at the Department of
    the Treasury from 1985 to 1988. At the request of President Reagan, I
    chaired the Working Group on Financial Markets to examine the effect of
    the October 19, 1987 stock market crash.
        I welcome the opportunity to be here today to discuss key aspects
    of a strengthened regulatory structure for Freddie Mac and Fannie Mae.
    Freddie Mac plays a central role in financing homeownership and rental
    housing for the Nation's families. Our job is to attract global capital
    to finance America's housing. Given the importance of housing to our
    economy, and the importance of housing finance to global capital
    markets, it is critically important that our regulatory structure
    provide world-class supervision. Hence, I would like to recognize
    Senators Hagel, Corzine, Sununu, and Dole for their legislative efforts
    in this regard. We commend them for helping to get these important
    discussions off the ground.
        Before expressing our views on specific proposals, I would like to
    say a few words about the resolution of Freddie Mac's accounting issues
    and steps we are taking to ensure these problems never occur again. I
    would also like to recount Freddie Mac's long track record supporting
    strong, credible regulatory oversight.
    Resolution of Accounting Issues
        On January 22, 2003, Freddie Mac announced, in conjunction with our
    new independent auditor, PricewaterhouseCoopers, the need to restate
    earnings for 2000, 2001, and 2002. In our June 25, 2003 press release,
    we described the major factors leading to the need to restate earnings,
    a copy of which is provided for the record. In stark contrast to other
    recent corporate restatements, we expect Freddie Mac's restatement to
    show a large cumulative increase in earnings for the prior years. As we
    announced last month, we expect to release restated earnings for prior
    years in November. We deeply regret this delay, which was largely due
    to a systems error uncovered during the final validation of results.
        While the restatement will represent an important milestone, we
    remain determined to bring our financials completely up to date as
    quickly as possible. Once we resume timely reporting of our financials
    next year, we will proceed with our commitment to complete the process
    of voluntarily registering our common stock with the Securities and
    Exchange Commission (SEC) under the Securities Exchange Act of 1934 so
    that we become a reporting company under that Act. We are irrevocably
    committed to the voluntary agreement we announced last summer to submit
    to the periodic financial disclosure reporting requirements that apply
    to registrants. Freddie Mac reaffirmed this commitment in a letter to
    Treasury Secretary John Snow on July 14, 2003.
        I would like to briefly mention steps we are taking to ensure
    problems like these never happen again. While the Board has taken many
    important steps to date, I will be the first to acknowledge that more
    can be done--and will be done.
        First, the Board is extremely ``hands on'' with regard to getting
    the restatement done--and getting it done right. The committee
    responsible for overseeing the restatement has met weekly since March,
    and the Board is in constant communication with management. We are also
    overseeing the implementation of a comprehensive remediation plan.
        Second, we are moving aggressively to address weaknesses in our
    disclosures and related processes. We have added highly qualified
    accounting personnel and we are working to strengthen our control
    infrastructure. In addition, we have brought in independent experts to
    review best practices and propose remediation. For example, we have
    engaged former SEC Division of Corporation Finance chief David Martin
    to help us with disclosure. The Board is fully committed to
    implementing his recommendations, as well as those of other independent
    experts.
    Regulatory Oversight Structure
        Freddie Mac has long supported strong regulatory oversight. In
    October 2000, Freddie Mac and Fannie Mae announced a set of public
    commitments to ensure that the two GSE's remain at the leading edge of
    financial risk management and risk disclosure. These commitments, which
    I will describe in greater detail below, continue to represent a high
    standard that few other financial institutions can meet.
        In May 2001, we appeared before a Senate Subcommittee and announced
    we had implemented five of the six commitments, with the sixth being
    implemented the following month. In June 2001, we testified before a
    House Subcommittee that a strong regulator is essential to maintaining
    the confidence of the Congress and the public that we can meet our
    mission. We outlined key principles for effective regulatory oversight
    and pledged to work with the Congress in that regard. Those principles
    are as follows:

     First, the regulator must be highly credible. We continue to
        firmly believe that the GSE regulator must have supervisory
        expertise, be adequately funded and be independent in its
        judgments. Credibility is absolutely fundamental to the continued
        confidence of the Congress, the public and the markets.
     Second, the regulator must support housing. Not only is
        housing an important public policy objective, but it has also been
        an economic powerhouse for the past several years. The necessity of
        expanding affordable housing opportunities is more urgent than
        ever. Over the next 10 years, America's families will need an
        additional $8 trillion to fund their mortgages. By innovating new
        mortgage products and new mortgage investment vehicles, Freddie Mac
        will open doors for the homebuyer of the future, who is more likely
        to be a low-income, minority, or immigrant family, eager to realize
        the American Dream. We continue to work diligently to fulfill our
        commitment to President Bush to significantly expand the number of
        minority homeowners by the end of the decade.
     Third, and very importantly, the regulator must enjoy strong
        bipartisan support. In this regard, I would like to commend
        Chairmen Shelby and Oxley for the joint statement they recently
        issued. In the statement, they pledged to seek a timely bipartisan
        resolution of questions relating to regulatory restructuring.

        With these principles in mind, today I will comment briefly on key
    aspects of the regulatory structure under consideration in this
    Committee. The Committee has requested our views on a number of issues,
    starting with regulatory structure and independence.
    Structure and Independence
        Freddie Mac would strongly support the creation of a new regulatory
    office within the Department of the Treasury, if Congress were to
    determine that this would enhance our safety and soundness oversight.
    We recommend that the new regulator have a Director appointed by the
    President, with the advice and consent of the Senate, for a 5-year term
    of office.
        To ensure that the new regulator is able to exercise independent
    judgment, we would support applying the same operational controls as
    apply to the relationships between the Secretary of the Treasury and
    the Office of the Comptroller of the Currency and the Office of Thrift
    Supervision.\1\ It is difficult to justify why the GSE regulatory
    structure should differ so strikingly from other regulators--at the
    risk of politicizing our mission and the critical role we play in
    global financial markets.
    ---------------------------------------------------------------------------
        \1\ See 12 U.S.C. Sec. Sec. 1, 250, 1462a(b)(2), (3), and (4).
    ---------------------------------------------------------------------------
    Funding of New Oversight Offices
        We also are prepared to support providing both the new regulator
    and the Secretary of HUD authority to assess Freddie Mac outside the
    annual appropriations process to pay for the costs and expenses of
    carrying out their respective responsibilities vis-a-vis the GSE's.
    Additionally, we recommend that the General Accounting Office regularly
    report to the Congress on the efficacy of the new regulatory structure
    and the reasonableness of the costs relative to other world-class
    financial regulators so that neither unnecessarily raise the cost of
    homeownership.
    Capital Adequacy
        Adequate capital is the touchstone of investor confidence and is
    key to our ability to attract low-cost funds to finance homeownership
    in America. Freddie Mac's regulatory capital requirements incorporate
    two different measures: A traditional (leverage) capital requirement
    and a risk-based capital stress test that requires Freddie Mac to hold
    capital sufficient to survive 10 years of severe economic conditions.
    Freddie Mac consistently has exceeded both stringent capital standards.
        Freddie Mac's capital requirements were developed in keeping with
    our charter, which restricts us to lower-risk assets than banks. Since
    1994, charge-off losses at the five largest banks have been, on
    average, 17 times larger each year than charge-offs at Freddie Mac.
    Even in these banks' best year, charge-offs were more than five times
    higher than Freddie Mac's worst year.\2\ Limiting the comparison to
    mortgage assets, the residential mortgages found in bank portfolios
    typically entail greater risk than those in Freddie Mac's portfolio.
    Banks tend to hold a higher proportion of second mortgages, adjustable
    rate mortgages, subprime mortgages, and uninsured mortgages with high
    loan-to-value ratios. These historically present greater risk than the
    fixed-rate conforming loans that are the core of Freddie Mac's
    business. In 2002, FDIC-insured institutions had an average charge-off
    rate of 11 basis points on their mortgage portfolios, compared to 1
    basis point for Freddie Mac.\3\
    ---------------------------------------------------------------------------
        \2\ Federal Financial Institutions Examination Council,
    Consolidated Reports of Condition and Income and Freddie Mac annual
    reports for 1994 to 2001. For 2002 Freddie Mac credit information, see
    http://www.freddiemac.com/news/archives/investors/2003/4qer02.html.
        \3\ Federal Financial Institutions Examination Council,
    Consolidated Reports of Condition and Income and Freddie Mac. See
    http://www.freddiemac.com/news/archives/investors/2003/4qer02.html.
    ---------------------------------------------------------------------------
        In addition to our low exposure to mortgage credit risk, Freddie
    Mac maintains an extremely low interest-rate risk profile. Our risk
    management framework has performed exceptionally well through a number
    of challenging interest-rate cycles--and recent months are no
    exception. Despite the most turbulent market environment in 8 years,
    our average monthly duration gap was just one month in July.
    Maintaining a low-risk profile that is durable through time is the
    hallmark of Freddie Mac's disciplined approach to managing interest-
    rate risk.
        Given this lower risk exposure relative to banks, we agree with
    Secretary Snow's testimony before the House last month that the GSE
    minimum capital requirement is adequate and need not be changed. The
    GSE's' minimum capital requirements are commensurate with our lower
    risk profile and the limitations of our charter. In addition, our
    rigorous risk-based capital stress test ensures that our risks remain
    low throughout a sustained period of severe economic conditions.
    According to an analysis prepared by L. William Seidman, former
    Chairman of the FDIC, the stringent risk-based capital standard
    applicable to Freddie Mac could be extremely challenging if applied to
    most other financial institutions.\4\ More recently, the CapAnalysis
    Group, LLC, concluded that the risk-based capital stress test is ``a
    much more stringent test for judging the safety and soundness of a
    financial institution than is a traditional capital-requirements
    test.'' \5\
    ---------------------------------------------------------------------------
        \4\ L. William Seidman, et al., Memorandum to Freddie Mac, March
    29, 2000.
        \5\ The CapAnalysis Group, LLC, OFHEO Risk-Based Capital Stress
    Test Applied to U.S. Thrift Industry (March 17, 2003), p.1.
    ---------------------------------------------------------------------------
    Regulator Discretion on Risk-Based Capital
        Conclusions about appropriate capital determinations will continue
    to evolve in the years ahead. Accordingly, our regulator must have
    adequate discretion to ensure that Freddie Mac's capital standard keeps
    pace with these developments. Although the basic parameters of the
    risk-based capital stress test are set in law, our present regulator
    has significant discretion in adjusting the risk-based capital
    requirements. Additional discretion, such as provided to Federal
    banking agencies, could help ensure the GSE risk-based capital standard
    remains at the forefront of financial sophistication, while continuing
    to tie capital to risk.
        Discretion must be balanced with continuity, however. A key
    component of a stable financial market is a stable regulatory
    environment. Unnecessarily changing the risk-based capital standard
    harms those who made investment decisions based on a particular set of
    rules, only to find later that the rules were changed. This sort of
    ``regulatory risk'' increases costs that are ultimately borne by
    mortgage borrowers. Therefore, until such time as an overhaul of the
    risk-based capital stress test appears warranted, the regulator should
    be encouraged to continue to apply the existing risk-based capital
    rule. The rule has been in effect for less than one year and has yet to
    show signs of need for reform.
        We also believe the new regulator should be encouraged to gather
    information over the entire business cycle before making changes. This
    could be accomplished by requiring that the current rule remain in
    place for a period of time and expressing Congressional intent to this
    effect. When a new rule appears warranted, policymakers should ensure
    that certain fundamental principles remain firmly intact. Any future
    capital standard must continue to:

     Tie capital levels to risk;
     Be based on an analysis of historical mortgage market data;
     Remain operationally workable and as transparent as possible;
        and
     Accommodate innovation so the GSE's can carry out their
        missions.

        It is imperative that any changes to the rule be accomplished
    through notice-and-comment rulemaking, with an adequate comment period
    for all interested parties to express their views, followed by an
    adequate transition period for the GSE's to make any necessary
    adjustments to comply with new requirements.
        In summary, Freddie Mac supports granting the regulator greater
    discretion to set risk-based capital levels that accurately reflect the
    risks we undertake. However, changing risk-based capital standards
    unnecessarily, capriciously or frequently will reduce the amount of
    mortgage business the GSE's can do, resulting in higher costs for
    homeowners and renters.
    Mission Oversight and New Program Approval
        We believe that the HUD Secretary should retain all existing GSE
    mission-related authority consistent with HUD's mission to expand
    homeownership and increase access to affordable housing. Specifically,
    HUD should retain authority to ensure that the purposes of the GSE's'
    charters are accomplished and continue to have regulatory, reporting,
    and enforcement responsibility for the affordable housing goals, just
    as under current law. Additionally, HUD should retain existing fair
    housing authority.
        We also believe that, in keeping with its housing mission, HUD
    should retain its authority to approve any new programs of Freddie Mac
    and Fannie Mac. HUD alone has the expertise to determine whether new
    mortgage programs are in keeping with our charter and statutory
    purposes. In this vein, we also urge the Committee to maintain a new
    program standard--not a new activity standard. Requiring the regulator
    to provide advance approval of each and every new activity
    significantly
    exceeds the standard required of banks and would chill innovation in
    mortgage lending. Our ability to lower housing costs for homeowners and
    renters is directly linked to our expertise in managing mortgage credit
    risk and our distinguished record of bringing innovative products and
    services to market.
    Supervisory and Enforcement Parity
        The current legislative structure provides our safety and soundness
    regulator an array of supervisory and enforcement authorities to ensure
    that Freddie Mac is adequately capitalized and operating safely.\6\ If
    Congress were to deem it appropriate, we would support providing the
    GSE safety and soundness regulator authorities similar to those
    accorded to the Federal banking agencies. These enhanced powers would
    include broadening the individuals against whom the regulator could
    initiate cease-and-desist proceedings; new authority to initiate
    administrative enforcement proceedings for engaging in unsafe and
    unsound practices; new removal and suspension authority and authority
    to impose industry-wide prohibitions; and new authority to assess civil
    money and criminal penalties.
    ---------------------------------------------------------------------------
        \6\ ``Comparison of Financial Institution Regulators' Enforcement
    and Prompt Corrective Action Authorities,'' GAO-01-322R, January 31,
    2001.
    ---------------------------------------------------------------------------
    Conservatorship
        In the unlikely event of extreme financial distress, we believe
    conservatorship is the right approach. Although we believe that current
    law provides ample convervatorship powers, we would be willing to
    consider whether additional authorities could enhance Congress' and the
    public's confidence in our safe and sound operation. We agree with
    Secretary Snow's testimony before the House that steps
    beyond potential enhancements to conservatorship would appropriately be
    left to the Congress and not to the GSE regulator.
    Market Discipline Commitments
        In October 2000, Freddie Mac and Fannie Mae announced a set of six
    public
    commitments to ensure the GSE's adhere to a high standard of financial
    risk management. Excluding the commitment to adhere to an interim risk-
    based capital standard (which was rendered obsolete with the completion
    of the current risk-based capital stress test) these commitments are as
    follows:

     Periodic issuance of publicly traded and externally rated
        subordinated debt on a semiannual basis and in an amount such that
        the sum of core capital and outstanding subordinated debt will
        equal or exceed approximately 4 percent of on-balance-sheet assets.
        Because subordinated debt is unsecured and paid to the holders only
        after all other debt instruments are paid, the yield at which our
        subordinated debt trades provides a direct and quantitative market-
        based indication of our financial strength.
     Maintenance of at least 5 percent of on-balance sheet assets
        in liquid, marketable, non-mortgage securities and compliance with
        the Basel Committee on Banking Supervision Principles of Sound
        Liquidity Management, which requires at least 3 months' worth of
        liquidity, assuming no access to new issue public debt markets.
        Because of the critical importance of liquidity to the achievement
        of our mission--and the importance of non-mortgage assets to this
        liquidity--the GSE's' non-mortgage assets should not be singled out
        for onerous regulatory treatment.
     Public disclosure of interest-rate risk sensitivity results on
        a monthly basis. The test assumes both a 50 basis-point shift in
        interest rates and a 25 basis-point shift in the slope of the
        Treasury yield curve--representing an abrupt change in our exposure
        to interest-rate risk.
     Public disclosure of credit risk sensitivity results on a
        quarterly basis. The disclosure shows the expected loss in the net
        fair value of Freddie Mac's assets and liabilities from an
        immediate nationwide decline in property values of 5 percent.
     Public disclosure of an annual independent rating from a
        nationally recognized statistical rating organization.

        In July 2002, the GSE's made an additional commitment to
    voluntarily register their common stock with the Securities and
    Exchange Commission under the Securities Exchange Act of 1934 so that
    both companies will become reporting companies under that law. Freddie
    Mac is fully committed to completing this process as soon as our
    financial statements are brought up to date.
        Freddie Mac would support giving the regulator authority to ensure
    we carry out these important public commitments. Taken together, they
    significantly enhance the degree of market discipline under which the
    GSE's operate. Robust and frequent credit and interest-rate risk
    disclosures, combined with the release of annual independent ratings
    and the issuance of subordinated debt, constitute an important ``early
    warning system'' for investors.
    Affordable Housing Goals
        I would now like to say a few words about mission oversight.
    Freddie Mac's mission is to ensure a stable supply of low cost
    mortgages for America's families--whenever and wherever they need them.
    This mission defines Freddie Mac and what we are trying to accomplish.
    Our business model flows directly from our Congressional charter, which
    requires us to focus exclusively on financing residential mortgages.
        Meeting the annual affordable housing goals is a key aspect of our
    meeting our mission. Established in 1993 and increased in 1995 and
    2000, the three affordable housing goals specify that significant
    shares of Freddie Mac's business finance homes for low- and moderate-
    income families and families living in underserved areas. In 2000, HUD
    specified that 50 percent of Freddie Mac's mortgage purchases must
    qualify for the low- and moderate-income goal,\7\ 31 percent must be of
    mortgages to borrowers in underserved areas,\8\ and 20 percent must be
    of mortgages to low- or very-low income borrowers or those living in
    low-income areas.\9\ Freddie Mac has successfully met all the permanent
    housing goals, which are the highest and toughest of any financial
    institution.
    ---------------------------------------------------------------------------
        \7\ Low- and moderate-income families have incomes at or below 100
    percent of the area median income.
        \8\ Underserved areas are defined as (1) for OMB-defined
    metropolitan areas, census tracts having a median income at or below
    120 percent of the median income of the metropolitan areas and a
    minority population of 30 percent or greater; or a median income at or
    below 90 percent of median income of the metropolitan area; and (2) for
    nonmetropolitan areas, counties having a median income at or below 120
    percent of the State nonmetropolitan median income and minority
    population of 30 percent or greater; or a median income at or below 95
    percent of the greater of the State nonmetropolitan median income or
    the nationwide nonmetropolitan median income.
        \9\ Low-income areas refer to census tracts in which the median
    income is at or below 80 percent of the area median income. Low-income
    families have incomes at or below 80 percent of area median income,
    while very low-income families have incomes at or below 60 percent of
    the area median income.
    ---------------------------------------------------------------------------
        The existing statutory and regulatory structure provides great
    discretion to our mission regulator to determine the goals--and creates
    strong incentives for us to achieve them. The HUD Secretary currently
    has the regulatory authority to establish and adjust the housing goals.
    In the event a GSE fails to meet one or more of the goals--or there is
    a substantial probability that a GSE will fail one or more of the
    goals--the Secretary is authorized to require the submission of a
    housing plan. Further, the Secretary may initiate a cease-and-desist
    proceeding and impose civil money penalties for failing to fulfill the
    housing plan. By contrast, bank regulators do not have authority to
    bring enforcement proceedings against an institution that is not
    meeting its CRA obligations. These are strong incentives for the GSE's
    to strive to meet the goals year after year--to say nothing of the
    reputational ``penalty'' for failing to meet a goal.
        Considering that we have consistently met the permanent affordable
    housing goals, and that existing powers already are the industry's
    toughest, additional enforcement authority seems completely
    unnecessary. Additional enforcement authority would add little to the
    legislative and regulatory incentives that Congress and HUD have put in
    place. Therefore, we respectfully suggest that no additional authority
    is needed.
    Conclusion
        Freddie Mac has long supported strong regulatory oversight. It is
    critical to the achievement of our mission. As we have stated on
    previous occasions before the Congress, our core principles for the
    creation of a new regulatory structure are credibility, commitment to
    the GSE housing mission and a high degree of bi-partisan support.
        As I have outlined today, Freddie Mac is prepared to embrace
    significant enhancements that will make our regulatory structure
    stronger, in many cases, than the bank regulatory model. Building these
    new enhancements into existing law would give the new GSE regulator
    comparable supervisory and enforcement powers as bank regulators. In
    addition, it would impose tougher regulatory requirements in many
    areas, including program approval standards and a risk-based capital
    stress test. Our mission regulator would continue to oversee the most
    challenging, quantitative affordable housing goals in the industry--
    with tremendous powers to enforce them. Taken together, this enhanced
    GSE regulatory structure is strong, solid, and credible. It is key to
    maintaining the confidence of the Congress and the public that we can
    meet our vital mission while remaining at the forefront of capital and
    risk management.
        Thank you for the opportunity to appear today. I look forward to
    working with Chairman Shelby, Ranking Member Sarbanes, and the Members
    of this Committee to secure the future of our housing finance system
    and, with it, the dreams of millions of families.
                                   ----------
                      PREPARED STATEMENT OF NORMAN B. RICE
       President and Chief Executive Officer, Federal Home Loan Bank of
                                    Seattle
                                October 16, 2003
        Good morning Chairman Shelby, Ranking Member Sarbanes, and Members
    of the Committee. I am Norman B. Rice, President and Chief Executive
    Officer of the Federal Home Loan Bank of Seattle.
        I would like to thank Chairman Shelby and the Committee for the
    opportunity to speak today on behalf of the Council of Federal Home
    Loan Banks, and the more than 8,000 member financial institutions that
    partner with us in building healthy communities and economies across
    our country.
        I think it is appropriate for me to start this morning by
    commending Congress for two things regarding the Federal Home Loan Bank
    System.
        The first is for creating the 12 banks under the authority of the
    Federal Home Loan Bank Act of 1932. Congress created the banks to both
    stabilize and improve the availability of funds to support
    homeownership in this country. And the banks have delivered an
    unmatched legacy of innovation and service to the U.S. housing market
    for the last 70 years.
        The second is for the current work underway regarding regulatory
    restructuring of the housing GSE's. Clearly, Congress has the right and
    responsibility to scrutinize the regulatory oversight of the housing
    GSE's, and to ensure that they provide the Nation's network of
    community-based financial institutions with the safest, soundest source
    of residential mortgage and community development credit possible.
        Like the Members of this Committee, the 12 Federal Home Loan Banks
    seek world-class regulatory oversight of our system. After all, our
    members have almost $40 billion in private capital invested in our
    banks. Due to our joint and several liability, we seek the same quality
    oversight and transparency that are of paramount concern to you, the
    U.S. Treasury, bondholders, and the public.
        Along with the regulatory reform process now underway, the Bank
    System is also working toward voluntary SEC registration, pending
    resolution of critical accounting and reporting accommodations.
        On September 17, 2003, the Federal Housing Finance Board issued a
    proposed regulation that would require the 12 banks to register their
    stock with the SEC under Section 12(g) of the 1934 Securities and
    Exchange Commission Act. Under this regulation, the Federal Home Loan
    Banks would also be required to submit periodic and current reports
    such as 10-K's, 10-Q's and 8-K's.
        Each bank has until January 15, 2004 to provide comments on the
    proposed regulation to the Finance Board.
        The Seattle Bank Board of Directors, at our September 2003 meeting,
    adopted a resolution calling for voluntary SEC registration, and we are
    now moving to make that happen.
        In addition, over the last year, the system's SEC Task Force has
    met several times with SEC officials to discuss the resolution of
    outstanding accounting and reporting issues we believe are necessary to
    accommodate the unique cooperative structure of the Bank System.
        The bottom line: The goal of the Federal Home Loan Banks is to
    provide complete and transparent financial disclosures that are
    considered no less than ``best in class.''
        So, I am pleased to sit before you today representing the
    collective intent of the Federal Home Loan Banks to work diligently
    toward that goal as the process and debate around regulatory reform
    moves forward.
        Among the 12 Federal Home Loan Banks you will find at least three
    banks--Boston, Cincinnati, and Indianapolis--that do not support direct
    regulatory oversight by the U.S. Treasury. These banks strongly believe
    that because the Bank System and Treasury are competitors in the
    capital markets--and Treasury provides an emergency line of credit to
    the banks--a systemic conflict of interest would be created. Therefore,
    they support maintaining the current regulatory structure provided by
    the Federal Housing Finance Board, which was approved by Congress in
    1989 when finalizing FIRREA legislation.
        While there remain clear differences of opinion within the Bank
    System on the matter of regulatory reform, we have reached consensus on
    four principles that we believe must serve as a framework for specific
    action and represent our bottom-line concerns as Congress moves forward
    on legislation.
        These principles are as follows:
    Number 1--Preserve and reaffirm our mission.
        Mission is everything. Otherwise, why should any of the housing
    GSE's exist? We strongly believe that any legislation should accomplish
    the following regarding the mission of the Bank System:

     Provide cost-effective funding to members for use in housing
        finance and community development.
     Preserve our regional affordable housing programs, which
        create housing opportunities for low- and moderate-income families.
        Since the inception of our Affordable Housing Programs in 1991, the
        Bank System has contributed more than $1.7 billion in grants to
        communities across America.
     Support housing finance through advances and mortgage
        programs.
     Allow for innovative new business activities that advance our
        mission without creating a cumbersome process that prevents us from
        responding in a timely way to the needs of our member financial
        institutions and the marketplace.
    Number 2--A strong and independent regulator.
        Safety and soundness of the Bank System is our number one concern.
    This is neither a partisan nor an ideologically-driven endeavor. It is
    for this reason we ask that Congress protect the Bank System through
    the creation of a strong and independent regulator. This is absolutely
    consistent with the role of other bank regulatory agencies, in which
    the regulator responsible for safety and soundness has free and
    unfettered authority to determine policy, rulemaking, application,
    adjudicative, and budget matters.
        The primary responsibility of the regulator is to implement policy
    made by the Congress, and to do so in a safe and sound manner. We
    strongly believe that a regulator lacking true independence may
    eventually find itself pursuing other agendas, not the will of
    Congress, nor what is demanded to assure safety and soundness.
    Number 3--Preserve Bank System funding.
        The reason a GSE can advance its housing mission more effectively
    than fully private companies is simple--we have a cost of funds
    advantage due to our GSE status. It is critical that we ensure that
    nothing is done to any of the housing GSE's that increases their cost
    of funds and, correspondingly, increases costs for financial
    institutions and consumers.
        In fact, we are convinced that strong, independent, and skilled
    regulatory oversight will give greater confidence to investors and
    continue to help us advance our housing finance mission.
        Therefore, any legislation must:

     Preserve the role and function of the Office of Finance.
     Ensure that neither the U.S. Treasury, nor the independent GSE
        regulatory unit, has the ability to impede or limit our access to
        the capital markets without cause.
     Not limit the financial management tools available to the
        GSE's to prudently manage the financial risks inherent in our
        funding and business activities.

        Although the shared service of the Office of Finance should be
    owned and operated by the Federal Home Loan Banks--and the banks should
    establish its governance principles and scope of operations--we believe
    the OF must be subject to the regulatory authority of any new
    regulator.
    Number 4--Preserve the unique nature of the Bank System.
        While all three GSE's have much in common, we believe it is
    important to both recognize and preserve the unique nature of the
    FHLBanks.
        Therefore, any legislation must:

     Preserve the cooperative ownership of the Bank System and the
        joint and several liability that is the underpinning of the Bank
        System.
     Preserve the unique regional structure of the 12 banks that
        assures we are locally controlled and responsive to the financial
        and economic development needs of our local communities.

        Regardless of the regulatory structure established by Congress, we
    believe these principles must be considered as you move forward in your
    policymaking.
        In closing, I would like to put forward some thoughts that reflect
    my own thinking on these matters.
        I believe there are two threshold issues that can help you attain
    your benchmark purpose of protecting the public interest in the housing
    GSE's.
        First, there is much that separates the Federal Home Loan Banks
    from the two other housing GSE's, and these differences must be fully
    recognized and factored into any regulatory reform measures being
    considered.
        Let me list what I consider to be the key differences:

     Our mission is somewhat broader than the other housing GSE's,
        incorporating economic and community development.
     There are different capital requirements, with the FHLBanks
        required to hold 4 percent capital and the others required to hold
        a lower percentage.

      When new capital rules were established by Congress through Gramm-
        Leach-Bliley, there was wide agreement among economists that the
        Federal Home Loan Banks were required to hold too much capital
        against advances.
      Given that the Bank System has NEVER suffered a credit loss on
        advances, a 4 percent minimum requirement, we believe, is
        excessive. It is important to keep in mind that requiring too much
        capital can sometimes work against the goal of safety and
        soundness. If an enterprise is underleveraged, it can create
        pressure to take greater risk in order to generate better return on
        equity.
      In the secondary mortgage business, the likelihood of credit losses
        within the Bank System has increased. However, Fannie Mae and
        Freddie Mac, who get paid a fee to put credit risk on their books,
        are required to hold less capital, while the Federal Home Loan
        Banks--who compensate lenders for keeping the credit risk on their
        own books--are required to hold nearly twice as much capital. We
        believe capital requirements should be standardized for all three
        housing GSE's.

     The Bank System is cooperatively owned and capitalized by our
        members, while the other housing GSE's must meet the earnings and
        stock valuation expectations of Wall Street investors.
     Two housing GSE's pay Federal income taxes, but the Federal
        Home Loan Banks pay special taxes equivalent to the Federal
        corporate income tax rate of 26 percent. We are required to
        contribute 10 percent of our net income for affordable housing
        grants while the other GSE's have affordable housing goals.

      This is a highly efficient way of passing on our GSE subsidy, to
        directly impact affordable housing and economic development in the
        communities we serve. Though we appreciate the goals the other
        housing GSE's maintain, we believe--as do most--the best way of
        passing along our GSE subsidy is through our Affordable Housing
        Program and the direct 10 percent contribution made by each of the
        12 Federal Home Loan Banks annually.
      The Bank System, in 2002, generated $199 million to award as AHP
        grants and subsidies, and over the last 13 years has awarded more
        than $1.7 billion in grants and subsidies, making the banks one of
        the largest sources of private funding for affordable housing in
        the Nation.
      The Affordable Housing Program targets incomes lower than those
        established by the housing goals administered by HUD. Affordable
        Housing Program subsidies must be used to fund the purchase,
        construction or rehabilitation of:

     Owner-occupied housing for very low-income, or low- or
        moderate-income (no greater than 80 percent of area median income)
        households; or
    Rental housing in which at least 20 percent of the units will be
        occupied by and affordable for very low-income (no greater than 50
        percent of area median income) households.

        AHP subsidies may be in the form of a grant (direct subsidy) or a
    below-cost interest rate on an advance from a Federal Home Loan Bank
    member institution. In supporting home purchases, AHP funds may also be
    used for downpayment assistance for income-eligible, first-time
    homebuyers.
        These are not inconsequential differences.
        But, in fact, we increasingly have more in common. Most importantly
    for purposes of this discussion, we are all managing increasingly
    complex sets of financial, operating, and accounting risks. For
    example, all three housing GSE's pursue very sophisticated interest
    rate risk management strategies. And, all three would benefit from more
    rigorous oversight of these activities.
        In my view, as business activities and associated risks converge
    among the GSE's, so, too, must the regulatory oversight evolve and
    adapt to a more complex world, and to greater scrutiny by Congress, the
    marketplace, and the American people.
        Also, the choices you make on regulatory reform must be based on an
    underlying philosophy about the housing GSE's. In your judgment, is the
    public interest best advanced by encouraging competition among the
    housing GSE's or encouraging market domination by them?
        It should come as no surprise that I have some views on this topic.
        At the urging of the bank members of our system--the Nation's home
    lenders who own our cooperative--we have chosen to compete. That's why
    we jumped with both feet into the mortgage purchase business. In the
    end, the Nation's home lenders will better serve the Nation's
    homebuyers if there are choices and competition in the secondary
    mortgage market.
        We welcome that competition because we are convinced we have a
    better way to meet our Congressionally mandated housing mission--to
    create homeownership opportunities. Because we are a cooperative, we
    are not beholden to the kinds of expectations of Wall Street investors,
    and because of the way we purchase mortgages, more of the risk is
    dispersed to those best able to manage the risk.
        From a public policy point of view, full-fledged competition among
    GSE's is a way to more prudently manage GSE growth and to disperse risk
    among more investors.
        The decisions you are about to make on regulatory reform and
    oversight will directly influence how this country best serves our
    network of community banks and consumers, and how we best protect the
    public interest and investment in the housing GSE's.
        It is my job, as a President and CEO of one of the 12 Federal Home
    Loan Banks, to preserve and enhance the strength, integrity and value
    of our Bank System, and continue its legacy of service to our member
    financial institutions and the communities they serve.
        Every day, I remind myself that I work for a cooperative that has,
    at its core, a public mission of making our communities better places
    to live and work. I do not own any part of this bank; it is owned by
    our members, and we are, at all times, fully accountable to them.
        My role is to protect and enhance this cooperative, for the good of
    our financial institutions, our communities and the overall public
    interest invested in the Federal Home Loan Banks--the same purpose that
    each of you bring to this process.
        I look forward to continuing to work closely with Members of
    Congress and the U.S. Treasury as we look for new and better ways of
    strengthening the oversight and value of our housing GSE's.
        Thank you for your time this morning. I would be happy to answer
    any questions you may have regarding my testimony.
            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                           FROM JOHN W. SNOW

    Prompt Corrective Action

    Q.1. Clearly, OFHEO and the Finance Board do not have the
    complete arsenal of prompt corrective action tools that the OCC
    and other bank regulators have. In fact, the Finance Board has
    no statutory Prompt Corrective Action authority.
        Do you believe that a new regulator must have the same
    Prompt Corrective Action tools as the bank regulators? Has the
    Administration given any thought as to how to fashion Prompt
    Corrective Action triggers for the Federal Home Loan Bank
    System, given its unique capital structure? I would be
    interested in any input that you might want to offer.

    A.1. Prompt Corrective Action requirements are important for
    ensuring that financial institution regulators take the
    necessary regulatory actions at appropriate times depending on
    the financial
    condition of their regulated entities. Such requirements
    provide greater assurance that financial problems will be
    corrected before it becomes too late. The Prompt Corrective
    Action provisions that are in place for bank regulators provide
    a good model for evaluating and developing such requirements
    for a new regulator for the housing Government Sponsored
    Enterprises (GSE's).

    Receivership/Conservatorship Authority

    Q.2. Your written testimony indicated that the new regulatory
    agency should have more than the powers associated with
    conservatorship.
        Which are the particular receivership authorities that you
    believe would be necessary? If the primary intent of a
    conservator is to maintain the ongoing business value of an
    enterprise, wouldn't broader receivership powers be
    unnecessary? What impact would receivership authority have on
    the ability of the GSE's to access the debt markets?

    A.2. The Administration has proposed that the new regulatory
    agency for the housing GSE's should have broader powers than
    those associated with conservatorship. In particular, the new
    regulatory agency should have all receivership authority
    necessary to direct the orderly liquidation of assets and
    otherwise to direct an orderly wind down of an enterprise, in
    full recognition that Congress has retained to itself, in the
    case of Fannie Mae and Freddie Mac, the power to revoke a
    charter. The Finance Board has the authority to liquidate a
    FHLBank under certain circumstances.
        We would not expect that providing the new regulatory
    agency with receivership authority would have an undue negative
    impact on the ability of the housing GSE's to access debt
    markets. Providing the new regulatory agency with the ability
    to complete an orderly wind down of a troubled regulated entity
    should encourage greater market discipline as creditors would
    have to evaluate fully their investment decisions. As with the
    powers granted to bank regulators, we would expect that the new
    regulatory agency could use its authority to place an entity in
    conservatorship if that was the appropriate course of action.
    However, if financial circumstances were sufficiently
    troubling, placing an entity in conservatorship and maintaining
    the ongoing business value may not be the appropriate course of
    action. The broad goals of financial regulation in this regard
    should be to promote a resilient housing finance system.
    Maintaining the operations of an entity that is no longer
    viable is inconsistent with that goal. We look forward to
    working with the Committee in developing specific receivership
    authorities for the new regulatory agency.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                           FROM JOHN W. SNOW

    Q.1. It is my understanding that if a new GSE regulating entity
    is created as an office within the Department of the Treasury,
    you would approve such a proposal only if Treasury had the
    power to approve its testimony, clear all of its proposed
    regulation, and maintain full control of its budget.
        If we are to establish a world-class regulator for the
    GSE's, isn't it important that such a regulator be an
    independent entity, like the Office of the Comptroller of the
    Currency (OCC), rather than an office within the Treasury
    Department, in order to ensure that its decisions are insulated
    from partisan politics and have greater credibility in the
    investor community? Furthermore, you stated that you believed
    that it was necessary for Treasury to have these powers over
    the new regulator in order to disabuse the investor community
    of any perceived Government backing. Wouldn't placing the
    regulator within Treasury with these powers increase that
    perception?

    A.1. The degree of independence for a new GSE regulatory agency
    is vitally important with regard to specific matters of
    supervision, enforcement, and access to the Federal courts. The
    ability of the new regulatory agency to take actions regarding
    supervision and enforcement outside of the political process is
    important for ensuring that the new agency can properly oversee
    the operations of its regulated entities. Without such
    independence, a regulator may be prevented from taking the
    appropriate regulatory actions if such actions have unpopular
    political consequences. Likewise, providing the new regulatory
    agency with access to the Federal courts provides it with a
    necessary tool to perform its duties, and such access is
    consistent with the powers of our Nation's other financial
    regulators. Permanent budget authority is also an important
    component of independence for the new GSE regulatory agency.
        While political independence for the new regulatory agency
    is important, the structure and location of the new regulatory
    agency deserves special consideration. Drawing upon the
    statements of those who have recommended placing the new
    regulatory agency within Treasury, it seems that it is believed
    that the Treasury would lend stature, authority, depth of
    experience, and a broader perspective to the new agency. None
    of those things would be available if Treasury is walled off
    from the policymaking processes (approving testimony, clearing
    proposed regulations, and having review authority over the
    budget) of the new agency.
        Establishing a new regulatory agency for the housing GSE's
    within the Treasury Department does create the potential for
    reinforcing any market misperception of an implied guarantee of
    GSE obligations. That is why it is vitally important that the
    Treasury Department be able to monitor the new regulator's
    policies to ensure that such policies are not reinforcing any
    market misper-
    ception of an implied guarantee and that such policies
    encourage greater market discipline of the GSE's. In that
    regard, Treasury approval of the new agency's policies will
    ensure that there is no confusion between Treasury debt, which
    is backed by the full faith and credit of the U.S. Government,
    and GSE debt, which does not have such backing.

    Q.2. Do you believe that the current GSE minimum capital
    standard of 2.5 percent is too low or too high? Please explain
    in detail.
        Has Treasury performed an analysis of the impact a change
    in the GSE minimum capital standard might have both on the
    housing and the investor markets? If so, please submit this
    analysis for the record. On what basis do you believe the
    decision to increase or decrease the minimum capital
    requirement should be made? Please describe how you envision
    the process to work. Do you believe that the Director of the
    proposed financial regulating entity should have the sole
    discretion to set both the risk-based and minimum capital
    standards? Why would allowing the regulator to have discretion
    over risk-based capital be insufficient to maintain safety and
    soundness for the GSE's?

    A.2. The current minimum capital standards for Fannie Mae and
    Freddie Mac are set in statute at 2.5 percent of on-balance-
    sheet obligations and 0.45 percent for certain off-balance-
    sheet obligations. We believe that the new regulatory agency
    should have broad authority with regard to setting the capital
    requirements of the Enterprises, both with respect to risk-
    based capital and minimum capital. It is not a question of
    whether the current standard is too high or too low, but rather
    that the authority for setting capital standards needs to be
    flexible enough to employ the best regulatory thinking,
    conscious of the Enterprises' own measures of risk, so that the
    regulator can require that its regulated entities maintain
    capital and reserves sufficient to support the risks that arise
    or exist in its business.
        In regard to the impact a change in the GSE minimum capital
    standard might have both on the housing and the investor
    markets, we would not expect the new regulatory agency to
    initiate such a change unless the risks undertaken by the GSE's
    warranted such a change. In that regard, changes in capital
    standards should go toward strengthening the financial position
    of the GSE's and further promoting our goal of a strong and
    resilient housing finance system that serves the needs of our
    Nation's homeowners. In addition, we would expect that any such
    changes to capital standards would go through the standard
    notice and comment rulemaking process that all financial
    regulatory agencies employ.
        Similar to the authority of our Nation's other financial
    institution regulators, the new regulatory agency for the
    housing GSE's should also have the authority to adjust the
    GSEs' minimum capital standards. Minimum capital standards
    provide protection against the general, indefinable, perhaps
    unforeseen risks that are present with any financial
    enterprise. Financial institution regulators rely on both
    minimum and risk-based capital standards in evaluating the
    financial health of their regulated entities. While risk-based
    capital standards are more finely tuned to the particular risks
    of a financial institution, the methodology for determining
    such standards is subject to its own unique set of risks. One
    such risk is model risk--the risk that the financial models
    underlying the risk-based capital standard turn out to be
    incorrect. Model risk is a key indefinable or unforeseen risk
    that risk-based capital standards will not adequately capture.
    Thus, not providing the new regulatory agency with the ability
    to adjust minimum capital standards would limit new agency's
    effectiveness as a financial regulator.

    Q.3. Current law provides that if one or both of the GSE's were
    in serious financial trouble, they would be placed in
    conservatorship, meaning that the Office of Federal Housing
    Enterprise Oversight (OFHEO) would attempt to financially
    restructure the GSE's to maintain their assets. In your
    testimony, you recommended changing this authority to
    ``enhanced receivership,'' directing the new regulator to
    liquidate the assets of the GSE's with ``appropriate wind down
    authority.'' Why do you believe that the current
    conservatorship authority should not be kept? Why is it not in
    the public interest to maintain the assets of the GSE's,
    instead of liquidating them to private entities?

    A.3. The Administration's proposal regarding receivership does
    not envision eliminating the new regulatory agency's authority
    to place an entity into conservatorship, but rather it provides
    the new regulatory agency with the receivership authority
    necessary to direct the orderly liquidation of assets and
    otherwise to direct an orderly wind down of an enterprise, in
    full recognition that Congress has retained to itself, in the
    case of Fannie Mae and Freddie Mac, the power to revoke a
    charter. Such receivership authority is necessary because if
    financial circumstances were sufficiently troubling, placing an
    entity in conservatorship and maintaining the ongoing business
    value may not be the appropriate course of action. The broad
    goals of financial regulation in this regard should be to
    promote a resilient housing finance system. Maintaining the
    operations of an entity that is no longer viable is
    inconsistent with that goal.

    Q.4. How does Treasury plan to regulate the process for new
    program and activity approval of the GSE's? In your testimony,
    you asserted that you believed Treasury did not recommend prior
    approval of new products and activity, but you did recommend
    giving Treasury the ability to withhold prior approval of new
    programs. Please elaborate on this. What criteria would
    Treasury propose for approval of new programs and activity?
    Please describe them in detail. How would this process differ
    from the current process administered by HUD? How would
    Treasury propose defining the
    difference between new programs and new activity? Many policy
    experts believe there is an unavoidable tension between
    maintaining safety and soundness and aggressively pursuing
    affordable housing goals. In reviewing new GSE programs and
    activity, how would Treasury balance safety and soundness of
    the GSE's with their housing mission objectives? What expertise
    in housing finance does Treasury have, that HUD does not, to
    justify Treasury becoming the new program and activity
    regulator?

    A.4. The Administration has proposed that the authority for
    approving new activities of the housing enterprises be
    transferred from the Department of Housing and Urban
    Development (HUD) to the new regulatory agency. This proposal
    is consistent with availability of one of the central tools
    that every effective financial regulator has--the ability to
    say ``no'' to new activities that are inconsistent with the
    charter of the regulated institutions, inconsistent with their
    prudential operation, or inconsistent with the public interest.
    The current financial regulator for Fannie Mae and Freddie Mac
    lacks that authority, one of its most serious weaknesses, and
    if we are serious about creating an effective, credible
    financial regulator, it must have the authority to approve new
    activities.
        As long as we are going to maintain a bifurcated regulatory
    structure for Fannie Mae and Freddie Mac, there may be some
    tension between mission regulation and safety and soundness
    regulation. As it relates to new activities approval, the
    Administration's proposal addresses this tension by providing
    the Secretary of HUD with a consultative role in reviewing new
    activities. Through this consultative process, HUD would
    continue to have an important role to play in providing its
    expertise on new activities that have a direct impact on the
    housing and mortgage markets.
        The Administration's proposal for regulatory reform of the
    housing GSE's also strengthens the authority of HUD to promote
    the housing goals of Fannie Mae and Freddie Mac. In particular,
    HUD would continue to have responsibilities for setting the
    affordable goals for Fannie Mae and Freddie Mac and enforcing
    the Fair Housing Act. Under our proposal, HUD would also be
    provided explicit enforcement authority over the housing goals
    to ensure that Fannie Mae and Freddie Mac are meeting their
    housing promotion requirements.
        In terms of the process for new activities, it is important
    to understand that Treasury's formal role in approval of new
    activities would only arise in those few cases when a new
    activity was such a departure from existing norms as to require
    formal promulgation of a new regulation. That is to say that
    variations within the GSEs' current secondary market activities
    that clearly are authorized by statute may not require any
    Treasury review of proposed regulatory changes by the new
    agency. In fact, we would not expect approval of new activities
    to require new regulations in most cases.

    Q.5. In your testimony, you argued that including the Federal
    Home Loan Bank (FHLB) System in GSE regulatory reform would be
    better than keeping them out. However, you mentioned that there
    were significant differences between the FHLBanks and the other
    housing GSE's. What differences between the FHLBanks and the
    other housing GSE's do you believe are significant with respect
    to their regulation and would you specifically address such
    differences in legislation reforming their oversight? Please
    explain in detail.

    A.5. The importance of our housing finance markets requires
    that all of the housing GSE's be included in a single program
    of world-class supervision. We see the need for this for the
    Federal Home Loan Bank System just as we see it for Fannie Mae
    and Freddie Mac. There are some differences between the
    FHLBanks and the other housing GSE's that require special
    consideration as changes to their regulation are considered.
    Some of these include: Debt issuance of FHLBanks by the Office
    of Finance; how the differing capital structures of the housing
    GSE's are addressed; and how the cooperative ownership
    structure of the FHLBanks would be addressed. While some of
    these issues may need to be addressed specifically with
    legislation, another useful way to account for the unique
    characteristics of housing GSE's is to create two divisions
    within the new regulatory agency--one division specializing in
    Fannie Mae and Freddie Mac and one in the FHLBanks. We look
    forward to working with the Committee on these issues.

           RESPONSE TO A WRITTEN QUESTION OF SENATOR SUNUNU
                           FROM JOHN W. SNOW

    Q.1. Secretary Snow, if you are calling for the GSE's to comply
    with bank-like capital standards, are you suggesting the
    elimination of the .45 percent capital charge that Fannie Mae
    and Freddie Mac currently hold for off-balance-sheet assets,
    such as mortgage-backed securities that they guarantee? Are you
    calling for a new capital requirement to be imposed on the off-
    balance-sheet assets of banks?

    A.1. We are not suggesting the elimination of any particular
    capital requirement nor are we suggesting new capital
    requirements for banks. The key aspect of our housing GSE
    regulatory reform proposal with respect to capital requirements
    is that we believe that the regulator should have broad
    authority with regard to setting the capital requirements of
    the Enterprises, both with respect to risk-based capital and
    minimum capital. Given the unique nature of mortgage guarantee
    business of Fannie Mae and Freddie Mac such authority could be
    used to set minimum capital standards for those obligations
    even though they are off-balance-sheet obligations. The new
    regulatory agency's authority for setting capital standards
    needs to be flexible enough to employ the best regulatory
    thinking, conscious of the Enterprises' own measures of risk,
    so that the regulator can direct its regulated entities each to
    maintain capital and reserves sufficient to support the risks
    that arise or exist in its business. One such risk is clearly
    the credit risk associated with the GSEs' guarantees of
    mortgage-backed securities, and the new agency should have
    authority to require capital for that risk.

           RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
                           FROM JOHN W. SNOW

    Q.1. As I said in my opening statement, I am very concerned
    about the unintended consequences this legislation may have on
    small banks. I am especially concerned that they may find
    themselves limited in products they can use to make loans to
    underserved populations and for CRA compliance. Do I have your
    commitment today to do what we can to ensure small banks are
    not adversely affect by this legislation?

    A.1. In developing our approach to regulatory reform for the
    housing GSE's we have been focused on two core objectives:
    Promoting a sound and resilient financial system, and increased
    homeownership opportunities for less advantaged Americans.
    Small banks form an important component of our housing finance
    system, and we do not see any reason why improving the
    regulation of the housing GSE's would have a negative impact on
    their operations. In contrast, we would expect that
    improvements in the regulatory oversight of the housing GSE's
    would help to ensure that we have a system in place that serves
    the needs of small banks and their customers both today and in
    the future, and I am committed to that result.

    Q.2. As you know, the OCC and the Fed require banks to notify
    their respective regulator after they have engaged in a new
    activity. Why do you think the OCC/Fed model would not work for
    the GSE's?

    A.2. The Administration has proposed that the authority for
    approving new activities of the housing enterprises be
    transferred from HUD to the new regulatory agency, and we do
    think that the OCC model for new activity approval is an
    appropriate model for the new regulatory agency. The key
    element is flexibility: Flexibility in bringing new products on
    line and flexibility to provide fully adequate supervision.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER
                           FROM JOHN W. SNOW

    Q.1. Secretary Snow, the initial thinking after Freddie's
    problems erupted was to put Fannie and Freddie's regulator into
    Treasury to bring confidence to the market. Is this still a
    timely rationale for moving the regulator into Treasury or have
    the markets calmed themselves regarding Fannie and Freddie and
    this issue has died?

    A.1. While the recent problems experienced by Freddie Mac
    highlighted problems with the housing GSEs' current regulatory
    oversight regime, the rationale for regulatory reform goes
    beyond these recent events. Because housing finance is so
    important to our national economy, we need to have a world-
    class regulatory agency to oversee the GSE's in a manner that
    is consistent with maintaining healthy national markets for
    housing finance. There is a general recognition that the
    supervisory system for the housing GSE's has neither the tools,
    stature, authority, nor resources to deal effectively with the
    current size, complexity, and importance of these enterprises.
    As with all forms of Government regulation, policymakers should
    continually evaluate where improvements can be made. It is in
    that regard that the Administration is recommending
    improvements to the oversight of our housing finance system.

    Q.2. Secretary Snow, Treasury is now interested in including
    the Federal Home Loan Banks in a bill. I was confused after
    your testimony today because in it you say ``that all housing
    enterprises be included in a single program of world-class
    supervision.'' But in your response to Senator Hagel you said
    there should be two divisions, one for the Banks and one for
    Fannie and Freddie. Do you mean one bureau with two divisions
    or two bureaus? Please clarify what you mean. What is your
    thinking for the structure you propose?

    A.2. The key point is that whatever the structure of the new
    housing GSE regulatory agency, the new agency should have the
    same set of enforcement tools and the same overall financial
    supervisory regime in place for all of its regulated entities.
    At the same time, the underlying statutory authority and
    business operations of Fannie Mae and Freddie Mac in comparison
    to the FHLBanks is different, so some specialization in
    regulation may be necessary. One way to address these issues
    would be to create one regulatory agency with two divisions.
    One division would be responsible for Fannie Mae and Freddie
    Mac, and the other division would be responsible for the
    FHLBanks. Under such a structure, benefits in financial
    oversight could be achieved through the sharing of best
    practices in examination procedures and overall measurement of
    risk, while at the same time the unique characteristics of each
    of these entities could also be considered.

    Q.3. Secretary Snow and Secretary Martinez, if Fannie and
    Freddie are put into Treasury, you discuss wanting new program
    and/or new activity review. The GSE's are concerned that this
    might impede their ability to be creative and innovative with
    new mortgage products. Do you agree?

    A.3. We see no reason why the GSEs' innovation should be
    stifled under a process whereby the new regulatory agency has
    authority to approve new activities. Our Nation's bank and
    thrift regulators have fostered and encouraged innovation using
    the same type of approval authority, and we see no reason why
    providing similar authority to the new regulatory agency would
    stifle innovation by housing GSE's.

    Q.4. Secretary Snow, the GSE's are concerned that giving the
    regulator greater discretion to change risk-based capital
    standards might result in higher costs for homeowners and
    renters. Has Treasury considered this concern and what is your
    response?

    A.4. In developing our approach to regulatory reform for the
    housing GSE's we have been focused on two core objectives:
    Promoting a sound and resilient financial system, and increased
    homeownership opportunities for less advantaged Americans. To
    serve both of these objectives we need to devote careful
    attention to the resilience of our system of housing finance.
    Housing finance is so important to our national economy that we
    need a strong, world-class regulatory agency to oversee the
    prudential operations of the GSE's and the safety and soundness
    of their financial activities consistent with maintaining
    healthy national markets for housing finance.
        In providing the new regulatory agency with the discretion
    to change risk-based capital standards, we would not expect the
    new regulatory agency to initiate such a change unless the
    risks undertaken by the GSE's warranted such a change. In that
    regard, changes in capital standards should go toward
    strengthening the financial position of the GSE's and further
    promoting our goal of a strong and resilient housing finance
    system that serves the needs of our Nation's homeowners today
    and in the future, ultimately increasing home affordability.

    Q.5. Secretary Snow, do you know if anyone in the Government
    has studied or is studying what the cost or impact to the
    Federal Home Loan Banks will be of registering their stock with
    the SEC? (If he says no. You might suggest that some staff
    attention be given to this issue.)

    A.5. The FHLBanks have raised the concern of potential costs or
    unintended effects of registering with their stock with the
    SEC. It is my understanding the FHLBanks and the SEC continue
    to discuss details (for example, how the joint and several
    liabilities of the FHLBanks will be described) regarding
    concerns the FHLBanks have raised with registration. I am
    confident that these types of concerns can be worked out, which
    would then remove any remaining impediment to the FHLBanks'
    registering with the SEC.
        As it relates to studying the issue of cost or impact on
    the FHLBanks, it is difficult to see how providing greater
    financial disclosure to the market could have a negative impact
    on the FHLBanks unless such disclosure reveals new information
    to financial market participants that raises questions
    regarding the FHLBanks' credit quality.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                           FROM MEL MARTINEZ

        The mission of Fannie Mae and Freddie Mac is expanding
    homeownership, and their housing goals are a barometer of that
    mission.
    Q.1.a. Do you believe the current housing goals are sufficient
    to fulfill the GSEs' mission? If yes, then why change the
    current system?

    A.1.a. No, HUD believes the current goals are not sufficient to
    ensure that the GSEs' focus on expanding homeownership. Goals
    must be dynamic to ensure that areas where there is a need can
    be adequately targeted. Under the Administration's proposal,
    HUD would receive enhanced authority to establish and enforce
    housing goals for the GSE's. This enhanced authority would
    include the ability to establish an annual home purchase goal
    for the GSE's which could be specifically targeted to first-
    time homebuyers, low-and moderate-income homebuyers, homebuyers
    in underserved areas, and homebuyers of special affordable
    housing. Other proposed enhancements include the ability to
    add, modify, or rescind existing goals as needed to better
    serve housing needs. In addition, to ensure that this function
    is given significant attention, the Administration also
    proposes establishing a new office within HUD, with the costs
    of regulation to be funded, as with other financial regulators,
    through assessments on the regulated entities, the GSE's.

    Q.1.b. What do you see as the dividing line between encouraging
    affordable mortgage lending and credit allocation? How do we
    make sure these goals are insulated from the political process?

    A.1.b. Congress chartered both Fannie Mae and Freddie Mac to
    fulfill certain public purposes, including providing ongoing
    assistance to the secondary market for residential mortgages,
    which
    includes 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. The Department's housing goals for the GSE's are in
    furtherance of these purposes and reflect Congress's
    objectives. In return for confining their businesses to meeting
    these objectives, the GSE's receive substantial benefits,
    estimated by the Congressional Budget Office in May 2001 at
    $10.6 billion per year.
        With enactment of the Federal Housing Enterprises Financial
    Safety And Soundness Act, FHEFSSA, in 1992, Congress clarified
    the GSEs' public purposes further by establishing specific
    affordable housing objectives and mandating that HUD establish
    quantitative targets under each goal. As a result of these
    actions, the requirement for improved performance and
    accountability in affordable mortgage lending and the
    requirement to allocate credit for these purposes are the same
    thing. In setting annual targets for each GSE under the FHEFSSA
    and to ensure that the Enterprises are able to provide
    liquidity to residential mortgage markets as intended by their
    charter acts, HUD evaluates the level of each goal against six
    factors as set forth in the FHEFSSA. These factors include the
    size of the market for each goal, the GSEs' past performance
    under the goals, and the GSEs' ability to lead the market. The
    purpose of these considerations is to assure that the goal
    levels are appropriate. The process and methodology that HUD
    relies upon in making its determinations weigh these
    considerations based on objective market data and are published
    for evaluation, review, and comment in each proposed rule for
    new goals. This transparent process ensures that goal levels
    are established in an environment that is objective and
    insulated from undue political influence.

    Q.1.c. How would the home purchase goal proposed by the
    Administration differ, operationally, from the current housing
    goals?

    A.1.c. The Administration's proposal would allow HUD to
    establish, through regulation, four components of an annual
    home purchase goal for single-family dwelling units. These
    components would include first-time homebuyers; low- and
    moderate-income homebuyers; homebuyers in central cities, rural
    areas, and other underserved areas; and homebuyers of special
    affordable housing. The components, expressed as percentages of
    each GSE's home purchase mortgage business, would be
    established at levels that would increase the GSEs' secondary
    market financing of home purchase mortgages serving the charter
    missions of the GSE's and the goals established by the FHEFSSA.
    The components would be enforceable as goals.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                           FROM MEL MARTINEZ

    Q.1. In your September 10 House Financial Services testimony,
    you said that you felt that it was important to place new
    program and activity approval authority with the proposed new
    regulator entity at Treasury. You said it should be moved to
    Treasury because you felt that such authority impacted the
    safety and soundness of the GSE's.
        You have proposed the creation of a new oversight office
    within HUD to oversee affordable housing goals. With an
    appropriate level of funding and a staff skilled in evaluating
    the financial implications of new programs and activities, why
    do you believe that such a HUD office would be unable to
    effectively regulate new program and activity approval?

    A.1. The Administration's proposal provides for establishing a
    new regulatory office within the Treasury Department. The new
    office, consistent with Treasury's experience as a financial
    regulator, would be responsible for overseeing the GSEs' safety
    and soundness. The new office also would have authority to
    review GSE
    activities that frequently present safety and soundness issues
    as primary concerns. Because new activities may also have
    mission implications, the new office will be required to
    consult with HUD in its reviews. This approach allows HUD to
    retain a key role as the GSEs' mission regulator while also
    ensuring that the new safety and soundness office has all the
    tools necessary to function as a world-class regulator.

        In your testimony, you have argued that the GSE's lag the
    private market in lending to minority and first-time
    homebuyers. It is my understanding that the studies you cite
    include data from the Home Mortgage Disclosure Act (HMDA),
    which doesn't reflect purchases of seasoned loans, and includes
    data from the private market that includes a higher percentage
    of the subprime market than the GSE's.
    Q.2.a. Can you cite for the record a study that compares
    minority and first-time conventional loan borrowers using data
    that includes seasoned loans that definitively demonstrates
    that the GSE's lag the private market among borrowers with
    similar income, credit, wealth, and racial profiles?

    A.2.a. HUD and private researchers have published numerous
    studies on the GSEs' performance in funding affordable home
    purchase mortgages. These studies concluded that both Fannie
    Mae and Freddie Mac have lagged the primary market in
    purchasing loans for groups covered by the housing goals: Low-
    and moderate-income and special affordable borrowers and
    borrowers living in underserved areas. HUD's most recent study
    analyzed GSE and market data through the year 2000.
        This response presents updated data for 2001 and 2002 and
    includes analysis of first-time homebuyers. The analyses
    reported in the tables below compare characteristics of loans
    originated in the conventional conforming market, as shown in
    HMDA data, with characteristics of loans purchased by the
    GSE's, as shown in the data they have provided annually to HUD.
        Loan characteristics (such as underserved area loans) are
    presented in the form of percentage shares of loans originated
    in the conventional conforming market, as compared with
    corresponding percentage shares of loans purchased by Fannie
    Mae or Freddie Mac. The percentage shares (or ratios) for the
    market are limited to loans originated during the current year,
    adjusted to exclude loans originated by ``B and C'' subprime
    lenders. As explained below, the GSEs' purchases include both
    (a) current-year, newly originated mortgages and (b) prior-
    year, seasoned mortgages, for which percentage shares can be
    presented in alternative ways.
        Question 2(a) raised the issue of the GSEs' purchases of
    seasoned loans. It is not possible to provide consistent
    comparisons including seasoned loans as well as newly
    originated loans, because the market data, provided under the
    Home Mortgage Disclosure Act (HMDA), do not include the
    seasoned loans that are available for purchase by the GSE's.
    There are different ways to treat seasoned loans when comparing
    the GSEs' purchases to market originations. The most
    appropriate and most consistent is to exclude seasoned loans
    from the GSE data for the year in which they are purchased by
    the GSE's, and count them instead in the year in which they are
    originated. This approach is taken in the accompanying Tables 1
    and 2. Table 1 reports the GSE data on an ``origination-year''
    basis. This is the closest in concept to the market data, which
    are also presented on an ``origination-year'' basis. The GSE
    data in Table 1 for the year 2001 include all the GSEs'
    purchases through 2002 of loans originated during 2001; in
    other words, it includes the GSEs' purchases of 2001
    originations during both 2001 and 2002. Thus, in Table 1,
    seasoned loans (that is, 2001 mortgage originations purchased
    by the GSE's in 2002) are reallocated back to their year of
    origination. This places them on a comparable basis with the
    HMDA market origination data. As shown in Table 1, low- and
    moderate-income families accounted for 41.7 percent of the
    GSEs' purchases (through 2002) of 2001 mortgages. Table 1 also
    shows that low- and moderate-income families accounted for 42.9
    percent of the mortgages originated in the conventional
    conforming market during 2001. Thus, for low- and moderate-
    income loans, the GSEs' purchases of 2001 originations lagged
    the 2001 origination market.
        The percentages reported in Table 1, taken together, show
    that the ratios for each of the GSE housing goals (indicated as
    ``Both GSE's'') were behind the market ratios in both 2001 and
    2002. Freddie Mac lagged behind both the market and Fannie Mae,
    except in 2002 when Freddie Mac equaled Fannie Mae in the
    special affordable category. Fannie Mae's mortgage purchase
    ratios lagged behind the market ratios, except in 2002 when
    Fannie Mae surpassed the market in the low- and moderate-income
    category.
        Table 2 compares the GSEs' ratios with market loan
    origination ratios for three race/ethnicity categories. Again,
    the ratios for ``Both GSE's'' were behind the market ratios for
    African American borrowers, Hispanic borrowers, and all
    minority borrowers in both 2001 and 2002. During 2001 and 2002,
    Fannie Mae's ratios lagged behind the market in the African
    American category but exceeded or equaled the market in the
    other two categories (Hispanic and All Minorities). Freddie
    Mac's ratios fell below the market in all three race/ethnicity
    categories in both 2001 and 2002.
        Tables 3 and 4 repeat the analyses in Tables 1 and 2,
    except that the GSE data are expressed on a ``purchase year''
    basis. This means that all the GSEs' purchases in a particular
    year are compared to mortgages originated in the market in that
    same year. Thus, in this analysis, the GSEs' data for 2001
    include not only their purchases during 2001 of mortgages
    originated during 2001, but also their purchases of prior-year,
    or so-called ``seasoned mortgages,'' such as mortgages
    originated during 1999 or 2000. These ratios for the GSE's are
    not as directly comparable to the market ratios as are the
    ratios in Tables 1 and 2. They measure the overall purchase
    activity of the GSE's during 2001, rather than the purchases of
    the GSE's of loans originated in 2001.
        Using this ``purchase year'' approach, Table 3 compares the
    percentage shares of goal-qualifying mortgages in the GSEs'
    purchases and market originations. It shows that all of the GSE
    housing goal category ratios (indicated as ``Both GSE's'') were
    behind the market ratios in both 2001 and 2002. Freddie Mac
    lagged behind Fannie Mae, while Fannie Mae's mortgage purchase
    ratios equaled or exceeded the market ratios in 2002. Table 4
    compares the GSEs'
    ratios with market loan origination ratios for three race/
    ethnicity categories. Again, the ratios for ``Both GSE's'' were
    behind the market ratios for African American borrowers,
    Hispanic borrowers, and all minority borrowers in both 2001 and
    2002. However, Fannie Mae's ratios exceeded the market in two
    of three racial/ethnicity categories in 2001 and all three
    racial/ethnicity categories in 2002, while Freddie Mac's ratios
    fell below the market in both years.
        As explained above, the GSEs' ratios in Tables 3 and 4
    include their purchases of loans originated both in the current
    year and in prior years. The GSEs' purchases of loans
    originated in prior years typically tend to include a greater
    share of goals-qualifying mortgages than do their purchases of
    loans originated in the year of purchase by the GSE. Thus, the
    GSE percentages tend to overstate the GSEs' performance in a
    particular category, relative to a consistent concept of loans
    originated in a given year (as presented in Tables 1 and 2).
        Tables 3 and 4 present the comparisons in the way that HUD
    traditionally has reported the GSEs' performance, even though
    the data are not as comparable as the origination-year basis.
    Throughout the 1990's the GSE's lagged the market by such a
    substantial margin that the differences in coverage between the
    GSE and market data did not affect the result materially and
    did not change the basic conclusion. The GSEs' improvement in
    very recent years, and the renewed public interest in their
    performance, has led HUD to refine the analysis and make the
    comparisons as precise as possible. These comparisons, as
    mentioned, appear in Tables 1 and 2.
        Table 5 compares the GSEs' funding of mortgages for first-
    time homebuyers with market loan originations for first-time
    home buyers. This table shows that first-time homebuyers
    represented 37.6 percent of market loan originations, compared
    with 26.5 percent of the GSEs' purchases; thus, the GSE's fell
    substantially short of the market originations ratio for first-
    time homebuyers over the period 1999-2001. For minority first-
    time homebuyers, the GSE ratio was 6.2 percent, compared to a
    market originations ratio of 10.6 percent. For African American
    and Hispanic first-time homebuyers, the GSE ratio was 3.8
    percent, compared to a market originations ratio of 6.9
    percent. For first-time homebuyers, particularly first-time
    minority homebuyers, both GSE's substantially lagged the
    private conventional conforming market. HUD has not previously
    published this comparison.

    Q.2.b. If you are able to definitively demonstrate such a
    difference between the GSE's and the private market exists,
    please describe why such a difference exists, considering that
    it is in GSE's financial interests to buy as many conventional
    loans as possible.

    A.2.b. In the past, the GSE's generally focused on borrowers
    with traditional backgrounds and living in suburban settings,
    as Congress observed in the early 1990's: ``Inadequate access
    to mortgage credit is a particular problem which results, in
    large part, from the vestiges of redlining and the unintended
    consequences of the Enterprises' orientation toward suburban
    and ``plain vanilla'' mortgages.'' \1\
    ---------------------------------------------------------------------------
        \1\ Senate Report 102-282, May 1992, p.38.

        The GSE's have made significant changes in their
    underwriting guidelines in recent years and, in conjunction
    with primary lenders, have introduced a variety of new products
    and programs for nontraditional buyers. Thus, major gains have
    been made by the GSE's in serving traditionally underserved
    borrowers and neighborhoods. However, HUD and others believe
    that additional steps could be taken by the GSE's, without
    damaging their safety and soundness, to reach out further to
    this market.
        For example, research on the GSEs' mortgage purchases has
    found that many of their goal-qualifying loans have rather low
    loan-to-value ratios. This has raised concerns that some
    nontraditional borrowers who are unable to make high
    downpayments are not able to obtain conventional loans that
    could be purchased by the GSE's, thereby forcing these
    borrowers to more expensive loans, such as FHA-insured loans.
    In this regard, there are indications that both GSE's
    understand the importance of improving access for borrowers
    with low downpayments. For example, Fannie Mae recently
    announced a plan for a joint venture with a mortgage insurer to
    increase such purchases.

    Q.2.c. Why hasn't HUD updated the affordable housing goals yet
    using its current authority? When do you plan on updating them?

    A.2.c. HUD is currently working on establishing new affordable
    housing goals. However, determinations regarding the market
    share, upon which each goal is based are highly dependent upon
    current census data. Complete data from the 2000 census has
    only recently become available. HUD's regulations state that
    housing goals will remain in effect until such time as a new
    regulation is promulgated. The Department anticipates that new
    goals will be in place for 2005. With respect to rulemaking for
    affordable housing goals and other HUD regulatory
    responsibilities, it is important to remember that the
    Department has limited staff that it can devote to these
    regulatory activities, because it lacks the ability to fund its
    regulatory activities through assessments on the GSE's. Other
    financial regulators do have assessment authority. The
    Administration's proposal, which will establish a dedicated
    office and staff to carry out HUD's regulatory responsibilities
    and which will provide for funding based upon fee assessments
    on the GSE's, will markedly improve HUD's ability to carry out
    its functions.

    Q.3.a. How does HUD currently define the difference between new
    programs and new activity and/or products?

    A.3.a. HUD relies on the current statutory definition in the
    Federal Housing Enterprises Financial Safety and Soundness Act
    of 1992 (FHEFSSA), as well as its legislative history, in
    making determinations about what is subject to review as
    required under the FHEFSSA. Section 1303 of the FHEFSSA defines
    a ``new program'' as--

        any program for the purchasing, servicing, selling, lending
    on the security of, or otherwise dealing in, conventional
    mortgages that (A) is significantly different from programs
    that have been approved under this Act or that were approved or
    engaged in by an enterprise before the date of the enactment of
    this Act [10/28/92]; or (B) represents an expansion, in terms
    of dollar volume or number of mortgages or securities involved,
    of programs above limits expressly contained in any prior
    approval.

        The legislative history states that ``[n]ew products or
    programs that differ from existing programs because of
    insignificant variations in mortgage characteristics, technical
    improvements, or those, generally, that represent
    recombinations of features used in existing programs need not
    be submitted for approval.'' \2\ There is no statutory
    definition or legislative history that differentiates
    ``activities'' from either ``products'' or ``programs.''
    ---------------------------------------------------------------------------
        \2\ Senate Report 102-282, May 15, 1992, p.15.

    ---------------------------------------------------------------------------
    Q.3.b. Is there a problem with this definition? Why or why not?

    A.3.b. The current definition is imprecise. It is often
    difficult to make the distinction between products and programs
    for regulatory purposes. Both GSE's have relied upon the
    imprecise language to determine for themselves that nearly all
    initiatives are either products, mortgage features, or other
    activities that do not fall within the meaning of ``new
    programs'' as defined in FHEFSSA. As a result, even though the
    current statute requires the GSE's to receive prior approval
    from HUD before instituting a new program, they rarely seek
    this approval.

    Q.3.c. If there is a problem with this definition, how would
    you propose changing it?

    A.3.c. The Administration is proposing the creation of a world-
    class regulatory office within the Treasury Department with
    authority over both safety and soundness and the review of new
    and ongoing activities of the Enterprises. The Administration's
    proposal for new activity review better delineates the scope of
    oversight authority by removing the definitional distinctions
    that have contributed to confusion and misunderstanding in the
    past.

    Q.4.a. You sent the Congress legislative language that would
    give the HUD Secretary the authority to rescind housing goals
    that Congress has established for these companies by only
    giving 30 days notice. By my reading of this language, you
    could rewrite the goals set by Congress simply by determining
    in your opinion that there are other housing needs. Why does
    HUD need the power to rescind housing goals with 30 days
    notice?

    A.4.a. The Administration's proposal would not authorize HUD to
    rescind housing goals upon a 30-day notice. Under the
    Administration's proposal, HUD may only establish, modify, or
    rescind a goal by regulation, with formal notice and comment.
    Therefore, if HUD rescinds a goal or establishes a new goal, it
    can only be done by notice and comment rulemaking.
        A new goal would not become effective until at least a year
    after it was promulgated by a final rule, that is, following at
    least a 1-year transition period. For example, a new goal
    established by a final rule promulgated on October 1, 2004,
    would be made effective on January 1, 2006.
        Under the Administration's proposal, HUD could establish
    necessary implementation requirements for the transition, for
    example, procedures for reporting on the transitional goal or
    for applying the goal requirements. These transition
    requirements could be established by notice only after
    providing the GSE's at least 30 days to comment. The
    Administration's proposal is modeled on the transition language
    for establishing the goals under FHEFSSA. Accordingly, the 30-
    day period is only relevant to the GSEs' opportunity to comment
    on the establishment of transition requirements for goals
    established through rulemaking.

    Q.4.b. In your testimony, you argued that there should be a new
    first-time homebuyer goal. Wouldn't such a goal damage the
    housing refinancing or multifamily markets? Why not?

    A.4.b. Under the Administration's proposal, the Enterprises
    could continue to purchase any volume of multifamily and
    refinanced single family mortgages that they desire with no
    adverse impact on their ability to achieve a first-time
    homebuyer goal. The reason for this lies in the way goals are
    established and performance under them is calculated.
        The Administration's proposal applies only to loans to buy
    homes that are purchased or securitized by the GSE's. There
    would not be a numerical target for the total number of home
    purchase loans, nor would there be a home purchase loan target
    in terms of the percentage of total GSE business that would be
    devoted to home purchase loans. Instead, the number of home
    purchase loans would be left to the business judgment of the
    GSE's. Whatever that number may be in a given year, some
    specified percentage of those loans would be for first-time
    homebuyers.
        The performance of the Enterprises under this component
    would be calculated by dividing the number of home purchase
    mortgages that are for first-time homebuyers by the total
    number of home purchase mortgages acquired, including both
    first-time and repeat homebuyers. The inclusion of other types
    of mortgages in the calculation, such as refinance mortgages,
    would indeed cause a corresponding drop in the reported
    percentage of first-time home purchase mortgages acquired and
    could possibly deter the Enterprises from purchasing these
    types of mortgages. This is not what the Administration
    proposes.
        Helping families become homeowners is an important public
    purpose of the GSE's, and home purchase loans are their ``bread
    and butter'' business. The housing goals do not now recognize
    the importance of homeownership. The Administration believes
    that they should.

           RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
                           FROM MEL MARTINEZ

    Q.1. As I said in my opening statement, I am very concerned
    about the unintended consequences this legislation may have on
    small banks. I am especially concerned that they may find
    themselves limited in products they can use to make loans to
    underserved populations and for CRA compliance. Do I have your
    commitment today to do what we can to ensure small banks are
    not adversely affected by this legislation?

    A.1. The Administration's GSE regulatory reform proposal
    provides that the new GSE regulatory office responsible for
    safety and soundness regulation will have the authority to make
    determinations with regard to the permissibility of new GSE
    activities. In carrying out this review authority, the new
    regulator must consult with HUD. The Administration believes
    that this new procedure will ensure that in any review of GSE
    activities, the GSEs' safety and soundness, as well as the
    GSEs' affordable housing mission, will be fully considered.
    Small banks, such as those in Kentucky that have expressed
    their concerns to you, serve important roles in funding
    affordable housing loans through their CRA programs. The
    Administration fully understands the extent to which CRA
    lenders, such as small banks, rely upon the GSE's to purchase
    seasoned portfolios of CRA-eligible loans and to offer products
    that meet those obligations. For these reasons, the
    Administration is confident that its regulatory proposal is the
    right approach. HUD's consultative role in new activity review
    along with enhanced goal-setting and enforcement authority will
    continue to provide strong oversight with respect to each GSE's
    affordable housing mission.

    Q.2. As you know, the OCC and the Fed require banks to notify
    their respective regulator after they have engaged in a new
    activity. Why do you think the OCC/Fed model would not work for
    the GSE's?

    A.2. With respect to the OCC/Fed model for regulation, the
    Department will defer to the Treasury Department because it is
    more familiar with the specifics of these models. However, I
    would like to point out that in developing its current
    proposals, the Administration followed the model previously
    established by Congress wherein prior approval was determined
    to be the appropriate method of regulation for Fannie Mae and
    Freddie Mac. (This approach was instituted under Fannie Mae's
    Charter in 1968 and Freddie Mac's Charter revision in 1989. The
    1992 Act reaffirmed the Department's authority for prior
    review.) The GSE's are limited-purpose corporations. At the
    time the 1992 regulatory legislation was enacted, it was
    apparent that the GSE's had also grown substantially since
    their creation, both absolutely and relative to the mortgage
    market. No single bank commands the market share that Fannie
    Mae and Freddie Mac do. Collectively, the Enterprises currently
    account for more than 70 percent of the conventional conforming
    mortgage market and between 40-50 percent of the entire
    mortgage market. In addition, the enterprises' mortgage-backed
    securities are widely held by other financial institutions in
    this country. These levels of concentration are so significant,
    and the implications of any unsafe enterprise activity so
    widespread, that the risk of significant financial impact
    extends well beyond the Enterprises themselves to the Nation's
    entire financial system. Given these implications and
    restrictions, the Administration believes that Congress was
    correct in mandating a prior approval review.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER
                           FROM MEL MARTINEZ

    Q.1. Secretary Snow and Secretary Martinez, if Fannie and
    Freddie are put into Treasury, you discuss wanting new program
    and/or new activity review. The GSE's are concerned that this
    might impede their ability to be creative and innovative with
    new mortgage products. Do you agree?

    A.1. HUD understands that the ability of the GSE's to innovate
    new products is important to achieving their public purposes.
    The Administration's proposals are intended to strengthen
    regulation in a manner that ensures prudent oversight without
    impeding either GSE's business operations or their ability to
    innovate in carrying out their public purposes. As the
    Department responsible for ensuring that the GSE's carry out
    their affordable housing mission, HUD has an interest in
    supporting the GSEs' ability to develop the tools necessary for
    this purpose. The Administration's proposed procedure for
    reviewing new activities requires that HUD serve in a
    consultative capacity, thereby helping to ensure that new
    activities are consistent with the GSEs' public purposes and
    that reviews are conducted expeditiously. The Administration's
    new procedure will also ensure that in reviewing new
    activities, the GSEs' safety and soundness, as well as their
    affordable housing mission, will be fully considered.

    Q.2. Secretary Martinez, you do not discuss the Federal Home
    Loan Banks in your statement. I wonder if you have any opinion
    about them regarding their housing mission and moving their
    regulator into Treasury?

    A.2. Fannie Mae and Freddie Mac share many characteristics with
    the Federal Home Loan Banks (FHLBanks). Congress created all of
    these enterprises to serve specific public purposes, and they
    all have a housing mission. We welcome a discussion on this
    issue and look forward to working with Congress, the FHLBanks,
    and other interested parties regarding the appropriate
    regulatory structure for the FHLBanks.

           RESPONSE TO A WRITTEN QUESTION OF SENATOR SHELBY
                        FROM FRANKLIN D. RAINES

    Q.1. The Administration has proposed that the new regulator
    have all the receivership authority necessary to direct the
    orderly liquidation of assets. What difficulties would you see
    in moving to receivership powers akin to those held by the
    FDIC? What impact would receivership have on the ability of the
    GSE's to access the debt markets?

    A.1. The receivership powers granted by Congress to the FDIC
    primarily protect the FDIC insurance deposit fund. The FDIC, as
    receiver, is charged with closing and/or selling a failing
    institution and giving priority to the claims of insured
    depositors. The charter of the troubled bank or thrift is
    extinguished. The receivership powers of the FDIC under Section
    11 of the Federal Deposit Insurance Act (FDI Act) are complex
    and have been subject to extensive interpretation by the FDIC.
        The FDIC is not required to put a bank or thrift into
    receivership; it may also elect to put an institution into
    conservatorship under Section 11 of the FDI Act in an effort to
    return the institution to financial health. The FDIC can also
    avoid putting an institution into receivership if the FDIC, the
    Fed, and the Treasury determine (in consultation with the
    President) that putting a bank or thrift into receivership
    ``would have serious adverse effects on economic conditions or
    financial stability and any action or assistance . . . would
    avoid or mitigate such adverse effects . . . .'' 12 U.S.C.
    1823(c)(4)(G).
        Simply importing all of the FDIC's receivership powers
    under Section 11 of the FDI Act into the GSE legislation raises
    several issues.
        First, many of the provisions of Section 11 serve primarily
    to protect insured deposits, which the GSE's do not have. It is
    unclear exactly how those sections might be applied to the
    GSE's.
        Second, H.R. 2575's provision on ``enhanced
    conservatorship'' appears to import all of the FDIC's powers as
    a receiver without providing any of the protections that exist
    for insured banks or thrifts. The proposal does not provide for
    an exception similar to the one that would apply to large banks
    or thrifts that might prevent those institutions from being
    placed into receivership by the FDIC. Given the importance of
    the GSE's to the housing markets, the serious consideration
    that would be given, for example, to Citibank before putting
    the institution into receivership, would be appropriate for the
    GSE's.
        H.R. 2575 also does not appear to protect expressly certain
    types of contracts in the event of receivership. The
    ``qualified financial contract'' exception to the FDIC's
    receivership powers (and the FDIC's interpretations thereof)
    was adopted to provide certainty to financial markets as to the
    treatment of these contracts by a receiver or conservator for
    an insured depository institution. Similar protections are
    included in the U.S. Bankruptcy Code for application in
    nondepository institution bankruptcies. In addition, the FDIC
    has provided by regulation (12 CFR 360.6), subject to the
    requirements therein, assurances to the markets and holders of
    mortgage-related securities issued by insured depository
    institutions that the FDIC will not reclaim, for the
    receivership or conservatorship estate, mortgage loans
    transferred by an insured depository institution into a
    securitization. Absent such express protections tailored to the
    GSEs' business, wholesale importation of the FDIC's
    receivership powers into GSE receiverships could, for example,
    impair the value and liquidity of the mortgage-backed
    securities issued in existing GSE securitization transactions,
    thus unnecessarily increasing costs and decreasing liquidity.
    Therefore, we believe that express protections for certain
    contracts and securi-
    tizations are critical to providing certainty to the markets
    and insuring that the cost of raising funds for the secondary
    mortgage market is not unnecessarily increased.
        Creating uncertainty is not necessary to enhance the power
    of the conservatorship provisions of the 1992 Act if such
    enhancement is Congress' goal. For example, specific and
    additional grants of authority could be given to a GSE
    conservator within the framework of the 1992 Act and by
    including express limitations on repudiation or
    recharacterization of GSE contracts in the 1992 Act.
        We note that our answers above do not change the point made
    in our testimony before the Committee on October 16, 2003. We
    do not see any need for any change to the conservatorship
    provisions that exist in the 1992 Act. In 1992, Congress
    affirmatively rejected the receivership model for the GSE's in
    favor of the conservatorship model. The legislative history of
    the 1992 Act makes clear that Congress considered and rejected
    the receivership option for the Enterprises. The Senate
    Committee Report notes that the version of the 1992 Act first
    passed by the Senate (which contained conservatorship
    provisions substantively similar to those eventually enacted)
    ``does not contain authority to appoint a receiver for the
    Enterprises.'' The Report explains:

        The Committee determined that providing for the appointment
    of a conservator was sufficient. This judgment takes account of
    the important role that the Enterprises play in our Nation's
    economy . . . . The Enterprises are clearly distinguishable
    from even the largest depository institutions, each of which
    may cease to be able to compete as a provider of financial
    services with varying degrees of economic impact. If the
    appointment of a conservator for an enterprise were ever to
    become imminent, the Congress would have the opportunity to
    consider the reasons for the Enterprise's condition and the
    options then available to address that condition. The
    legislation provides for continuing reports to the Congress on
    the capital condition of the Enterprises, so the Committee
    expects the Congress will have more than ample notice to
    proceed deliberately in considering any possible future action
    with respect to the enterprises.
        Senate Report, 102-282, at 16.

        The conservatorship powers Congress authorized in 1992 are
    very broad and would permit the conservator to run the
    institution on a day-to-day basis, including selling off
    assets, until the GSE returned to financial health or Congress
    took some other action. Pursuant to the 1992 Act, a conservator
    has ``all of the powers of the shareholders, officers, and
    directors'' of Fannie Mae or Freddie Mac. 12 U.S.C. 1369A(a).
    In addition, a conservator may (i) avoid any security interest
    taken by a creditor with the intent to hinder, delay, or
    defraud the company or its creditors, (ii) enforce any contract
    notwithstanding a provision of the contract providing for the
    termination of the contract upon the appointment of a
    conservator, and (iii) receive a stay in a judicial action or
    proceeding for up to 45 days. OFHEO also may require that a
    conservator set aside and make available for payment to
    creditors amounts that may be safely used for such purpose; all
    similarly situated creditors must be treated similarly. The
    appointment of a conservator does not affect OFHEO's authority
    under the 1992 Act to oversee the companies and to impose
    requirements and restrictions based on the capital-based
    classification system.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                        FROM FRANKLIN D. RAINES

    Q.1. I realize that the GSE's have continued to meet their
    affordable housing goals. However, in light of the rising
    housing costs in many communities across the Nation, do you
    believe the current goals are sufficient to expand
    homeownership in high-cost communities across the country? Why
    or why not?

    A.1. The current goals are only one measure of Fannie Mae's
    efforts to make homeownership more affordable in communities
    across the country. We believe the current goals are very
    demanding, particularly in the current business environment,
    and they are ensuring that we continue to expand homeownership.
    The low- and moderate-income goal applies across the Nation,
    including in high-cost communities, and to reach and exceed
    that goal we innovate to create products and partnerships that
    make homeownership more affordable to low- and moderate-income
    families everywhere.
        Many low- and moderate-income renters aspire to
    homeownership, but they often face daunting barriers such as
    the difficulties in accumulating a downpayment or qualifying
    for an affordable mortgage, especially with imperfect credit.
    Fannie Mae has worked with lenders and community partners to
    develop products and services to overcome these barriers. We
    have developed automated underwriting that has lowered the
    costs of mortgage originations, new low-downpayment products
    that help people get into homes with as little as $500 down,
    and products with flexible underwriting that serve credit
    blemished borrowers. We have worked to expand employer-assisted
    housing programs; many employers--especially in high-cost
    areas--have found it is in their interest to help employees
    afford a home as part of the employer's recruitment and
    retention strategies. These initiatives make homeownership more
    affordable in high-cost areas and help us meet our regulatory
    requirements. The results are clear, as shown below:

        The affordable housing goals set by HUD do not limit us to
    serving only targeted borrowers. They require us to devote a
    percentage of our business to these populations, but our
    mission is to serve a broader market. Our charter mandates that
    we provide liquidity to the market for residential mortgages,
    including, but not limited to, mortgages that qualify for the
    affordable housing goals. By attracting low-cost funding to the
    mortgage market and creating liquidity, we reduce the interest
    rate on all conforming mortgages by at least 0.25 percentage
    points. We serve this entire market in a way that expands
    liquidity and reduced mortgage rates for all conforming
    mortgages, while focusing special attention on low- and
    moderate-income borrowers.

    Q.2. Are there any new affordable housing goals you would
    support adding to those currently authorized? If so, please
    describe them.

    A.2. HUD sets housing goals as a regulatory requirement to
    ensure that Fannie Mae focuses particular attention on low- and
    moderate-income borrowers and underserved areas. We have
    consistently met or exceeded the current goals. The Agency is
    developing proposed goals for next year and beyond.
        Over the years, HUD has sought to establish goals that
    require the company to stretch beyond levels we might otherwise
    achieve, without threatening our safety and soundness or
    jeopardizing the liquidity of the mortgage finance system. HUD
    relies on predictions of market growth to establish these
    goals. This kind of forecasting is not easy and predictions are
    likely to be inexact. The refinance boom of the last 2 years,
    which exceeds anything foreseen by HUD when these goals were
    set, highlights that fact.
        It is critical that the housing goals structure allows
    Fannie Mae the ability to make business decisions based on
    actual market conditions. Under the structure created by the
    1992 Act, HUD has considerable flexibility in establishing the
    goals in its rulemaking process, and can use that authority to
    focus our efforts toward specific high-priority portions of the
    market.
        HUD's recasting of the goals in 2000 is an example of that
    flexibility. The Department increased all three housing goals.
    The goal for Fannie Mae's purchase of loans to low- and
    moderate-income borrowers was increased from 42 percent in 1999
    to 50 percent in 2000. In addition, the new goals that gave
    Fannie Mae an incentive to pay special attention to financing
    small multifamily properties and owner-occupied 2-4 unit
    properties.
        Going forward, it is critical that housing goals are not
    increased to the point that they threaten our safety and
    soundness or undermine our ability to serve a market that
    includes middle-class as well as low-income borrowers. Today,
    we work to expand the
    universe of Americans who can afford to purchase a home by
    increasing low-cost funding available for mortgages for middle
    class families, as well as for underserved communities. Goals
    that become too numerous or narrow can lead to fragmentation in
    the market and credit allocation. This would distort Fannie
    Mae's business and undermine the critical role we play in the
    market.

    Q.3. If Congress were to establish an independent regulator and
    with a well-respected impartial Director to head it, why
    shouldn't that Director be able to raise minimum capital
    standards, if he or she believed it to be necessary to ensure
    the safety and soundness of the GSE's? Please explain.

    A.3. Fannie Mae operates under two capital requirements--a
    minimum capital, or leverage, requirement and a risk-based
    capital requirement. Each quarter, Fannie Mae must meet both
    requirements.
        The leverage requirement, also known as minimum capital,
    does not change based on the risk of the assets a financial
    institution. Instead, the leverage limit serves as a capital
    ``floor'' based on the general risk of an entity. Fannie Mae
    and Freddie Mac's leverage ratio, set by statute, is 2.5
    percent for on-balance-sheet assets and 0.45 percent for off-
    balance-sheet assets. Unlike the bank leverage ratio, the GSE's
    leverage test requires capital support for off-balance-sheet,
    as well as on-balance-sheet, exposures. Fannie Mae's capital as
    a percentage of on-balance-sheet assets (as the bank ratio is
    calculated) was 3.4 percent on June 30, 2003. Including
    outstanding subordinated debt, that figure rises to 3.9 percent
    of on-balance-sheet assets. Bank regulators set minimum capital
    requirements, typically requiring a bank to hold 5 percent
    capital against on-balance-sheet assets, regardless of how
    risky those assets are, in order to be considered well-
    capitalized. The leverage measure ignores all off-balance-sheet
    assets, although a bank may have significant off-balance-sheet
    exposures.
        Fannie Mae invests only in U.S. residential mortgages,
    which are far less risky than many bank investments like
    consumer debt, commercial real estate, or third-world debt.
    Thus, having a leverage limit for Fannie Mae and Freddie Mac
    that is somewhat lower than the leverage limit for banks makes
    sense if the average risk of Fannie Mae and Freddie Mac's
    assets is lower than the average risk of banks' assets.
    Experience shows that in fact the risks of holding a mortgage
    are a fraction of the risk of other loans. Furthermore, Fannie
    Mae's book of business is more geographically
    diverse than those of most banks, and the company is required
    to obtain mortgage insurance or other credit enhancements
    against higher risk loans.
        This lower risk is reflected in the comparable capital-to-
    loss ratios of Fannie Mae and commercial banks. For the first
    half of 2003, Fannie Mae's ratio of capital to credit losses,
    on an annualized basis, was 357. By comparison, large
    commercial banks had a capital coverage ratio of only 17.7, and
    for the whole banking industry the ratio was 14.5.
        Increasing minimum capital when there is no increase in
    risk raises the cost of funds to housing and undercuts our
    ability to fulfill our mission.

    Q.4. In [Director] Falcon's testimony from the October 23, 2003
    GSE hearing, he described adjusting the minimum capital
    requirement as a ``fail-safe'' mechanism, because the risk-
    based capital standard cannot quantify all of the potential
    risks to the GSE's. Do you believe the current risk-based
    capital does not quantify all of the potential risks to the
    GSE's? Why or why not? What is your response to the notion of
    the need for a ``fail-safe'' mechanism?

    A.4. No capital standard can quantify all the risks a financial
    institution faces. However, the risk-based standards applied to
    Fannie Mae and Freddie Mac are the most comprehensive in the
    industry and come much closer to covering all the risks the
    companies face than the capital standards that are applied to
    banks.\1\ These risks include credit risk, interest-rate risk
    (including prepayment risk), and operations risk.
    ---------------------------------------------------------------------------
        \1\ ``Primary emphasis is placed on a risk-based capital standard
    that reflects risks more accurately than bank and thrift standards by
    directly incorporating interest rate risk and by disaggregating credit
    risk to a much finer degree. The standard for GSE's also explicitly
    sets an acceptable limit for those risks: Survival for a 10-year period
    in an environment with credit losses equal on a national basis to the
    worst actual experience on a regional basis and sustained interest rate
    movements more threatening than any experienced in GSE history. At the
    same time, substantial allowance is made for other, less quantifiable
    risks. The result is a more forward looking standard, less tied to
    current, and sometimes misleading, balance sheet data.'' Federal
    Housing Enterprises Regulatory Reform Act of 1992, Report of the Senate
    Banking Committee, May 15, 1992 at 19 (emphasis added).
    ---------------------------------------------------------------------------

    Credit Risk

        Fannie Mae and Freddie Mac are required to have enough
    capital to survive Depression-era credit conditions that last
    for 10 years. Such conditions over that period of time have
    never been seen in the country at large, at least in modern
    times.
        The coverage of credit risk in bank capital standards is,
    in contrast, less sophisticated--as is admitted by bank
    regulators worldwide. As a result, in a process commonly known
    as Basel II, the international bank capital standard setters
    are in the process of updating capital rules to make them more
    responsive to risk, although this effort will probably take
    several more years to implement.

    Interest Rate Risk

        In the companies' RBC requirement, the draconian and
    prolonged credit shock is coupled with dramatic and sustained
    changes in interest rates. Indeed, an econometric study
    conducted for Fannie Mae by Nobel laureate Joseph Stiglitz and
    colleagues found that ``the probability of the stress test
    conditions occurring is less than one in 500,000.'' \2\
    ---------------------------------------------------------------------------
        \2\ Implications of the New Fannie Mae and Freddie Mac Risk-Based
    Capital Standard, Joseph E. Stiglitz, Jonathan M. Orszag and Peter R.
    Orszag, Fannie Mae Papers, Volume 1, Issue 2, March 2002 at 2. Paper
    available at http://www.fanniemae.com/global/pdf/commentary/
    fmpv1i2.pdf.
    ---------------------------------------------------------------------------
        Banks do not have an interest-rate component in their risk-
    based capital requirements. Interest-rate risk tends to be the
    largest risk in mortgage lending, particularly for a portfolio
    with geographic diversification. The standards applied to
    Fannie Mae cover this risk comprehensively; those for banks do
    not cover it at all.

    Operations Risk

        To some extent, operational risk is the unquantifiable risk
    that is not covered by the credit and interest rate risk
    components of the stress test. In OFHEO's risk-based capital
    requirements, there is a 30 percent add-on to the stress test
    to provide an extra cushion to the capital already required by
    the stress test.
        Currently, banks do not have a requirement covering
    operational risk. Basel II contemplates adding one, but it will
    be lower than that applied to the GSE's. The add-on charge for
    banks is likely to be around 9 percent to 12 percent, roughly
    one-third of that applied to Fannie Mae.\3\
    ---------------------------------------------------------------------------
        \3\ Regulatory Treatment of Operational Risk, Basel Committee,
    September 2001.
    ---------------------------------------------------------------------------
        In addition to the distinctive structure of their risk-
    based capital requirement, the minimum leverage ratio for
    Fannie Mae and Freddie Mac is unique in that it requires
    capital support for off-balance-sheet, as well as on-balance-
    sheet, exposures.\4\ As the Senate Banking Committee reported
    with regard to the minimum capital requirements in the 1992
    Act:
    ---------------------------------------------------------------------------
        \4\ As of June 2003, Fannie Mae's core capital equaled 3.32 percent
    of total balance sheet assets.

        ``[T]he risk-based measure is supplemented by a more
    traditional minimum capital standard, which actually bears more
    in common with the risk-based measures for banks and thrifts,
    in that it explicitly covers the very sizable off-balance-sheet
    risks of the GSE's.'' \5\
    ---------------------------------------------------------------------------
        \5\ Senate Banking Committee, id. (Emphasis added)

        The leverage requirement for banks does not have a similar
    provision. Banks often have large off-balance-sheet exposures,
    and those exposures have been increasing in recent years,
    partly in an effort to avoid the leverage requirement that
    would apply if they were held on balance sheet.
        Additionally, it is appropriate that the leverage ratio for
    banks provides an additional cushion against interest rate and
    prepayment risks since, as outlined above and unlike the Fannie
    Mae stress test, bank risk-based capital requirements do not
    include a component for these risks.
        Thus, to the extent that the minimum capital requirement is
    regarded as a ``fail-safe'' mechanism, Fannie Mae has one that
    is tailored to our operations and consistent with the level of
    risk we manage.
        In order to judge the appropriateness of the mandated
    requirements for the GSE's, they have to be viewed within the
    context of the companies' restrictive charters. Fannie Mae is a
    private company with a single purpose--to promote homeownership
    through secondary market operations in residential mortgages.
    Confined as we are to residential mortgages, Fannie Mae is
    exposed to less credit risk than a typical large complex bank,
    operating in many countries around the world and investing in a
    range of asset classes that carry more risk and are more
    difficult to manage. Were the GSE charters as broad as a
    bank's, Congress would undoubtedly have required Fannie Mae to
    meet the same capital standards as banks.
        It should also be recognized that OFHEO has a panoply of
    supervisory powers to deal with problem situations, from cease-
    and-desist orders, to civil money penalties, limitations on
    dividends, and a requirement to hold additional reserves
    against particular assets. These protections complement the
    capital requirements. And they reflect the practice in the
    banking industry where regulators have the power to set special
    individual capital requirements but rarely use that power,
    preferring to use their other supervisory powers instead.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGEL
                        FROM FRANKLIN D. RAINES

    Q.1. In a format similar to your annual report, please tell us
    what the fair value of Fannie Mae's shareholders' equity would
    have been on a quarterly basis for the last 12 quarters, using
    the definition of fair value that you have been applying in
    your most recent annual reports.

    A.1. At the end of every year, GAAP requires us to provide the
    market value of our financial instruments. We go a step further
    by reporting the market value of all our assets and liabilities
    at the end of each calendar year. The estimated fair value of
    our net assets (net of tax effect) was $22.1 billion as of
    December 31, 2002, $22.7 billion as of December 31, 2001, and
    $20.7 billion as of December 31, 2000. Our fair value as of
    year-end 2003 will be included in our 2003 Form 10-K, which is
    due by March 15, 2004. Like many other large financial
    institutions, we believe this fair value balance sheet is an
    imperfect means to determine our profitability and value as an
    ongoing enterprise. We do not primarily use mark-to-market
    valuation measures to run our business or prepare a full fair
    value balance sheet on a quarterly basis.
        We run our business on the basis of core business results,
    which rely on historical cost accounting. Assets and
    liabilities are booked at their initial value and the cost is
    amortized and the income recognized over time. We believe this
    traditional approach to accounting provides the best
    representation of how our business operates.
        Mark-to-market valuation, on the other hand, takes a
    snapshot of the market value of an asset or liability at a
    specific moment in time. This would be useful for certain
    investors such as hedge funds that trade securities in the
    market every day, because that is how they would determine the
    net value of their business on a given day.
        But for portfolio investors like Fannie Mae, especially
    those that hold assets to maturity, marking to market is not a
    very meaningful way to measure our performance. Indeed, it
    might be misleading for management--and investors--to value our
    performance solely on a mark-to-market basis, for a very
    important reason.
        Mark-to-market accounting produces paper gains and losses
    that a held-to-maturity enterprise may never realize. That is
    why financial regulators generally do not consider these
    noncash, unrealized gains or losses in judging a company's
    financial strength, or in judging whether it meets regulatory
    capital requirements.

    Q.2. With reference to the $16.09 billion of ``cashflow hedging
    results'' losses in your equity account, as reported in your
    quarterly statement, exactly what proportion of those losses
    are either realized, unrecoverable, or not recoupable because
    you have closed out the derivatives at a loss, and paid out the
    loss amount in cash? Are these losses likely to reverse
    themselves as the hedges come to maturity?

    A.2. We provide on a quarterly basis our cashflow hedging
    results according to GAAP requirements. As you may be aware,
    these numbers have become very volatile since the
    implementation of Financial Accounting Standards Number 133
    (FAS 133), Accounting for Derivative Financial Instruments and
    Hedging Activities. The details behind these numbers are not
    publicly disclosed and are confidential and proprietary.
        FAS 133, Accounting for Derivative Financial Instruments
    and Hedging Activities, became effective for Fannie Mae in
    January 2001 and requires companies to record the current
    market value of derivative instruments on their balance sheets.
    Unfortunately, the standard can often result in an incomplete
    or distorted picture of a corporation's financial position.
    This is particularly true for investors who use derivative
    instruments extensively in their interest rate risk management.
        The reason is that FAS 133 requires all derivatives to be
    recorded at their current market value, while other assets and
    liabilities do not obtain the same treatment. Financial
    statements produced under FAS 133 include a mix of treatments--
    some assets and liabilities are reported at their current
    value, while others are reported at historical cost. As a
    result, financial statements under GAAP can give an incomplete
    picture of a company's net worth and overall risk position.

    Q.3. It has been alleged that permitting a regulator to review
    and approve Fannie and Freddie's new activities will stifle
    your innovation. Yet this country's banks are the most
    innovative in the world and they operate under a system in
    which their regulator has this authority. Please explain to us
    how reviewing Fannie and Freddie's new activities would stifle
    your ability to innovate.

    A.3. Under current law, Fannie Mae must submit a new program
    approval request to HUD if an initiative is ``significantly
    different'' from a program that has been previously approved or
    is a program in which Fannie Mae had not engaged prior to
    passage of the 1992 Act. HUD may deny approval of any new
    program if our charter does not permit it or if the Secretary
    determines that the activity is not in the public interest. HUD
    generally has 45 days within which to approve a new program
    request. This short time frame for decisionmaking is crucial to
    timely market innovation.
        Some recent proposals have suggested that a regulator
    should review all of the ``new activities'' of Fannie Mae. In
    H.R. 2575, for
    example, the term ``activities'' is broadly defined to include
    ``any program, activity, business process, or investment that
    directly or indirectly provides financing or other services
    related to conventional mortgages.'' This definition could
    require prior regulatory approval for every change in
    underwriting standards made by Fannie Mae or every transaction
    in which we engage to buy mortgages.
        Banks and other entities regulated by Federal financial
    regulators are not generally subject to prior approval
    requirements for their activities. In the banking context,
    ``activity'' means line of business. The Gramm-Leach-Bliley Act
    contains a list of ``activities'' financial institutions may
    undertake without prior approval, such as insurance, securities
    underwriting, and merchant banking. Particular changes in the
    way in which an institution engages in one of these lines of
    business are also not subject to prior approval. In adopting
    this regulatory structure for banks, Congress has recognized
    that innovation within permitted lines of business benefits
    consumers and the economy as a whole. Financial institution
    regulation is biased against time consuming preapproval
    processes, and instead focuses on prudently imposed limitations
    and safety and soundness principles, compliance with which is
    evaluated by financial institution examiners.
        A comparable regulatory structure, if applied to Fannie
    Mae, would recognize that we have one main business line,
    mortgages, and would require no prior approval for new products
    or processes related to that line of business. The new
    regulator would, like bank regulators, rely on examiners,
    conducting on-site continuous examinations, to review all
    ongoing activities to determine that they are safe and sound
    and within our charter. Under the bank model, if Fannie Mae
    were to go into a broad new line of business, the company would
    be required to seek prior approval from its regulator.
        The mortgage market today provides consumers with a wider
    variety of products than ever before, and therefore is better
    poised to meet the individual financing needs of a broader
    range of homebuyers. This has been possible because the program
    approval
    requirements in the 1992 law respect the need for innovation.
    Lenders have been able to innovate and develop new products to
    reach underserved communities because we have been able to
    review the products and, whenever possible, assure them, in a
    timely manner, that we will purchase these loans in the
    secondary market.
        Imposing intrusive or cumbersome regulatory requirements or
    processes would put the Government--not the private sector--in
    the position of deciding or delaying which products are brought
    to market. This lack of predictability and potential for delay
    would
    inhibit our ability to work with our lender partners to support
    innovation to expand homeownership opportunities. Without that
    secondary market outlet, lenders would have to assume more risk
    and expense in developing innovative mortgage products that are
    vital for reaching new markets.

    Q.4. Your company charges a ``guarantee fee'' for each mortgage
    sold to Fannie. It seems those guarantee fees continue to be
    high while your credit losses shrink. If losses are down, why
    the need for proportionately higher guarantee fees, and how
    much does this ultimately mean out-of-pocket to the individual
    mortgage customer?

    A.4. Fannie Mae's guaranty fee has to cover the full costs of
    guaranteeing mortgages. These costs include:

     Insurance (credit) losses;
     The costs of credit enhancements where Fannie Mae pays
        other parties to share possible losses, thereby dispersing
        risk;
     The administrative costs of running the business; and
     The cost of capital needed to support the business.

        The proportion of the guaranty fee designed to cover
    expected losses is generally not the largest component of that
    fee. Best practice for financial institutions requires that
    they hold economic capital against the risks they face.
    Economic capital is an amount of capital sufficient to prevent
    company insolvency in bad economic times. In the case of Fannie
    Mae's guaranty business, best practice requires holding
    sufficient capital to withstand stressful economic conditions.
    That capital has to earn a competitive return--or it would not
    be attracted in the first place.
        As shown in Exhibit 1, insurance is somewhat unusual in
    that returns above the average occur more often than those
    below the average. (In more formal statistical terms, the
    median is greater than the mean.)
        Typically, in insurance, losses in very bad times tend to
    be greater than profits in good times. (Loss distributions are
    said to have ``fat tails.'') And, in guaranteeing loans as in
    other insurance, it takes many profitable outcomes to cover the
    losses from a single bad outcome (Exhibit 2). Thus, over a long
    period of time, there must be more occurrences of good outcomes
    to counterbalance the fewer, but weightier, bad outcomes.

         And most crucially it means that one cannot look at the
    results from an individual year (or even from a particular
    cohort of business) to judge the adequacy of profits.
    Currently, Fannie Mae's portfolio is very strong from a credit
    perspective, and one should expect very good outcomes and low
    credit losses. Fannie Mae, like other insurers, looks beyond
    expected outcomes, to the unlikely possibility that a severe
    credit event could occur, leading to much higher levels of
    defaults. Holding sufficient capital to withstand such an event
    is a business and regulatory requirement. To do otherwise would
    rightly be regarded as an unsafe and unsound business practice.
    We compete for capital in the broader marketplace, and
    therefore this capital held against a potential credit event
    must earn the return it could have earned on a similarly risky
    investment elsewhere.
        Fannie Mae's 10-K clearly breaks out the different
    components of income and expense to the credit guaranty
    business. In 2002, total pretax guaranty fee income was $3.2
    billion, credit-related expenses were $92 million, and
    administrative expenses were $1.5 billion (including $638
    million in Federal income taxes). The credit-related expenses
    were indeed at record lows, as were delinquency and default
    rates for Fannie Mae.
        These surprisingly low credit expenses cannot be taken for
    granted. Credit expenses are expected to increase. Note that
    administrative expenses, excluding taxes, are almost 10 times
    as large as credit-related expenses. Although Fannie Mae is
    highly efficient (these administrative expenses were incurred
    on a book of business that averaged $1.8 trillion in 2002), the
    charged guarantee fee must be sufficient to cover these
    expenses as well.

    Q.5. The Administration has proposed eliminating Presidential
    appointed members from your Boards and leaving the appointment
    responsibility in the hands of your shareholders. What are your
    thoughts on this?

    A.5. We have seen many benefits from the presence of
    Presidential directors on the board of Fannie Mae. They have
    well represented the interests of the company's shareholders
    and helped advance our mission. Indeed, our board is seen as a
    leadership model of stakeholder representation on corporate
    boards. Our experience has been very good over the years with
    our Presidential directors and our preference would be to
    retain them. Ultimately, this will be an issue for the Congress
    and Administration to decide.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER
                        FROM FRANKLIN D. RAINES

    Q.1. Do you want to be under Treasury or do you want a beefed
    up independent regulator? If you were put into Treasury do you
    want [Fannie Mae/Freddie Mac and the FHLBank System] to be
    together under one bureau or do you prefer two separate bureaus
    and why?

    A.1. Fannie Mae supports legislation to create a new safety and
    soundness regulator for Fannie Mae and Freddie Mac as a bureau
    of the Treasury Department, funded independently of the
    appropriations process.
        While recent events raise fresh questions about FHLBank
    regulation, it is also true that including the FHLBank System
    in regulatory reform legislation would complicate the
    legislative process. At a minimum, there are many questions
    Congress would have to answer before incorporating the Banks
    into any new regulatory structure. For instance, the Congress
    would have to decide whether to focus the Bank System on its
    traditional mission of providing advances or to endorse the
    Banks' recent ventures into acquiring mortgages. There are
    questions as to whether the current FHLB regulatory structure
    is consistent with the new lines of business the Banks are
    undertaking.
        However, if Congress decides to include the FHLBanks in a
    reform proposal, we believe that Fannie Mae, Freddie Mac, and
    the Bank System should be placed under the umbrella of a single
    regulator, and that the FHLBanks mortgage acquisition
    activities should be subject to the same set of safety and
    soundness regulations that apply to Fannie Mae and Freddie Mac.
    Such a regime would best be served by a single bureau that
    could institute comparable regulatory requirements for
    comparable activities.

    Q.2. In your view, what is the difference between new program
    and new activity standards?

    A.2. Under the Federal Housing Enterprises Financial Safety and
    Soundness Act of 1992, the standard for HUD prior approval of
    ``new programs'' is simple: The current law says the Secretary
    must disapprove a ``new program'' if it does not comply with
    our charter or is not in the public interest. The 1992 Act also
    established time limits for consideration of new program
    requests by the Secretary. A ``new program'' is generally
    defined by the 1992 Act as a broad and general plan or course
    of action for purchasing or dealing in mortgages that is
    significantly different from programs previously approved by
    HUD or engaged in prior to enactment of the 1992 Act.
        Secretary Snow described the concept of a ``new program''
    very well in his recent testimony before the Senate: New
    programs are akin to ``new lines of business.''
        Some proposals have suggested that a regulator should
    review all of the ``new activities'' of Fannie Mae. In H.R.
    2575, for example, the term ``activities'' is broadly defined
    to include ``any program, activity, business process, or
    investment that directly or indirectly provides financing or
    other services related to conventional mortgages.'' This
    definition is so broad that it could encompass every change in
    underwriting standards made by Fannie Mae or every transaction
    in which we buy mortgages.
        Bank regulators do not mandate prior approval for
    ``activities'' in the manner some have suggested would be
    appropriate for Fannie Mae's ``activities.'' In the banking
    context, the term ``activities'' is used to mean ``lines of
    business.'' The Gramm-Leach-Bliley Act contains a list of
    preapproved ``activities'' financial institutions may
    undertake. The ``activities'' listed in the statute are broad
    lines of business, including insurance business, securities
    underwriting business, and merchant banking business.
        Any proposal requiring prior notice for Fannie Mae's
    ``activities,'' as defined in H.R. 2575, clearly has no
    parallel in current banking law.

                            PROPOSALS FOR IMPROVING
                        THE REGULATION OF THE HOUSING
                        GOVERNMENT SPONSORED ENTERPRISES

                                  ----------

                           THURSDAY, OCTOBER 23, 2003

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:06 a.m., in room SD-538, Dirksen
    Senate Office Building, Senator Richard C. Shelby (Chairman of
    the Committee) presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The hearing will come to order.
        This morning the Committee meets to hold our second hearing
    on proposals to improve the regulation of Government Sponsored
    Enterprises. During our hearing last week, we heard from the
    Administration and the Government Sponsored Enterprises. Today,
    we will hear from a variety of viewpoints, including the
    current regulators.
        These hearings will provide the Committee with a thorough
    debate of the critical issues that must be resolved in order to
    establish a strong and credible regulator for the Government
    Sponsored Enterprises. It is my view that any new regulator
    must oversee the Federal Home Loan Bank System as well as
    Fannie Mae and Freddie Mac. Comprehensive regulatory reform of
    this nature deserves careful consideration, and this Committee
    will work diligently to craft an appropriate reform package.
    Whether we can do so this fall is not clear, but I will
    certainly make this a continued priority as the Chairman.
        For our first panel today, we welcome three witnesses: Mr.
    John Korsmo, Chairman of the Federal Housing Finance Board; Mr.
    Armando Falcon, Director of the Office of Federal Housing
    Enterprise Oversight; and Mr. Douglas Holtz-Eakin, Director of
    the Congressional Budget Office.
        Our second panel will include five witnesses: Mr. John D.
    Koch, Executive Vice President and Chief Lending Officer,
    Charter One Bank of Cleveland, Ohio, testifying on behalf of
    America's Community Bankers; Mr. Dale Torpey, President and CEO
    of Federation Bank of Washington, Iowa, testifying on behalf of
    the Independent Community Bankers of America; Mr. Allen
    Fishbein, Director of Housing and Credit Policy for the
    Consumer Federation of America; and Mr. Robert Couch, Chairman
    of the Mortgage Bankers Association; and Ms. Iona Harrison,
    Chairman of the Public Policy Committee of the National
    Association of REALTORS'.
        I want to thank all of the witnesses for appearing before
    the Committee today.
        Senator Sarbanes.

                 STATEMENT OF SENATOR PAUL S. SARBANES

        Senator Sarbanes. Thank you very much, Mr. Chairman, for
    convening this important hearing. As you said, this is the
    second opportunity for the Committee to consider the question
    of how to effectively regulate the GSE's--Fannie Mae, Freddie
    Mac, and the Federal Home Loan Banks.
        Understanding and improving the supervision of the GSE's
    involves many complex and challenging issues. I think our
    hearing last week made that clear. Testimony from two Cabinet
    Secretaries and representatives of the regulated entities I
    think made valuable contributions to our deliberations. But I
    believe it is fair to say that there are a number of questions
    still to be examined. I look forward to further consideration
    of those issues today.
        Of course, the GSE's do not make the mortgage market
    function by themselves. They work in partnership with a network
    of lenders and realtors who are integral to the smooth running
    of our housing finance system. We will hear today from several
    representatives of these industries who interact daily with the
    GSE's. I look forward to hearing their perspectives, indeed the
    perspectives of all of our witnesses today, as we examine this
    question of effective supervision of these entities.
        Mr. Chairman, I want to commend you for putting together
    hearings with a variety of interested parties on this important
    issue so that we really get the benefit of a wide range of
    points of view.
        Finally, as I did last week, I want to underscore the
    importance of acceding to the Administration's request for an
    additional $7.5 million for OFHEO to conduct reviews of
    accounting practices at the enterprises it regulates. I very
    much hope that will be included in the funding for fiscal year
    2004. It is an Administration request, and I very much hope
    that Congress will deliver on it.
        While we deliberate on creating a new, more effective
    regulatory structure, we obviously need to be sure that the
    current regulator is adequately funded.
        Thank you very much.
        Chairman Shelby. Senator Bunning.

                    STATEMENT OF SENATOR JIM BUNNING

        Senator Bunning. Thank you, Mr. Chairman, for holding this
    very important meeting and hearing. I would like to thank all
    of our witnesses that are going to testify for their testimony.
        Last week, we heard from two Cabinet Secretaries as well as
    representatives from Fannie Mae, Freddie Mac, and the Federal
    Home Loan Banks. Now we will hear from the Federal Housing
    Finance Board, the CEO of OFHEO, and the representatives from
    the banking industry, the realtors, and the consumer groups. I
    applaud the Chairman for bringing so many who could be affected
    by the GSE legislation before the Committee.
        We all agree that Fannie and Freddie need a new regulator.
    Even Fannie and Freddie agree to that. But that was the easy
    part. Now we have to figure out how to do it. If we do not do
    it right, we are simply rearranging the deck chairs on the
    Titanic. It will sink. We all agree that we must not do
    anything in this bill that could harm our housing markets, and
    I warn those that are in positions of authority in the Treasury
    to watch what they say. As of yesterday, one of them popped his
    mouth off, and the market went completely haywire in the
    interest rates.
        We all agree we must worry about unintended consequences. I
    do want to reiterate a concern I voiced last week at the
    hearing we had. I had a number of small community banks in
    Kentucky, contact me about their concerns about this effort. We
    only have small banks in Kentucky, and they are scared to
    death. My small banks are worried that they will not be able to
    use the same GSE products they use today. They are worried
    about the products they use to stay in compliance with their
    CRA obligations, and they will not have them available if we do
    something to change the regulator.
        I would like to make sure my little banks are not harmed. I
    would like to hear from all of our witnesses on if they feel
    this concern is a valid concern.
        I would also like to hear from our witnesses on whether or
    not they feel the Federal Home Loan Bank should stay with their
    existing regulator or should be moved to a new regulator and
    why, because I do not agree with the Chairman on this, and I
    would like to hear from our witnesses. I will look forward to
    broaching this with our witnesses and in the question and
    answer period.
        Once again, I thank all of our witnesses for testifying,
    and we thank the Chairman for holding the hearing.
        Chairman Shelby. Senator Johnson.

                    STATEMENT OF SENATOR TIM JOHNSON

        Senator Johnson. Thank you, Mr. Chairman, for calling
    today's hearing to discuss the regulatory framework for housing
    GSE's, and I welcome the members of our panels today.
        It is critical that we move forward with regulatory
    restructuring, and today will give us an opportunity to get the
    current GSE regulators' take on what tools will be useful in
    strengthening oversight. But even more important, we will hear
    from those who work together with the GSE's to make affordable
    housing a reality for millions of Americans.
        Mr. Chairman, I have to admit that my patience has worn
    thin with Treasury at the moment. A statement yesterday from
    our Assistant Secretary of Financial Institutions, Mr.
    Abernathy, making veiled threats about what might happen to the
    GSE $2.5 billion line of credit with the Treasury if they do
    not get their way relative to a proposed safety and soundness
    regulator under the Treasury having the authority to approve
    new products and very low firewalls between the Agency and the
    Treasury Secretary and the politics of the Treasury Department
    are very distressing to me and should be distressing to anyone
    concerned about affordable housing for American families.
        I am disappointed at what appears to be a decreasing
    momentum for regulatory reform. Clearly, there is a significant
    agreement about the need for strengthened regulatory oversight,
    and yet at last week's hearing, Secretary Snow put forward a
    proposal that I think raised as many questions as it answered.
        It is essential, I believe, that any new GSE regulator, if
    housed in Treasury, be independent in the same way or in
    similar ways as the OCC and the OTS. I have signed a letter
    with some of my Committee colleagues supporting the idea that
    the GSE regulator may well be moved to Treasury, and yet I am
    disappointed that the Administration seems to want to retreat
    from the conventional wisdom that it is good policy to remove
    the financial regulators from political forces.
        The whole point of this exercise is to create a credible
    regulator. Why would we want to do it in a way that increases
    its vulnerability to political whims, regardless of which party
    is in the White House?
        We need to look at safety and soundness implications for
    allowing a regulator to set minimum capital requirements as
    well as the effects such a change in capital would have on the
    affordable housing mission of the GSE's. In addition,
    thoughtful deliberations must take place on how new products
    and activities should be addressed in any legislation to alter
    the regulation of GSE's. I share the concern that my colleague
    from Kentucky has expressed about the regulatory oversight
    structure of the Federal Home Loan Banks, and I think we need
    to approach that with great care as we progress on this issue.
        And yet, at the same time that we look at changes in the
    regulatory structure, we have to take great care not to upset a
    system of housing finance that has allowed successfully
    millions of middle-income Americans to realize the dream of
    homeownership. There is a ``First, do no harm'' criteria here,
    I believe, that we need to address. In so many ways, the
    housing GSE's have helped to create a system that has
    strengthened our communities and broadened the reach of
    homeownership. That should continue to be our top priority, and
    I look forward to working with my colleagues in a bipartisan
    fashion on this Committee to that end.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Hagel.

                    STATEMENT OF SENATOR CHUCK HAGEL

        Senator Hagel. Mr. Chairman, thank you. I want to add my
    welcome to our guests this morning, and I appreciate very much
    their testimony and an opportunity to exchange thoughts about a
    rather vital issue for the future of our housing market.
    Really, it is attached to and part of a significant dynamic of
    our economy, which you all understand, and we appreciate that.
        Mr. Chairman, I also appreciate your continued focus on
    this issue, with this a hearing coming back to back with last
    week's hearing. And I would hope that this Committee will be in
    a position to actually finalize something soon, and I know the
    Chairman's commitment to that. There is little question, as my
    colleague from Kentucky noted, as to a requirement to reform
    what you are doing every day so that there is a new sense of
    confidence in the market as we move forward into this new
    century.
        Thank you.
        I might, as a matter of personal privilege, Mr. Chairman,
    acknowledge that our distinguished colleague from Kentucky's
    birthday is today.
        [Laughter.]
        It is worthy of note because there is a new serenity about
    him, a new peacefulness.
        [Laughter.]
        He is more docile than I have ever seen him, and I
    attribute it all to a wiser, more mature U.S. Senator on his
    birthday. Happy birthday, Senator Bunning.
        Mr. Chairman, thank you.
        Chairman Shelby. Thank you, Senator Hagel. You noticed
    something we have not noticed about the Senator.
        [Laughter.]
        Chairman Shelby. Senator Reed.

                     STATEMENT OF SENATOR JACK REED

        Senator Reed. Thank you very much, Mr. Chairman. And Happy
    Birthday. I cannot say anything else to begin.
        Let me also say, Mr. Chairman, how much I appreciate these
    hearings. You have assembled an array of witnesses that will
    provide valuable insights to the Committee as we go forward,
    and thank you for that. I think it is good that we have the
    regulators here who can offer very specific recommendations
    based upon real experience over several years, and I think that
    is very valuable.
        There are several issues, obviously, that I think we should
    touch upon: Whether the Housing Finance Board and OFHEO should
    be merged together in some new constellation of regulators;
    whether the GSE's' regulator should have the ability to set
    minimum capital standards--that is an issue that repeatedly
    comes up before us and amongst us; how we can best ensure that
    Fannie Mae and Freddie Mac and the 12 Federal Home Loan Banks
    are expanding affordable housing opportunities for low-income
    families. We talk a lot about the housing sector here. It is a
    very vital part of our economy, but, frankly, we are not doing
    enough to produce low-income homes in this country, and that is
    something that these Government enterprises should be at the
    forefront of trying to do. I know they have a mission and they
    are doing it, but I think we can do more.
        Then, of course, the overarching question, the impact of
    any changes we make on the housing finance industry, as alluded
    to by Senator Bunning and others, that has to be foremost in
    our considerations.
        Again, thank you, Mr. Chairman, for scheduling these
    hearings, and I appreciate your interest in this very important
    topic.
        Thank you.
        Chairman Shelby. Thank you, Senator Reed.
        Senator Bennett.

                 STATEMENT OF SENATOR ROBERT F. BENNETT

        Senator Bennett. Thank you, Mr. Chairman. I simply join in
    thanking you for holding these hearings. They are very useful
    and informative. We are learning a great deal, and I am willing
    to get on with it.
        Thank you.
        Chairman Shelby. Gentlemen, your written testimony will be
    made part of the record in its entirety. We will start with Mr.
    Korsmo, and you proceed as you wish.

                      STATEMENT OF JOHN T. KORSMO

                CHAIRMAN, FEDERAL HOUSING FINANCE BOARD

        Mr. Korsmo. Good morning, and thank you, Mr. Chairman,
    Ranking Member Sarbanes, and distinguished Members of the
    Committee.
        In December 2001, this Committee and the Senate honored me
    with confirmation to membership on the Federal Housing Finance
    Board, and President Bush entrusted me with the Board's
    chairmanship. During my confirmation hearing, both Senator
    Sarbanes and former Senator Gramm impressed on me--indelibly--
    their concern over the Finance Board's inadequate performance.
        In response, I committed myself to leading the Agency to
    fulfill the intent of Congress in FIRREA in 1989 and the Gramm-
    Leach-Bliley a decade later, that is, to create a credible
    arm's-length regulator for the Federal Home Loan Banks. I
    testify today not as an apologist for the Federal Home Loan
    Banks and certainly not as a partisan for the Finance Board
    but, rather, as a safety and soundness regulator who takes his
    oath of office and his promise to this Committee very
    seriously.
        In that spirit, I offer my experience at the Finance Board
    as you seek to establish policy for the supervision of the
    Nation's 14 housing-related Government Sponsored Enterprises.
        The Federal Home Loan Bank Act grants the Finance Board the
    authority, the independence, and the executive branch voice
    that I believe are needed for robust supervision of Government
    sponsored public trusts.
        Of course, not only are regulatory tools necessary, but
    also the willingness to use those tools. At this Committee's
    oversight hearing on September 9, I discussed the aggressive
    and disciplined agenda of improvement my colleagues and I have
    undertaken at the Finance Board. Today, in the interest of
    time, let me cite my earlier testimony and give you just a
    brief update on activities since that oversight hearing.
        Our Office of Supervision is continuing its enhancement of
    bank supervision and oversight and its expansion of critical
    staff. The Finance Board now has more than double the number of
    examiners on staff when I took the oath of office in December
    2001. This core of 18 staff examiners will expand to 30 by this
    time next year, and it is supplemented by additional financial
    analysts, accountants, and risk management and mortgage
    specialists. My prepared testimony includes a chart that
    summarizes the examiners' accreditations and experience, and I
    think you will find them impressive.
        Effective oversight of GSE's also requires full
    transparency of the regulated entities. The day following this
    Committee's oversight hearing, the Finance Board unanimously
    adopted a proposed rule to require each of the Federal Home
    Loan Banks to comply with the periodic financial reporting
    provisions of the Securities Exchange Act of 1934. I regard SEC
    registration as critical to improving corporate and financial
    transparency, a factor of significant value to both Federal
    Home Loan Bank members and investors in Federal Home Loan Bank
    debt.
        I believe the Finance Board has dramatically improved the
    job it does of ensuring the safety and soundness and housing
    mission compliance of the Federal Home Loan Banks. As I come
    before you today, I know of no immediate or imminent safety and
    soundness or liquidity imperative forcing us to do the job of
    recasting supervision of the housing GSE's any way but the
    right way--with a strong, independent regulator. We are all
    aware the stakes are high if gains made are diluted or lost in
    the course of attaining the worthy goals of GSE reform. These
    high stakes suggest to me the value of undertaking a complete
    review of all housing GSE's, their charters and missions, and
    their role in the capital and mortgage markets, not just for
    today but also for the future. Development by policymakers of a
    coherent national agenda clearly outlining Government and
    private housing finance roles and informed policy to ensure
    another seven decades of stability, growth, and innovation in
    housing finance will guarantee all parties to the debate are
    fully equipped to design a world-class supervisor able to
    evolve along with the housing GSE's and the markets of
    tomorrow.
        A review of housing GSE charters and principles would not
    preclude, of course, immediate action with respect to OFHEO.
    OFHEO's mission could well benefit from budget independence and
    the granting of the full powers in use by other banking
    supervisors, including the Finance Board, under the Federal
    Home Loan Bank Act. I understand as well that Congress may
    decide to establish an enhanced regulatory structure for Fannie
    Mae and Freddie Mac that includes the Federal Home Loan Banks.
    If so, I would urge this Committee, of course, to equip the new
    regulator with the principles of strength and independence
    proven by the Federal Reserve, FDIC, OCC, and OTS, augmented by
    the proven housing GSE supervision features already in practice
    at the Finance Board.
        But your effort must also focus on the very real
    differences--differences of charter, differences of ownership,
    differences of capital structure--that exist between the
    Federal Home Loan Banks on the one hand and Fannie Mae and
    Freddie Mac on the other and anticipate adoption of reasonable
    methods to accommodate those differences. This is no small
    task, and I respectfully ask you to proceed carefully.
        As a matter of housing GSE policy, Congress and the
    Administration may also wish to safeguard in a consolidated
    regulator the potential for Federal Home Loan Banks to offer to
    their members products and services in competition with other
    housing GSE's to lower costs and increase choices for
    homebuyers.
        Thank you, Mr. Chairman and Members of the Committee, for
    the opportunity to appear before you this morning. I am pleased
    to respond to any questions.
        Chairman Shelby. Mr. Falcon.

                    STATEMENT OF ARMANDO FALCON, JR.

                          DIRECTOR, OFFICE OF

                  FEDERAL HOUSING ENTERPRISE OVERSIGHT

        Mr. Falcon. Chairman Shelby, Ranking Member Sarbanes, and
    Members of the Committee, thank you for inviting me to appear
    before you today. I am pleased to provide my views on
    improvements that can and should be made to the regulatory
    oversight of Fannie Mae and Freddie Mac. My views are my own
    and are not necessarily those of the President or the Secretary
    of Housing and Urban Development.
        When I took office as Director of OFHEO in October 1999, I
    quickly realized that the Agency's long-term success was
    jeopardized by inadequate resources, a constraining funding
    mechanism, and a lack of powers equal to those of other
    regulators. And so over the past 4 years, I have been a
    consistent advocate of legislation designed to address those
    shortcomings, and so I was encouraged by the Administration's
    comprehensive proposal. I am in general agreement with it, but
    I do have a few concerns that I hope can be properly addressed.
        I would like to outline my views in the context of five
    guiding principles. They are: First, the regulator should
    remain independent; second, the regulator should be permanently
    funded, outside the appropriations process; three, the
    regulator should have powers equal to those of other safety and
    soundness regulators; four, the regulator should have full
    discretion in setting capital standards; and, five, legislation
    should build on progress made.
        Adherence to each of these principles will strengthen
    supervision and the safe and sound operation of the
    Enterprises. Our ultimate goal and benchmark should be to
    establish a new regulator that is on an equal plane with the
    OCC and the OTS, both of which operate as independent safety
    and soundness regulators within the Treasury Department. I
    would like to elaborate on the five principles.
        First, the regulator should remain independent. The concept
    of an independent Federal agency to oversee Fannie Mae and
    Freddie Mac was established in the legislative history of the
    1992 Act that created OFHEO. The need for regulatory
    independence was born out of Congress' experience with the
    savings and loan crisis. I had the privilege of serving as
    counsel to the House Banking Committee for 8 years during that
    difficult period. One of the clear lessons learned was that all
    safety and soundness regulators should be objective,
    nonpartisan, and protected from political interference. This is
    especially critical at times when regulators must make
    difficult and sometimes politically unpopular decisions. In
    addition, independent regulation protects Congress' ability to
    receive the regulator's best judgment on regulatory matters
    unfiltered and without delay. With billions of dollars of
    potential taxpayer liability at stake, it is in everyone's
    interest that this important safeguard not be weakened.
        Second, the regulator should be permanently funded, outside
    the appropriations process. Currently, OFHEO is funded annually
    through the Federal budget and appropriations process, even
    though the Agency does not utilize any taxpayer funds. OFHEO is
    funded through assessments on the Enterprises, but those
    assessments cannot occur until approved by an appropriations
    bill and at a level set by the appropriations act. OFHEO is the
    only safety and soundness regulator funded in this limited
    manner. At a minimum, this serious anomaly should be fixed.
        Third, the regulator should have powers equal to those of
    other regulators. While OFHEO's regulatory powers are fairly
    comparable to those of other financial safety and soundness
    regulators, certain authorities need to be provided and others
    clarified. For example, a safety and soundness regulator should
    have independent litigation authority, enhanced hiring
    authority, and a full range of enforcement powers provided to
    financial regulators. Also, the laws should be revised to
    provide clearly that the regulator is empowered to address
    misconduct by institution-affiliated parties and to exercise
    general supervisory authorities.
        Fourth, the regulator should have full discretion in
    setting capital standards. Capital is one of the fundamental
    bulwarks of effective safety and soundness regulation. The
    regulator should have broad discretion to exercise his or her
    best judgment, using all the information available through the
    examination process and otherwise, to determine if capital
    adjustments are necessary. All other safety and soundness
    regulators have this discretion.
        Going forward, the Agency needs to have the authority to
    modify both minimum and risk-based capital standards. This
    authority would help meet the changing mix of enterprise
    business, the market environment in which they operate, and the
    changing nature of risk measurements themselves.
        Fifth, legislation should build on progress we have made
    over the last 10 years. Regulating Fannie Mae and Freddie Mac
    requires a specialized skill set. The capacity to model the
    cashflows of all the mortgages, debt, and other financial
    instrument of the Enterprises needed for the stress test is
    unique among financial institution regulators.
        Over the past 10 years, OFHEO has developed the specialized
    expertise, from our examiners and financial analysts, to our
    researchers and capital analysts, and that is necessary to
    supervise those two unique companies. The cost in terms of lost
    regulatory capacity spent while trying to rebuild that
    infrastructure would be substantial. That is why I recommend
    that, if a new regulator is established, OFHEO's personnel,
    regulations, and administrative infrastructure should be
    transferred intact to the new agency. I believe it would be
    highly counterproductive to do otherwise.
        There are a couple of other matters I would like to briefly
    discuss. First, I agree with Secretary Snow that the
    Presidentially
    appointed board members should be discontinued. This is not a
    reflection of current or former Presidentially appointed
    directors. Rather, I think corporate governance would be
    enhanced if the shareholders were allowed to select all members
    of the board.
        Also, I support the granting of authority to the safety and
    soundness regulator to determine whether the activities of the
    Enterprises are consistent with their charters. This would mean
    that a single regulator would have the ability to review all of
    the Enterprises' activities--new and existing. This change will
    consolidate the supervision of the enterprises in a manner
    consistent with the authorities of other regulators.
        In conclusion, let me raise two other points. I would be
    remiss in not noting my appreciation for the interest and
    support of the Members of the Committee, as expressed by
    Senator Sarbanes, with respect to the Administration's request
    for an additional $7.5 million for the Agency to conduct its
    business. I would urge the Committee to help us get those
    additional funds, and they would be much needed.
        Second, with regard to our ongoing investigation of Freddie
    Mac, I would like to inform the Committee of a recent
    development. Last night, OFHEO entered into a consent order
    with Mr. David Glenn, the former Vice Chairman, President, and
    Chief Operating Officer of Freddie Mac. Mr. Glenn now loses
    some $13 million in benefits, and under the order Mr. Glenn
    will cooperate fully with OFHEO, pay a civil money penalty of
    $125,000, and be barred from working for the Enterprises, even
    on a consultant basis. This is a significant development, and
    as you would expect, we will proceed deliberately and carefully
    in building a complete record of what has transpired. In
    addition, we will continue to take any appropriate regulatory
    action necessary to hold individuals accountable and bring this
    event to a proper resolution.
        I look forward to working with the Committee on the
    legislative developments, and I would be happy to answer any
    questions you may have.
        Senator Bennett. [Presiding.] Thank you.
        Dr. Holtz-Eakins.

                    STATEMENT OF DOUGLAS HOLTZ-EAKIN

                 DIRECTOR, CONGRESSIONAL BUDGET OFFICE

        Mr. Holtz-Eakin. Thank you very much, Senator Bennett,
    Senator Sarbanes, Members of the Committee. Thank you for the
    chance to be here today.
        Over nearly two decades and in what amounts to nearly 15
    studies and testimonies, under the direction of Congress the
    Congressional Budget Office has looked closely at the housing
    GSE's and GSE's more generally. And as Congress contemplates a
    restructuring of the oversight and regulation of those GSE's, I
    thought it would be useful to frame the discussion in the
    context of the broad findings of that body of research. What
    emerges from those studies are really three major points.
        First, the sponsored status of the GSE's provides an
    implied guarantee which bestows upon them substantial benefits;
    second, these substantial benefits at the same time expose
    taxpayers to a risk that they will be forced to pick up the
    losses from the failure of a GSE in excess of those that can be
    accommated by private capital and, finally, an effective
    regulator can help to manage these risks, but not entirely
    eliminate them. These findings may be helpful to the Congress
    in thinking about the design of a new regulator.
        Let me talk about each of these points in turn.
        The benefit bestowed upon GSE's is that, compared to a
    fully private sector enterprise that has equivalent capital and
    takes equivalent risks, a GSE can both borrow more and borrow
    at a lower rate than this comparison firm. How can it do this?
    Well, the implied guarantee stems from the existence of several
    features of its setup: the line of credit at the Treasury, the
    exemption from SEC registration and disclosure requirements,
    the exemption from State and local taxes, the fact that some
    members of the board of directors are appointed by the
    President, and that Federally insured banks can hold larger
    amounts of GSE's' securities than private securities. These are
    sufficient in the eyes of market participants to overwhelm the
    explicit denial of such a guarantee by the GSE's.
        In 2001, the Congressional Budget Office estimated that the
    implied subsidy to the housing GSE's during the period 1998 to
    2000 was on the order of $10 to $15 billion per year, and if we
    were to update that today, we would guess that the current
    subsidy would be at the higher end of that range.
        This subsidy exists despite the fact that with the
    evolution of private capital markets and the maturation of
    mortgage finance in general, it no longer appears necessary for
    GSE's to be present in the market in order to generate a
    reliable flow of money to the housing sector.
        Nevertheless, the presence of this subsidy does place the
    taxpayer at risk. The implied guarantee means that taxpayers
    may be forced to assume risks for losses above the GSE's
    capital holdings. These risks emerge from various sources. The
    GSE's face credit risk from the default on mortgages, interest
    rate risks from changes in long-term rates, prepayment risks
    from the decisions of private borrowers, and operations risks
    in the conduct of any hedges against the previous risks,
    including the possibility of counterparty default in their
    derivative operations.
        The fact that a small credit risk may be present in GSE
    operations should not change the overall focus on the risk
    faced from the composite of these different sources, and indeed
    the ability to assess the overall risk facing a GSE is one of
    the paramount features of thinking about a new regulator.
        It is true that the presence of private capital in the
    GSE's provides some inherent incentives for monitoring and risk
    management, and the GSE's undertake great efforts, in fact, to
    manage their risks from prepayment and interest rate. However,
    this risk cannot be eliminated due to the private market
    incentives alone. As a result, it is useful to keep it within
    bounds so that the taxpayer does not face risks that are
    undesirable, and that there be a transparent statement of risks
    so that regulators, taxpayers, and Congress may be able to
    assess the risks that they face.
        Importantly, there is an extent to which shareholders will
    want to undertake more risk. If one looks at the record from
    1990 to 2000, the GSE's' average return on their equity of
    about 23 percent compared to 14 percent for similar private-
    sector financial entities. The source of this increased rate of
    return is the fact that they held lower capital, less than half
    of the capital held by comparable private sector entities. This
    ability to get a higher return stems directly from the ability
    to exploit higher risk with that lower capital. The low
    capital, of course, places the taxpayer in the position of
    dealing with the consequences should there be some financial
    distress at a GSE, and in turn would place Congress in the very
    difficult position of deciding either to walk away from a GSE
    or to face the consequences of a financial shock of unknown
    magnitude.
        With that background, the design of any enhanced regulatory
    agency should have many objectives, and these should include
    the ability to limit taxpayer risk and the overall subsidy to
    GSE's. GSE's, Fannie and Freddie, in particular, have the
    ability to either hold directly mortgages which they purchase
    or to sell off mortgage-based securities. In holding mortgages,
    they undertake to incur the entire interest, prepayment, and
    operations risks. In selling off the mortgage-backed
    securities, they retain only the credit risk.
        In this way, their business model allows them to determine
    the degree to which the taxpayer is exposed to risk, and for
    that reason, the regulator should have the power to limit the
    risk that the GSE's undertake in order to protect the
    taxpayer's interest.
        Given the complex activities used to hedge against
    prepayment and interest rate risk, the regulator must have the
    ability to assess the quality of those hedges and the overall
    exposure to risk. The regulator must be able to prevent, in the
    worst case, a failed GSE from continuing to exploit such a
    subsidy by taking on more risk in an effort to return to
    solvency.
        In addition, it would be useful for the new regulator to be
    able to leverage the Public Company Accounting Oversight Board
    and the most obvious way to do that would be to give the
    regulator the ability to adjust the capital requirements of the
    GSE's in order to place the broad oversight of private capital
    markets on the side of the regulator. And to make that easier
    for the private sector, it would be useful to increase the
    public disclosure of oversight findings and the transparency of
    the GSE's in general.
        In closing, I would point out that Congress can support
    such a regulator in a variety of ways, not the least of which
    would be by setting boundaries for capital requirements that
    support the regulator's need to provide some insurance against
    the taxpayers facing unwanted risks and by forcing greater
    disclosure and registration requirements as a part of the
    ongoing oversight of the operations of the GSE's.
        I thank you for the opportunity to be here today and look
    forward to answering your questions.
        Senator Bennett. Thank you very much.
        Senator Bunning, you were the first Member of the majority
    here, let's start with you.
        Senator Bunning. A question for Chairman Korsmo. What issue
    would arise if all three GSE's were consolidated under one
    regulator? I know in your testimony you gave some examples, but
    do you foresee any others?
        Mr. Korsmo. I do not think it is possible, Senator, really
    to overstate the importance of recognizing the differences in
    the way that Fannie Mae and Freddie Mac and the Federal Home
    Loan Banks are structured and what constitutes their
    membership, their capital structure, and how they do business.
    The cooperative nature of the 12 Federal Home Loan Banks I
    think is significant. It was you, Senator Bunning, who cited
    the small banks in your State. I am from North Dakota. The 70
    members of the Federal Home Loan Bank of Des Moines from my
    State are extremely dependent on the liquidity options that
    membership in the Federal Home Loan Banks affords them.
        I think that important mission, as I say, has to be
    recognized and protected. I also think it is incumbent upon
    policymakers as they look at the possibility of combining
    regulation to recognize the importance of the competition that
    exists on a minimal level, but potentially at a larger level,
    between the Federal Home Loan Banks and Fannie and Freddie. I
    think the fact that the acquired member assets programs, which
    are really another methodology of providing housing finance
    liquidity to member banks, the growth of those programs is
    indicative of the need for another outlet, another service, if
    you will, to be provided, particularly to community lenders,
    but lenders of all sizes who are members of the system, another
    outlet for liquidity sources for mortgage financing that is
    afforded by their membership in the banks.
        I think also we want to take a very careful look at the
    affordable housing programs and measure the affordable housing
    programs at the Federal Home Loan Banks against the affordable
    housing goals that are now relevant for Fannie and Freddie.
    There are arguments in favor of both, but I think the success
    of the affordable housing programs, the importance that any
    number of Members of Congress have cited, the importance that
    those programs play in providing another source of affordable
    housing funding I think are significant. And so any review, I
    would hope, that would look at consolidation would take that
    into play.
        And, finally, of course, the whole question of the
    operation of the Office of Finance. The Office of Finance, of
    course, is the vehicle through which the Federal Home Loan
    Banks issue debt in the debt markets. It is an odd creature. It
    is not incorporated. It does not have a balance sheet. It has
    no management responsibilities. It is, if you will, a joint
    venture of the 12 Federal Home Loan Banks, and I think how that
    would function under a combined regulator needs to be looked at
    carefully.
        Senator Bunning. You almost took up my entire 5 minutes
    with one answer.
        Mr. Korsmo. Sorry, Senator.
        Senator Bunning. The last hearing that we had with
    Secretary Snow and Secretary Martinez, the need for financial
    experts to staff a new regulator for Freddie and Fannie, with
    the recent discoveries of losses at the banks in New York and
    Atlanta, there is a concern that the Finance Board may not have
    the resources to effectively regulate the Federal Home Loan
    Bank System.
        How do you respond to those concerns?
        Mr. Korsmo. I think certainly 18 months ago those concerns
    were legitimate, and I do not want to downplay what has
    occurred at both New York and Atlanta, although I will say that
    the Atlanta loss is an accounting loss, reflective of the
    vagaries of FAS 133. That is not to say that it is not
    significant.
        I will say that it has been an important process for us to
    set up a process to attract the kind of talent that is
    necessary, and I would suggest that we have made dramatic
    improvement in that regard over the last 18 months. And I think
    it goes beyond the question of adding examiners, for example.
        We have nine Ph.D.s in economics and finance on our staff
    who----
        Senator Bunning. And all of them have a different opinion.
        Mr. Korsmo. Who are involved in the process of establishing
    risk-monitoring procedures and risk-modeling procedures. They
    are the ones that--supervision, I should say, is more than just
    examination. Part of what we have accomplished is we have
    actually built a supervision function at the Federal Housing
    Finance Board that really did not exist until 2 years ago.
        And so I think we are making significant progress. Do we
    have a long way to go? I think the answer to that is yes, but I
    would hate to see any change in structure at this point lose
    the progress that we have made to this point.
        Senator Bunning. Thank you.
        Thank you, Mr. Chairman.
        Senator Bennett. Senator Sarbanes.
        Senator Sarbanes. Thank you, Mr. Chairman.
        Let me follow up Senator Bunning's last question. The OCC
    has an average of 20 or so on-site examiners at each of the
    largest banks under its supervision. How many examiners does
    the Finance Board have on-site at each of the Federal Home Loan
    Banks?
        Mr. Korsmo. Today there are no examiners on-site, sir.
        Senator Sarbanes. How many examiners do you have all
    together?
        Mr. Korsmo. Today we have 18 staff examiners, three
    examiners who are also mortgage analyst specialists, and, of
    course, the supervisor of our supervision function.
        Senator Sarbanes. And I understand you have plans to go up
    to 30--is that right?--by the end of next year.
        Mr. Korsmo. That is correct.
        Senator Sarbanes. Now, that is 30 total to examine the
    whole system?
        Mr. Korsmo. That is correct.
        Senator Sarbanes. So we should compare that with the OCC
    having--well, I do not know the full number they have, but they
    have, on average, 20 resident examiners at each of the largest
    banks. Is that correct?
        Mr. Korsmo. I cannot speak to the situation at OCC. I do
    not know. Or OTS, I do not know.
        Senator Sarbanes. Well, what is your view of that
    situation?
        Mr. Korsmo. Needless to say, I am concerned about it, and
    that is why we have made, as I was mentioning to Senator
    Bunning in response to his question, fairly dramatic
    improvements from where we were when I arrived. And I have to
    thank my board colleagues for their support in this effort.
        When I got there, we had eight bank examiners on staff,
    eight very good examiners, but eight who had an impossible task
    of overseeing, as you so correctly point out, 12 very large
    financial institutions with, at the time, assets in excess of
    $700 billion, capital of $30 billion, debt in excess of $650
    billion.
        What we have put in place starting with the process of
    hiring a professional director of our Office of Supervision and
    a professional, experienced assistant director of our Office of
    Supervision is a very deliberate, a very disciplined, and a
    very orderly process to upgrade not only our examination
    function but also really to create an off-site supervisory
    function.
        Is the progress enough? Have we moved fast enough? That is
    a question, you know, I have to leave to others to decide. But
    I can tell you that the progress is dramatic. It is not where
    we want to be by any stretch of the imagination, but the
    movement is in the right direction.
        Senator Sarbanes. Where do you want to be? What is your
    goal?
        Mr. Korsmo. Our goal is--and part of the difficulty of
    moving any faster, sir, is the simple process of bringing
    qualified people on board and, frankly, attracting them. We are
    now at the point where we now have as many as 250 applicants
    for qualified exam positions. But we can only move so fast.
        Senator Sarbanes. How many examiners do you think you need?
    First of all, I take it it is your view that you do not know
    have enough examiners to do the job.
        Mr. Korsmo. Let me answer that question this way: I think
    we are doing a very effective job of oversight of the banks. Am
    I saying that we have enough? Clearly not. We have already
    budgeted, for 2004, to have more.
        Senator Sarbanes. All right. Well, how many do you think
    you need in order to do the job?
        Mr. Korsmo. Again, I think that is a question I cannot
    answer. Certainly our Director of Supervision----
        Senator Sarbanes. Well, you are the head of----
        Mr. Korsmo. --has suggested that 30 is what we can
    reasonably expect to have on board and coordinate a new
    supervisory function between now and the end of next year.
        Senator Sarbanes. Well, now, if you get the 30----
        Mr. Korsmo. Will we be done? No.
        Senator Sarbanes. --is that where you want to be? I mean,
    how many--you are the Chairman of this Board.
        Senator Bennett. If there were no budgetary constrictions
    and you could have whatever you want, what number would you
    give us?
        Senator Sarbanes. Yes, how many do you need to do the job?
        Mr. Korsmo. I appreciate the question, but understand,
    budgetary restrictions are not the only constraint. One of the
    constraints is doing this in a disciplined and orderly fashion.
    Moving from a supervisory program that was nonexistent to one
    that exists today has been serious progress. I do not know the
    answer to how many. I would suggest 50 or 60 is probably
    appropriate, and that is the goal that we have set long term.
        The problem is, of course, we cannot----
        Senator Sarbanes. So you have set a long-term goal?
        Mr. Korsmo. That is correct, sir, yes.
        Senator Sarbanes. Well, I wish we had gotten to that
    sooner.
        [Laughter.]
        What is that long-term goal?
        Mr. Korsmo. Fifty or 60.
        Senator Sarbanes. Well, my time is about up. I do want to
    ask a couple of questions to Mr. Falcon before the red light
    goes on.
        Senator Bennett. Proceed.
        Senator Sarbanes. In light of OFHEO's consent order with
    David Glenn, which you announced this morning, when do you
    expect a report on Freddie Mac to be completed?
        Mr. Falcon. We are going to take at least a couple of
    weeks, Senator, to assess the information that he will provide
    to us and determine how much additional investigation will be
    warranted by the information he gives us.
        At the end of the 2-week period, I would like to come back
    to you, if I may, and tell you based on what we have learned
    how much additional time we think it will take based on the
    additional investigative work.
        Senator Sarbanes. Do you have adequate resources to
    complete the report as you would like?
        Mr. Falcon. Not currently, however, once we get the
    supplemental funds, I hope that will suffice. But if it does
    not, I will certainly let you know as soon as we understand
    that.
        Senator Sarbanes. So your target date now for doing the
    report is when? Because, earlier, it was by now, as I recall.
        Mr. Falcon. Yes, and we were planning to release the report
    by the end of the month, but given the fact that we will have
    new information available to us from the second ranking
    individual in the company, I would not want to produce an
    incomplete report. I would rather, if you would allow us
    additional time, take that new information into consideration.
        Senator Sarbanes. All right. Thank you.
        Senator Bennett. Thank you.
        Senator Hagel.
        Senator Hagel. Thank you.
        Mr. Falcon, in your testimony, you said, ``I also support
    the granting of authority to the safety and soundness regulator
    to determine whether the activities of an enterprise are
    consistent with its charter authority.'' Would you develop that
    a little more fully? I note that you do talk further about it
    in your testimony, but why do you think that is so important?
        Mr. Falcon. I think it is important to establish as a
    benchmark that any new safety and soundness regulator should
    have, if one is established, the same authorities as every
    other safety and soundness regulator. And every other regulator
    does have the authority to opine on what activities are
    permissible under the terms of the charter. And certainly as
    the regulator with the enforcement powers over the two
    enterprises, I think consistent with that standard, we should
    have the authority to opine on what is and is not permissible
    under the terms of the charter.
        Senator Hagel. Obviously, to keep them within the mission,
    the charter of that mission.
        Mr. Falcon. Yes, Senator.
        Senator Hagel. Do you think the two GSE's that you regulate
    have drifted from that charter, that mission?
        Mr. Falcon. What I think has happened is increasingly there
    is a gray area. The terms of the charters are very ambiguous,
    and there is not a black and white line in the charters as to
    what they can and cannot do. But certainly as the marketplace
    evolves and changes and technology advances, certainly the gray
    area expands and the Enterprises will continue to test the gray
    area.
        Senator Hagel. So that is one of the reasons that you think
    this should be clearly defined, at least in the regulator's
    eyes, and within the empowerment of that regulator so it all
    connects?
        Mr. Falcon. I think it is to everyone's benefit that there
    not be uncertainty as to what is or is not permissible,
    including for the two companies. And if there was a regulator
    with the authority to clearly state that this is or is not
    permissible, you would not have any cloud hanging over the
    activities of the companies.
        Senator Hagel. There would be no question.
        Mr. Falcon. Right.
        Senator Hagel. Do you think, as we rewrite a new regulatory
    reform document, that we should be clear and more definitive?
        Mr. Falcon. I think that would be preferable.
        Senator Hagel. But still give the new regulator the
    enforcement powers over both--safety and soundness, and
    mission?
        Mr. Falcon. Yes.
        Senator Hagel. And more clearly define the mission.
        Mr. Falcon. Yes.
        Senator Hagel. Thank you.
        Mr. Holtz-Eakin, thank you for your contributions. I was
    interested in some comments you made about the housing market,
    and it leads me to this question: Do you think there is a
    continued need for GSE's?
        Mr. Holtz-Eakin. I think that if one looks at the various
    objectives of GSE's, one is to ensure a reliable flow of
    financial funds to the housing sector. There is a good reason
    to believe that in large integrated capital markets these flows
    would occur in the absence of GSE's, and indeed, there is some
    evidence in that private sector firms that have undertaken to
    provide capital market financing for those mortgages not
    covered by the GSE's and other firms that have securitized
    different kinds of loans, such as credit cards or commercial
    mortgages. So there is a considerable amount of
    evidence that these activities--the provision of funds and the
    disbursement of risk among capital market participants--can be
    undertaken by other entities as well.
        Senator Hagel. Do you think then that the markets have or
    are going to outgrow GSE's?
        Mr. Holtz-Eakin. I think there is every reason to believe
    the private capital markets can funnel these funds to the
    housing sector, and there is also some evidence in the research
    community that the private market is equal or in some cases
    ahead of the GSE's in providing funds to low-income borrowers.
    On those two fronts, there has been a maturation of private-
    sector capital markets that has in many ways caught up to the
    GSE's.
        Senator Hagel. Thank you.
        My light is about ready to turn red, and I wanted to ask
    you a question, Mr. Korsmo. You, in your testimony, suggested
    to some extent that you look at Federal Home Loan Banks as
    maybe a competitor, some competition to the other two GSE's,
    more choice, lower rates, and so on. Could you define that a
    little bit more clearly, what you meant by that?
        Mr. Korsmo. As I alluded to, the acquired member asset
    programs, MPF and MPP, do provide albeit a small competitor at
    this point to Fannie and Freddie, they do provide competition,
    competition that I think has become recognized in some of the
    comments you probably heard Fannie and Freddie make about the
    desirability of banks being in that line of business, although
    I would argue it is the same line of business as advances.
        I think having another outlet, another vehicle for
    providing mortgage funding to lenders, particularly small
    lenders, particularly rural lenders, but also members of the
    Federal Home Loan Banks in general does provide a competitive
    edge that leads to lower costs, presumably over time, at the
    very least, for homebuyers.
        Senator Hagel. Thank you.
        Mr. Chairman, thank you.
        Senator Bennett. Thank you.
        Senator Reed.
        Senator Reed. Thank you, Mr. Chairman.
        Mr. Falcon, the current minimum capital standard is 2.5
    percent for these GSE's. Is that too high or too low?
        Mr. Falcon. I believe it is adequate for the time being.
        Senator Reed. And the proposal is to allow the regulator
    set both the minimum capital and the risk-based capital. What
    are the advantages that you see for that, or disadvantages?
        Mr. Falcon. I think it would be an advantage to give the
    regulator the discretion to adjust both capital levels, if the
    regulator determined in its best judgment it was appropriate.
    There are two different types of standards. The risk-based
    capital standard is one that tries to quantify measurable risk
    through the use of models, through the use of historical
    analysis of performance of assets and liabilities. And that is
    all fed into a stress test which produces cashflows and
    determines what is the appropriate capital level.
        But nothing is ever fail-safe. That is why you also need a
    minimum capital standard to ensure that, at a minimum, they
    will always maintain a certain amount of capital. And so the
    two capital standards interact in that manner.
        If given the changes in the marketplace, the changes in the
    companies' risk profile, it is in the regulator's judgment that
    either standard needs to be adjusted upward, I believe it would
    be important for the regulator to have that discretion and to
    be able to exercise that discretion in a timely manner.
        Senator Reed. Why wouldn't it be sufficient simply to have
    the discretion to adjust risk-based capital since the most
    critical change is a result of business practices of the firm
    that drives the risk-based capital? That is something I think
    you alluded to in your response.
        Mr. Falcon. Right. Well, as I said, I think since risk-
    based tries to capture quantifiable risk, I do not think it is
    ever possible to capture them perfectly, and so you always have
    to rely on at least a flat leverage type ratio as a fail-safe
    in the event that anything was not fully captured in a stress
    test.
        Senator Reed. Typically, risk-based capital is higher than
    minimum capital.
        Mr. Falcon. Not currently, sir.
        Senator Reed. Not currently?
        Mr. Falcon. Yes, Senator.
        Senator Reed. So, you are saying risk-based capital is
    lower than minimum capital?
        Mr. Falcon. Yes, sir.
        Senator Reed. And, again, I guess if you adjusted risk-
    based capital up, you would effectively in this case compensate
    for the perceived lack of capital. You would just raise it
    above the minimum level, which you could do. Is that correct?
        Mr. Falcon. Yes.
        Senator Reed. While you have been Director of OFHEO, has
    HUD ever approved or declined to approve a new program or
    product that you believed would undermine the safety and
    soundness of one of your regulated entities?
        Mr. Falcon. Not that I am aware of, sir.
        Senator Reed. Do you see the difficulty there, where there
    could be a possibility of programmatic approval of something
    that would be unsafe or unsound? Wouldn't you object and
    wouldn't your objections--even though you technically do not
    have the authority, but your objections would be heard?
        Mr. Falcon. Well, I think they would be taken into account.
    Our role still would continue to be to make sure there was
    adequate capital held against the activity. So if we thought
    something was an extraordinary risk, even if it was consistent
    with the charters, we would make sure that there was adequate
    capital to set aside against the potential risk of loss of the
    activity.
        Senator Reed. Just a general question, and, Mr. Korsmo, you
    might respond to it also. There has been some discussion of
    having one regulator for both Fannie and Freddie and for the
    Federal Home Loan Banks. I know you have alluded to this and
    commented on it. Once again your thoughts, and then, Mr.
    Falcon, if you could comment.
        Mr. Korsmo. I certainly think there is the potential for
    advantages, and I will leave to the policymakers the decision
    as to whether or not those advantages outweigh the
    disadvantages. My only admonition along those lines is the one
    I made in my opening statement, and that is to remain cognizant
    of the very real differences that exist between the Federal
    Home Loan Banks and Fannie and Freddie in terms of charter and
    capital structure and membership structure. So long as those
    are recognized, the decision may be easier.
        Senator Reed. Mr. Falcon.
        Mr. Falcon. I think as the Federal Home Loan Banks develop
    into more of a competitor of the enterprises, I think it would
    be a benefit to the regulator of each entity to be able to
    fully understand the operations and activities of each. The
    real question is to what extent you have any uniformity of
    regulatory policies as expressed in the regulations or
    guidances, and whether or not you require--or have an
    uniformity as those policies apply to each entity. I think that
    is the more difficult question.
        Senator Reed. Thank you.
        Senator Bennett. Thank you.
        I would like to follow along on the comments that were made
    in response to Senator Hagel. Mr. Holtz-Eakin, you are
    suggesting the market would fill in for the GSE's if the GSE's
    were to disappear.
        Mr. Holtz-Eakin. I believe that there is a lot of evidence
    that the private markets can manage the finance of the U.S.
    housing sector, and at present the presence of an uneven
    playing field with taxpayers assuming a credit enhancement for
    the GSE's makes it impossible to observe them filling in, but
    in the absence of that there is good reason to believe they
    would.
        Senator Bennett. What would be the effect on cost? Would
    the price of mortgages go up if the GSE's were to disappear?
    You outline in your testimony or the GAO that the GSE's can
    borrow at lower rates of interest, and presumably that would go
    away. Would that not reflect in the higher cost in the housing
    market?
        Mr. Holtz-Eakin. The research we have done to date suggests
    that of the subsidy provided by taxpayers, about 25 basis
    points shows up in the form of lower rates to borrowers, the
    remainder is retained by the GSE's. Given our most recent
    estimates, there would be about a 25-basis-point impact on
    mortgage interest rates.
        Senator Bennett. Let me be sure I understand what you are
    saying. Would the mortgage rates go up by 25 basis points if
    the GSE's were to disappear?
        Mr. Holtz-Eakin. With no other changes in the market, the
    elimination of the implicit guarantee would raise mortgage
    interest rates by 25 basis points.
        Senator Bennett. Is that not a social good that the
    Congress decides is worth the implied guarantee, to have lower-
    cost housing, particularly for the low-income Americans?
        Mr. Holtz-Eakin. It is clearly only one element of the
    overall benefit cost test: Whether the cost of having taxpayers
    assume more risk is outweighed by the benefits of this,
    particularly for low-income individuals. The research suggests
    that 25 basis points alone would not move substantial numbers
    of low-income borrowers into homes, that a larger movement in
    interest rates, of around 2 percentage points, is needed to
    really have a substantial impact on homeownership rates among
    lower-income individuals.
        Senator Bennett. So you are saying 25 basis points is
    basically trivial.
        Mr. Holtz-Eakin. Trivial is in the eye of the beholder, but
    those are the magnitudes that we estimate would happen and the
    magnitudes the research community suggests are important.
        Senator Bennett. Thank you.
        Now, following along the lines that Senator Reed raised, in
    our previous hearing and in post mortems of the previous
    hearing, it strikes me that one of the sticking points here is
    the question of the role of the regulator, assuming a new
    regulator is established within the Treasury, the role of the
    regulator and the role of HUD. I think that was the issue that
    Senator Reed's comments were getting toward.
        Mr. Falcon, you have said you as the existing regulator
    have never seen HUD do anything that would in fact affect
    safety and soundness. The GSE's prefer to deal with HUD because
    they prefer the devil they know to the devil they do not know.
    They worked out an accommodation with HUD whereby new products
    are approved relatively rapidly, and their fear, as I
    understand it, is that a new regulator would ultimately end up
    approving the same new products, but do so in a manner that
    would take enough time, create some bureaucratic arterial
    sclerosis, that it never moves, and ultimately therefore there
    would be a delay in getting new products to the market.
        Could you comment on that whole thing? I imagine you have
    given it some thought, and you are the only one who has had
    some practical experience with the dichotomy between HUD's role
    and a regulator's role.
        Mr. Falcon. The way things are set up now, Senator, is with
    HUD as the mission regulator, and us as the safety and
    soundness regulator, we are also tasked for enforcing, as the
    enforcement arm for the Enterprises, even in most matters
    related to mission regulation. If HUD thought there was an
    issue, an activity that the Enterprises could not engage in and
    an enforcement action was necessary, it would be up to OFHEO to
    take the enforcement action.
        As the safety and soundness regulator and responsibility
    for assuring that the Enterprises are in compliance with all of
    the laws and regulations that apply to them, we have to make
    sure that we understand what is going on in the area of their
    activities, and if we saw that there was a clear violation of a
    law, including their charters, we would step in and advise the
    company that it was not permissible. We have done that before.
        But where they operate in the vast gray area, we defer to
    HUD on what is permissible and what is not. What I am
    suggesting is that we just take it a step further and give the
    safety and soundness regulator the authority to also opine in
    this gray area. There are different ways to do this to make
    sure that HUD continues to have a role when the activity
    involves some affordable housing or low-income housing program.
    I think something could definitely be structured there. But I
    think it is just a matter of making sure that the regulator--we
    do not prefer that the agency is operating under a cloud and
    leave themselves open to a potential legal challenge, that it
    be clear what they can and cannot do.
        That is why I think it is the interest of the safety and
    soundness regulator to have this type of authority as all the
    others do.
        Senator Bennett. Senator Corzine.

                   COMMENTS OF SENATOR JON S. CORZINE

        Senator Corzine. Thank you, Chairman Bennett, and welcome
    to the panel. I apologize for not being here. I had another
    obligation.
        Just a quick question to Director Holtz-Eakin. This 25
    basis points has to be an average, cannot possibly be every
    single element. I think that is what Senator Bennett was
    talking about. It is a range of benefits to different mortgage
    takers. I would presume that since there are credit spreads in
    the mortgage market, in the mortgage lending market, that some
    people, while they may be spending a lot more than they would
    otherwise be, it is still going to be a lower spread than
    otherwise. I presume it is an average.
        Mr. Holtz-Eakin. There is certainly a spread, and this is
    an average result from our study.
        Senator Corzine. So that different elements of the market
    may benefit more than 25 basis points. Folks accessing with
    less quality credit or at least credit histories than other
    people, and therefore some of that might be more important for
    certain segments of the market than it would be others. It
    would not just be a standard 25 basis points.
        Mr. Holtz-Eakin. There will certainly be a spread, and what
    we will look at is those mortgages that qualify under Fannie's
    and Freddie's requirements.
        Senator Corzine. As you probably can recognize that
    sometimes the spread gets so much that supply and demand would
    actually allocate out some money at the long end of the
    widening of the spread, 200 basis points or 400 basis points
    for some element. It gets to a point where it is prohibitive or
    the market rate just gets to a marginal rate somebody cannot
    afford. I presume that at some level that occurs because of
    this.
        Mr. Holtz-Eakin. As an economist, I would never dispute the
    fact that some people get priced out of markets. I take that
    point. The degree to which that is an empirical phenomenon is
    not something we investigated.
        Senator Corzine. I think that when we are talking a about
    25 basis point, I think I do not know what the outstanding
    mortgage lending money is, but on an average basis, on an
    annual basis, time discounted value over a period of time, that
    is actually a pretty substantial benefit to consumers, and
    since it would be different for different segments I still
    think it is a quite substantial benefit for mortgage production
    and homeownership which I think is one of the core cases of
    what we would be arguing, why GSE's have a reason to exist.
        Mr. Holtz-Eakin. In terms of the magnitudes, our estimate
    at the time was $10 to $15 billion a year in subsidy, of which
    something on the order of half to two-thirds shows up in the
    form of lower mortgage interest rates. So that is a way to
    divide up the degree to which the subsidy benefits consumers.
        Senator Corzine. It goes to the core of whether
    policymakers think that is an appropriate way to generate these
    kinds of issues enough.
        Mr. Holtz-Eakin. Absolutely.
        Senator Corzine. I have a question, Mr. Korsmo. I know
    these things could take months. What is the capital standards
    that the Federal Home Loan Banks have? We talked about minimum
    standards and there are risk-based standards, but what do they
    look like at the Federal Home Loan Banks? Maybe you answered
    that in your testimony.
        Mr. Korsmo. Let me answer that question a couple of ways.
    Obviously, there is a statutory minimum of 4 percent that is
    included in the statute, a minimum leverage requirement that is
    based on the definition of capital that Congress has provided
    that goes to 5 percent. There is also a risk-based capital
    element that is established by regulation, as Mr. Falcon
    alluded to earlier with the case with Fannie and Freddie. The
    risk-based capital level that is provided by the regulatory
    definitions is below the statutory minimum, and so all the
    banks are operating under that 4 percent statutory minimum.
        There is a variety of course among the 12 institutions--I
    should say there is a variety of levels of capital among the
    variety of--among the 12 institutions I think they range from a
    low of about 4.2 percent maybe to a high in excess of 5.5. I
    know the Chicago Bank just announced their new level is
    approximately 5.15 percent. I can talk a little bit about what
    is included in the risk-based capital reg if that is----
        Senator Corzine. But it has not really bitten.
        Mr. Korsmo. No, it has not really bitten, that is correct.
        Senator Corzine. Have you looked at the nature of your
    risk-based capital standards relative to what OFHEO has
    developed with regard to the GSE's?
        Mr. Korsmo. I have not. There is a comparison of course.
    The standards are different and the factors that go into the
    standard are different. For example, our scenarios are
    substantially different than the scenarios under which OFHEO
    develops their risk-based capital standard. It is much more----
        Senator Corzine. I see the red light is on. Are those
    differences a function of a different mission, different
    purpose, or are they a function of different intellectual
    framework?
        Mr. Korsmo. I think they are different intellectual
    framework, different methodology.
        Senator Corzine. If there was a consolidation, then we
    would want to think about how----
        Mr. Korsmo. They would have to be reconciled, yes, sir.
        Senator Bennett. Thank you, Senator.
        Senator Allard.

                   STATEMENT OF SENATOR WAYNE ALLARD

        Senator Allard. Mr. Chairman, I would like to inquire about
    the Federal Housing Finance Board in its role as a
    nonappropriated agency, as you enact your own budget and assess
    the Banks on the cost of the operation. How important is this
    authority in your ability to carry out your mission?
        Mr. Korsmo. I think it is significant, and I would
    certainly urge the policymakers to take a look at any new
    regulatory body or any change in the current regulatory
    structure to reflect the ability to generate a budget.
        Senator Allard. So you think OFHEO or any new agency that
    we set up should have that capability?
        Mr. Korsmo. Yes, sir, I do indeed. Obviously, there have to
    be some constraints. I think that the process at the Finance
    Board, whereby the budget is adopted by a majority vote at an
    open meeting provides the balance that is necessary to make
    sure that we are not penalizing the entities we regulate by the
    budget process.
        Senator Allard. Dr. Holtz-Eakin, how do we apply
    accountability to a regulatory agency like this? I think back,
    for example, of the FDA. Before they approve drugs they go back
    to the industry and say, well, we are not going to approve any
    more applications for new drugs and we are going to slow down
    the process unless you work with us to increase fees on
    services. Is there a way that we can bring accountability into
    the budget process on that type of a proposal or do we already
    have it?
        Mr. Holtz-Eakin. I think accountability follows
    transparency on the part of both those being regulated and the
    regulator. So the degree to which the regulatory oversight
    process is transparent and made as clear as possible to all
    parties--the regulators, those regulated, and the Congress--
    will help accountability more probably than any other single
    factor, the observability of the actions of both parties. If I
    had to pick one thing, I would point to that.
        Comparability across regulatory agencies is useful as well,
    so that in the same way that competition in private markets
    allows comparison shopping, having the same accounting
    standards and disclosure standards and being able to observe
    differences across----
        Senator Allard. I would like to have both of you respond to
    this question. How do we know you, the regulator or regulators,
    have established a reasonable budget? If it does not go through
    the appropriation process? Any of you who would like to respond
    to that.
        Mr. Falcon. I think what would weigh heavily on my mind is
    the fact that what powers you give us can also be taken away.
    If we abuse the authority that you would give us at OFHEO to
    set our own budget outside the appropriations process, and we
    abuse that authority by not being responsible with how we set
    our budgets, then you would have every opportunity to put us
    back in the appropriations process. But our budget process
    would be very transparent, and our assessments would be based
    on a regulation that would be set in formula, would be
    predictable to the companies that we regulate, and they would
    not be set without their input through the regulatory process.
        Senator Allard. You imply in your comments that somehow it
    is always easy to get legislation through the Senate. It is
    not.
        [Laughter.]
        How is it that we have, again, I come back to
    accountability, and Mr. Korsmo, maybe you want to speak on
    that.
        Mr. Korsmo. I think Dr. Holtz-Eakin is right. It is the
    transparency of the process that is significant, and that is
    why one of the things we have done in the last 2 years at the
    Finance Board is to adopt the budget in an open meeting.
    Previously, it was done by notational vote. One year it was
    adopted by fiat of the chairman. I think the assurance of
    accountability that lies at least in the structure of the
    current Federal Housing Finance Board, besides the obvious
    element of transparency is the fact that the 8,008 financial
    institutions who are members of one or another of the 12
    Federal Home Loan Banks and who pay those assessments
    ultimately, I suspect you would hear from them if they thought
    our level of assessment was inappropriate.
        Senator Allard. I am going to move on--my time is about
    ready to expire. Mr. Chairman, if I may just briefly----
        Senator Bennett. Does anyone else have an additional
    question they would like to ask?
        Senator Sarbanes. Yes, but why do you not----
        Senator Bennett. Why don't you go a little bit over time.
    And I have one additional question.
        Senator Allard. Then I do not have any questions. That will
    take care of it for me.
        So we have divided responsibility. How do we get
    communication channels open so regulators can communicate back
    and forth, and maybe if you all, Mr. Falcon and Mr. Korsmo,
    would talk about that a little bit.
        Mr. Falcon. It does occur through regulatory agencies. Our
    examiners are part of an interagency examination council, where
    they meet regularly to discuss evolving benchmarks, evolving
    regulatory practices, and best practices at the different
    entities that we all regulate. That occurs I think at different
    type of program levels within the agencies. It certainly, as
    issues come up that are of mutual interest to myself and the
    chairman, we certainly discuss those with each other.
        Mr. Korsmo. I think that is one limitation under which we
    operate that could be corrected. Our examiners do not belong to
    FFIEC, Federal Financial Institutions Examination Council. I
    think that is a shortcoming. The ability for us to participate
    in that process would be very important, particularly the
    opportunity to interact with other examiners of large financial
    institutions.
        Senator Allard. So this would be to your advantage then in
    that respect, to be brought in with Fannie Mae and Freddie Mac
    with a Treasury regulator. That would give you an----
        Mr. Korsmo. I think that is a larger issue, Senator. A
    simpler approach to it would just be to make the Federal
    Housing Finance Board a member of FFIEC, which it is not today.
        Senator Allard. I see.
        Thank you, Mr. Chairman.
        Senator Bennett. Thank you.
        Senator Sarbanes.
        Senator Sarbanes. Mr. Korsmo, you have been increasing the
    budget, but you could set the budget at the figure that you
    thought was necessary in order to adequately regulate, could
    you not?
        Mr. Korsmo. We could. Again, I will mention that in the 20
    months I have been there, what we have tried to do is proceed
    in a deliberate, disciplined, and orderly fashion. One of the
    things----
        Senator Sarbanes. I understand that. I was prompted to ask
    you that question by your response to Senator Allard, saying
    that your member banks, you would presume, would protest if you
    were taking the budget up. But there is a conflict there, is
    there not? You are the regulator. If you do not think the
    budget is adequate you need to make it adequate whether they
    protest or not, do you not?
        Mr. Korsmo. That is absolutely correct, sir, which I think
    you will see reflected in the budget for fiscal year 2004 where
    we have made a fairly dramatic increase.
        Senator Sarbanes. All right. I wanted to ask both you and
    Mr. Falcon this question. If an independent regulator were to
    be set up, perhaps not in the Treasury, or even in the
    Treasury, I mean wherever, should it be a single person
    regulator or a multiperson regulator, and why, or does it make
    any difference?
        Mr. Falcon. My preference would be for a single head of the
    agency as opposed to a board or commission structure. I have
    not had experience being the chairman of the board, regulatory
    agency run by a board, but I can tell you from my experiences
    as a single head of an agency that it provides me the ability
    to take quick and decisive action as necessary without the need
    to consult with a board. It provides me to clearly set the
    mission of the agency. It allows me to make sure that all the
    policies are consistent with those as in my best judgment I
    think are appropriate.
        Now, granted, you can have some of that with a board
    structure as well, but I think just as far as the ease in
    running the agency, the administrative functions, as well as
    setting policy, I much prefer a single head of an agency.
        Mr. Korsmo. As Director Falcon has only had the experience
    of the single member or single director institution, I have
    only functioned with a board. There are certainly limitations
    inherent, and he has outlined them, in functioning with a
    board. The flip side of that of course is there are certain
    advantages I think that are inherent in having five individuals
    who come from different backgrounds, different perspectives,
    the opportunity to participate in the decisionmaking process.
        If I were to construct an administrative process for the
    Finance Board, would I structure it precisely the way it is
    now? I am not sure that I would. But again, it is the only
    paradigm I have experienced. So, I would say it certainly
    works.
        Senator Sarbanes. Thank you.
        Chairman Shelby. [Presiding.] Thank you.
        Dr. Holtz-Eakin, your testimony indicates that when the
    GSE's hold more mortgages in portfolio the risk faced by the
    GSE's may be increased. You also indicate in your written
    testimony that this activity has increased over time. What are
    some of the possible explanations for the shift in activity by
    the GSE's, and what can you tell us about how the GSE's have
    managed the risk.
        Mr. Holtz-Eakin. I can only speculate on the ultimate
    motivation for shifts in portfolios. The result is that by
    holding more risk there is a greater rate of return to these
    activities, and one would expect that to be reflected in return
    on equity, for example.
        The degree to which that risk is managed is very hard to
    quantify. Net positions on hedges and derivatives are very
    difficult for even the best examiners to keep up with on a day-
    to-day basis. It is one of the challenges that would face any
    regulator, and for that reason, quantifying the management of
    that risk is hard. The bottom line is, however, they have
    earned higher rates of return on equity than have comparable
    private-sector financial institutions, and that typically is
    associated with greater risk.
        Chairman Shelby. To what extent is it necessary to achieve
    liquidity in the housing finance markets, to have the GSE's
    hold mortgage or MBS's in portfolio?
        Mr. Holtz-Eakin. I do not think that is a central part of
    achieving liquidity. Financial markets will price the
    attributes of securities, not the names on them, and the risk
    characteristics--the
    interest rate risk, the prepayment risk--have little to do with
    who has actually got its name on the securities.
        For the Nation as a whole, there will be an outstanding
    stock of mortgages at any point in time, and the bearing of
    that risk is typically a voluntary action in private markets.
    The GSE's shift some to the taxpayer in a slightly different
    fashion.
        Chairman Shelby. Mr. Falcon, you have indicated that you
    believe the new safety and soundness regulator should have
    program approval authority. Do you believe this would inhibit
    the GSEs' ability to meet their mission of expanding
    homeownership?
        Mr. Falcon. I do not think it would. The authority would
    not be used in a manner to inhibit their ability to fulfill
    this affordable housing mission. In fact, as we have performed
    our regulatory duties, because we have some role in charter
    compliance presently, where we see a clear violation we will
    step in and tell the Enterprise that is not permissible. And as
    we put our risk-based capital standard in place, we did that in
    a way that did not provide any disruption to the company, it
    was a smooth implementation. And they are meeting the standard
    now. I think it is more a necessity for the risk for the safety
    and soundness regulator to be able to ensure that the companies
    are in compliance with the charters and that none of their
    activities are under a cloud.
        Chairman Shelby. You also suggest a mechanism to ensure
    that the new regulator solicit and consider all views. How
    would such a process work in practice, just briefly?
        Mr. Falcon. I think what would be beneficial is that when
    the agency decided that there was an activity that needed to be
    reviewed for purposes of charter compliance, that it should put
    out a notice to all interested parties that the agency is
    considering that activity, and ask for comment from anyone who
    is interested about whether or not in their view the activity
    is or is not permissible, and the benefits and the downsides of
    the activity.
        Chairman Shelby. Doctor, as you know, the minimum capital
    threshold of 2.5 percent that Fannie and Freddie are subject to
    is often compared to the 4 percent minimum capital standard
    that banks and thrifts must meet. Fannie and Freddie--and they
    have done it here--that they do not need to hold as much
    capital as banks and thrifts because they pursue lower-risk
    activities, which there is some truth to. How would you respond
    to this assertion? If a 2.5 percent threshold was appropriate
    in 1992 how should the Congress evaluate whether it remains the
    appropriate threshold today?
        Mr. Holtz-Eakin. I think there are two types of responses
    to that. The first is that I think the record is quite clear
    that the overall credit risk pursued by the GSE's is, in fact,
    relatively modest. However, that is only a narrow component of
    the overall types of risks that I outlined in my testimony.
    Judging the adequacy of capital standards against those other
    risks, which are, in fact, shared by the private sector, is
    probably a more fruitful way to go.
        In revisiting the minimum capital requirements, it is
    useful to keep in mind that one part of the purpose of those
    capital requirements would be to ensure not just the
    institutions but the overall impact of those institutions on
    financial markets against large disruption. That is a role that
    regulators should have a keen eye toward and may affect the
    decision on capital requirements.
        Chairman Shelby. Mr. Korsmo, the Finance Board supports
    requiring each Federal Home Loan Bank to register with the
    Securities and Exchange Commission. I agree with enhancing
    disclosure, but I am not sure that all the appropriate issues
    have been addressed here. My question to you is: How does the
    Finance Board propose to address certain unique structural
    factors in the Federal Home Loan Bank System, such as joint and
    several liability of the system?
        Mr. Korsmo. That is an excellent question, Mr. Chairman.
    And our view on that has been that the best way to address
    those questions is to have the questions resolved between the
    12 potential registrants and the SEC themselves. At least 5 of
    the Banks have been actively engaged in those discussions.
    There were certainly any number of threshold issues that we
    recognized that the Finance Board is having to have some
    successful resolution in terms of their accounting practice
    prior to moving ahead. I think we have made sufficient
    progress, that the final progress needs to be made between the
    staff of the SEC and the staffs of the 12 potential
    registrants.
        Chairman Shelby. Senator Corzine.
        Senator Corzine. Thank you, Mr. Chairman.
        Let me just follow on on this joint and several concept. Do
    you have joint oversight of the consolidated balance sheet? Do
    you look at balance sheet and the risk-based capital standards?
    Are they applied on a consolidated basis?
        Mr. Korsmo. I understand that joint and several liability
    only applies to consolidated obligations. I guess the short
    answer to your question is yes.
        Senator Corzine. So you look at the minimum capital
    standards and the risk-based capital standards for the overall
    balance sheet even though the joint and several only relates to
    the----
        Mr. Korsmo. No, no. I am sorry.
        Senator Corzine. You look at the individual unit banks.
        Mr. Korsmo. That is correct.
        Senator Corzine. I just have a question then. The main
    financing technique for the Banks is through the consolidated
    borrowing debentures. One last question that I had. Mr. Falcon,
    I think I used the term ``mind boggling'' last time when I
    talked about a $1.5 to $3 billion estimate, under reported
    earnings, and that seemingly has grown from that $1.5 to $3 to
    $4.5. Are there any obvious explanations on the size of what
    moved us out of that range, and when do we feel that a full
    accounting for the difference in Freddie Mac can actually be
    explained?
        Mr. Falcon. The process is on track to be concluded
    sometime in mid-November, and so they will then be issuing
    statements, assuming everything goes as planned. That is just
    the magnitude of which earnings were moved into future time
    periods, rather than being recognized in the earlier time
    periods if the proper accounting rules were utilized. It is
    just a reflection of the cumulative impact of all the different
    transactions that we are engaged in to try to smooth out these
    earnings over time.
        Senator Corzine. Was there a standard procedure that was
    used that was used to move forward earnings?
        Mr. Falcon. There was a wide variety of different types of
    transactions.
        Senator Corzine. Pardon?
        Mr. Falcon. There was a wide variety of different types of
    transactions.
        Senator Corzine. It was not just one kind.
        Mr. Falcon. Right, right.
        Senator Corzine. It was not a generic methodology.
        Mr. Falcon. No.
        Senator Corzine. Thank you.
        Chairman Shelby. Senator Bennett.
        Senator Bennett. Thank you, Mr. Chairman.
        Two quick questions. Simply the terminology that has been
    used around here. There has been reference to the taxpayer
    subsidy. Subsidy usually means that if it is not done, money
    ends up in the Treasury. Is there a suggestion that if the
    GSE's were eliminated there would be an extra $10 billion in
    the Treasury?
        Mr. Holtz-Eakin. The nature of the subsidy is the lower
    borrowing costs to the GSE's and the budgetary reflection of
    that is the low probability, over long periods of time, that
    there would be an event which would place the taxpayer at the
    risk of actually providing funds directly was done with the
    Federal Farm Credit System in the 1980's.
        Senator Bennett. But there is not a subsidy like a farm
    subsidy that we can quantify every year. If we were to
    eliminate the GSE's, presumably there would be an elimination
    of risk, but there would not be an immediate amount of money
    showing up in the Treasury if we eliminated the GSE's.
        Mr. Holtz-Eakin. There would not be a cashflow to the
    Treasury, but the situation is similar to credit reform, where
    we could reflect on the budget the implicit cost of that risk
    and take account of it in budgetary deliberations.
        Senator Bennett. Is there a budget figure for implied risk?
        Mr. Holtz-Eakin. Not in this area, but in other areas where
    guarantees are provided by the Federal Government credit reform
    does allow for an explicit entry in the budget for the value of
    that guarantee.
        Senator Sarbanes. Yes, but the more you talk that way, the
    more explicit the guarantee becomes and everyone runs around
    saying this is not an explicit guarantee and they are required
    to state it absolutely. Then everyone comes along here, it is--
    I mean you are sitting there at the table taking an implicit
    guarantee and making it explicit, are you not?
        Mr. Holtz-Eakin. I am not. I am not in any way advocating a
    particular budgetary treatment. I am trying to explain that to
    the extent that it is perceived to be a guarantee, it has
    consequences for the real provision of resources and perhaps
    for the Government.
        Senator Bennett. There is no cashflow subsidy.
        Mr. Holtz-Eakin. Not at present.
        Senator Bennett. The only other question. We talk about
    taxpayer risk, and I admit there is an implication of some
    taxpayer risk, but isn't the first line of risk the
    shareholders? They stand to lose everything if the GSE's fail,
    do they not?
        Mr. Holtz-Eakin. Absolutely. And the empirical question is
    the degree to which that line of defense is adequate. As was
    mentioned, I think in Mr. Falcon's opening remarks, capital is
    the bulwark against which you would place these risks, and the
    question is whether the capital is adequate.
        Senator Bennett. And if the capital is attracted to the GSE
    by the noncash subsidy and the risk is borne by the capital,
    maybe this is a good idea.
        Mr. Holtz-Eakin. The outcome is that the GSE's, as compared
    to simliarly rated private sector entities, have less capital.
    There is less there, and there is a higher rate of return
    because of this lower capital.
        Senator Bennett. Now we get into the Chairman's question
    about the reason there is less capital is that there is less
    risk because they do not issue credit cards, they stay with
    mortgages. And that is another philosophical argument. I simply
    wanted to be sure I understood the terms we are using here and
    when we are talking about subsidy we are not talking about a
    cash subsidy, we are talking about an implied subsidy, and when
    we are talking about risk, it is true that the risk is all held
    by the shareholders, and there is an implied risk for tax
    holders, but again, we cannot truly quantify it until we see
    how much of a disaster the shareholders have to absorb.
        Mr. Holtz-Eakin. The degree to which it can be quantified,
    we have taken one approach in our past studies which is to
    compare borrowing costs of comparable private sector entities
    with the GSE's. There is another approach basically called an
    options value approach--where by you could, in the same way,
    try to quantify the magnitudes involved, and if that was
    something of interest, we would be happy to work with you on
    that.
        Senator Bennett. Thank you, Mr. Chairman.
        Chairman Shelby. When we are talking about risk, the 2.5
    versus the 4, have there been any studies that any of you know
    done showing the real risk in the marketplace there? In other
    words, what is the percentage of losses of Freddie and Fannie
    compared to an ordinary bank that is into all kinds of other
    risk? See, they, by statute, are limited to what they can
    invest in. Is that not right, Mr. Falcon?
        Mr. Falcon. Yes, sir.
        Chairman Shelby. Go ahead. Do you know if there are any
    studies showing this, if there are risks, and then their risks?
        Mr. Holtz-Eakin. I think the spirit of the question is what
    are the outcomes that you can look at. You can look at the
    default rates and outcomes for comparable private-sector
    entities. In my testimony, I reference this. Over a 15-year
    period for comparably rated private sector entities, that rate
    is nearly 2 percent.
        Chairman Shelby. Gentlemen, we thank you for your testimony
    here today and participating. I apologize for having to leave
    and come back, but I am Chairman of a Subcommittee on
    Appropriations that has opened up on the floor, so I will be on
    the floor a lot today. Thank you.
        Chairman Shelby. We will now move to our second panel. All
    of your written testimony will be made part of the hearing
    record in its entirety, and if you would take 5 minutes
    apiece--I know that is compressing your time--to sum up your
    remarks, we would be very appreciative, and then we will get
    into the others.
        Mr. Koch, we will start with you. First, I want to yield to
    Senator Sarbanes for a statement.
        Senator Sarbanes. Mr. Chairman, I join with you in
    welcoming the witnesses, but I particularly want to welcome
    Iona Harrison, who is here on behalf of the National
    Association of REALTORS'. Ms. Harrison is from Upper
    Marlboro, Maryland in nearby Prince George's County. She has
    long been active in her community there. She has played an
    important leadership role with the realtors, both in the
    Maryland chapter and nationally, and we are very pleased she is
    here today, and I am looking forward to her testimony. Thank
    you.
        Chairman Shelby. Thank you.
        Mr. Koch.

                       STATEMENT OF JOHN D. KOCH

           EXECUTIVE VICE PRESIDENT AND CHIEF LENDING OFFICER

                 CHARTER ONE BANK, NA, CLEVELAND, OHIO

                              ON BEHALF OF

                      AMERICA'S COMMUNITY BANKERS

        Mr. Koch. Chairman Shelby, Ranking Member Sarbanes, and
    Members of the Committee, I am John Koch, Executive Vice
    President and Chief Credit and Lending Officer for Charter One
    Bank in Cleveland, Ohio. I am also Chairman of America's
    Community Bankers GSE Policy Committee and a member of ACB's
    board.
        Many of our members are specialists in mortgage lending and
    actively involved in the secondary market. Therefore, we
    appreciate this opportunity to provide our comments to the
    Committee.
        ACB has intense interest in GSE regulatory reform for
    several reasons. We strongly support efforts to improve
    regulation of all the housing GSE's including the Federal Home
    Loan Banks to better ensure safety and soundness. We strongly
    support the secondary market role of Fannie Mae and Freddie Mac
    and their
    important housing mission. We particularly note their
    contribution to our underserved communities, which has been
    most substantial, but we further note that significant
    disparities still sadly exist in homeownership rates for low-
    and moderate-income households in this country.
        Our members are also substantial stockholders and borrowers
    in the Federal Home Loan Bank System. For example, my own
    institution has active relationships with all these entities.
    Charter One Bank services over $15 billion in home mortgages
    for Fannie Mae and Freddie Mac. Our Federal Home Loan Bank
    advances total nearly $10 billion. Our investment in the
    Federal Home Loan Bank System totals $700 million, which is our
    largest investment by far. So the safety and soundness of the
    Federal Home Loan Bank System is of paramount interest to us
    and to the members and to our bankers members across the United
    States.
        ACB recognizes that the legislative situation we face is
    very fluid. During the House Committee's consideration of this
    issue, we supported shifting regulation of Fannie Mae and
    Freddie Mac to a fully funded independent regulator within the
    Treasury. We also support an amendment to include the Federal
    Home Loan Banks in that agency. We continue to support both of
    these concepts and strongly urge you to consider including them
    in your legislation. It is essential that this new agency be
    independent. My written testimony details the key elements of
    independence that are currently provided to other financial
    regulators at this point in time. If the Treasury can not
    accept an independent agency within the Department, ACB would
    consider and support a stand-alone agency.
        Regardless of location, however, the new agency must also
    be able to fund itself without going through the annual
    appropriations process. It must have sufficient resources to
    get its job done. ACB strongly endorses the Administration's
    position that the new agency have the authority to review both
    current and future programs of Fannie Mae and Freddie Mac.
        For over a decade, HUD has not exercised its current
    program approval authority. As a result, Fannie Mae and Freddie
    Mac have engaged in or attempted to engage in activities
    inconsistent with their secondary market responsibilities. Most
    importantly, these activities further raise the risk profile of
    these institutions. New initiatives such as acquisition and
    development lending underscore this point, that the review
    process and the authority needs to be shifted into one
    regulator. This process after all is good enough for all the
    banks of this country throughout the entire banking system.
        ACB strongly agrees with the Administration's position that
    there should be no limit to the new agency's ability to adjust
    capital requirements for Fannie Mae and Freddie Mac. Let me be
    clear that we are not proposing that capital requirements be
    increased at this time, but capital is the foundation for the
    safety and soundness of our financial system, and must remain a
    flexible regulatory tool. Without capital authority the new
    regulator's power is gutted.
        While supporting the regulator for the housing GSE's, the
    new agency should administer the unique statutory arrangements
    that apply to each. The Federal Home Loan Banks are
    cooperatives, not public companies, and pose different
    regulatory issues. While acknowledging key differences, we note
    that the Federal Home Loan Banks, Fannie Mae, and Freddie Mac
    are all engaged in extensive interest rate management. A
    combined agency would be better able to supervise these risks.
    Concentrating all the expertise in one agency would provide
    good regulatory leverage for analysis of hedging risks, for
    example, investment concentrations, et cetera. This would be
    more efficient Government.
        I wish to again express ACB's appreciation for the
    invitation to testify to these important issues. We certainly
    support the Committee's efforts to strengthen the regulation of
    Fannie Mae, Freddie Mac, and Federal Home Loan Banks. We look
    forward to working with you as you craft legislation to
    accomplish this goal.
        Chairman Shelby. Thank you.
        Mr. Torpey.

                      STATEMENT OF DALE J. TORPEY

                           PRESIDENT AND CEO

                   FEDERATION BANK, WASHINGTON, IOWA

                              ON BEHALF OF

                INDEPENDENT COMMUNITY BANKERS OF AMERICA

        Mr. Torpey. Chairman Shelby, Ranking Member Sarbanes and
    Senate Banking Committee Members, I appreciate this opportunity
    to present ICBA's views on proposals for improving housing GSE
    regulation. This is a matter of critical importance to
    community banking.
        I am Dale Torpey, President and CEO of Federation Bank in
    Washington, Iowa. I serve as Chairman of the ICBA's Lending
    Committee. I also chair the board of directors of the Federal
    Home Loan Bank of Des Moines. But my testimony today is
    delivered exclusively on ICBA's behalf.
        As a general principle, we do not believe the Treasury
    should direct the housing policy, just as it should not run the
    monetary policy of our Nation. In our view should Treasury be
    granted oversight of either Fannie Mae, Freddie Mac, or all
    three of the housing GSE's, its tax and fiscal policy
    responsibilities would likely present clear conflicts of
    interest with housing policy.
        We also share concerns expressed by others regarding the
    historical absence of housing policy expertise at Treasury.
    Since the Gramm-Leach-Bliley Act of 1999 widened membership in
    the Federal Home Loan Bank System and expanded the categories
    of eligible collateral for Federal Home Loan Banks' advances,
    thousands of community banks use advances as a competitive and
    flexible funding tool. Our ability to continue to use this
    increasingly important funding source is crucial to safe and
    sound asset liability
    management and to provide lendable funds for our communities.
    Similarly, the fact that Federal Deposit Insurance coverage
    levels have not increased since 1980 has given communities
    banks further incentive to turn to FHLB advances as a stable
    alternative funding source.
        ICBA continues to believe that Federal Home Loan Banks
    should be regulated by a separate and independent agency, a
    status the existing Federal Housing Finance Board already
    enjoys. Under FHFB's regulatory's guidance, the FHLB's have a
    near impeccable record of providing well collateralized
    advances to thousands of institutions. The FHFB has and
    continues to take important steps to upgrade its examination
    and supervision capacities. ICBA has long supported independent
    financial regulatory agencies such as the Federal Reserve,
    FDIC, and the SEC.
        Earlier this month the ICBA Board of Directors discussed
    FHLB regulation at length. Our board voted unanimously to
    oppose, including the FHLB's, in any new proposed new Fannie/
    Freddie regulatory structure in Treasury. Our board did not
    discuss the concept of a new independent regulatory structure
    outside Treasury for Fannie/Freddie and the FHLB's, a concept
    voiced by some in recent days.
        While not our first preference, ICBA may not oppose the
    concept of a new independent regulator for all three housing
    GSE's outside Treasury depending on how the details flesh out.
    First, the specific regulatory powers of such an agency would
    have to be determined. We note that the FHFB and OFHEO do not
    currently have the same powers. Second, the unique ownership,
    operational, and capital structure and mission of the FHLB's
    would have to be recognized and preserved. Community banks are
    significant direct and indirect users of Fannie/Freddie
    conduits into the secondary mortgage market, and the sale of
    mortgages originated by community banks into the secondary
    market increases our liquidity and in turn allows us to make
    more loans in our communities.
        The current system has enabled us to reach record
    homeownership levels and to accommodate consumer refinancing
    needs in the recent low interest rate environment. We must be
    careful not to jeopardize this success.
        Regarding proposals to bring Fannie/Freddie regulation
    under Treasury, the ICBA reiterates its staunchly held view
    that any such entity must be politically independent in order
    to be a world class financial regulator.
        We strongly urge Congress to ensure that any potential
    legislation contain appropriate firewalls and independence
    between Fannie, Freddie, and Treasury's politically appointed
    policymakers.
        In closing, the ICBA urges the Committee to carefully and
    fully consider the issues associated with housing GSE
    regulation before rushing to action. There is no shortage of
    opinions and strongly held viewpoints on these issues. We
    concur with the sentiments expressed by a number of Committee
    Members that it is imperative that any regulatory structuring
    be done right, given its potential impact on our crucial
    housing sector and on community banks' continued ability to
    meet the lending needs of Main Street America.
        I thank you for the opportunity today to testify, and I
    would be pleased to answer any questions.
        Chairman Shelby. Thank you.
        Mr. Fishbein.

                     STATEMENT OF ALLEN J. FISHBEIN

                 DIRECTOR FOR HOUSING AND CREDIT POLICY

                     CONSUMER FEDERATION OF AMERICA

                              ON BEHALF OF

                CONSUMER FEDERATION OF AMERICA, NATIONAL

              ASSOCIATION OF CONSUMER ADVOCATES, NATIONAL

               COMMUNITY REINVESTMENT COALITION, NATIONAL

              CONGRESS FOR COMMUNITY ECONOMIC DEVELOPMENT

                   AND NATIONAL FAIR HOUSING ALLIANCE

        Mr. Fishbein. Thank you, Mr. Chairman, Senator Sarbanes,
    and Members of the Committee. My name is Allen Fishbein, and I
    am Director of Housing and Credit Policy for the Consumer
    Federation of America, and we appreciate the opportunity to
    testify on proposals for improving the regulation of housing
    Government Sponsored Enterprises.
        My opening statement today is also on behalf of the
    following organizations: The National Association of Consumer
    Advocates, the National Community Reinvestment Coalition,
    National Congress for Community Economic Development, and the
    National Fair Housing Alliance.
        As national consumer community and civil rights
    organizations committed to the promotion of fair and affordable
    housing for all of America's citizens, we watch with
    considerable interest the ongoing debate about possible changes
    to the regulatory structure for Fannie Mae and Freddie Mac, and
    wanted to share a few of our observations.
        We appreciate those in Congress who desire to assure the
    adequacy of safety and soundness and mission-related
    requirements for the GSE's. We also urge that Congress be very
    careful in tinkering with the GSE's' basic overall regulatory
    structure. At a minimum such changes to the regulatory
    structure should do no harm to the GSE's' housing mission.
    However, we also believe that the current debate provides an
    opportunity to clarify those areas of the GSE's' affordable
    housing mission that should be expanded. Fannie Mae and Freddie
    Mac have fulfilled an important part of their mission by
    providing affordable housing capital for low- and moderate-
    income and minority households, yet much remains for the GSE's
    to accomplish in expanding fair and affordable housing
    opportunities for the residents of our Nation's underserved
    communities, such as providing greater assistance to first-time
    minority and low-income homeowners, securitizing multifamily
    rental mortgage products. Similarly, while the GSE's have been
    industry leaders in adopting policies to combat a number of
    predatory lending practices such as their repudiation of the
    purchase of single-premium credit life insurance products, they
    have yet to address certain other egregious lending practices.
        More specifically, we believe important improvements to
    present affordable housing goals requirement are desirable.
    Clearly, the establishment of these goals has served an
    important function, encouraging the GSE's to better serve the
    needs of underserved areas and low- and moderate-income
    households, and in fact, both Enterprises have consistently met
    or exceeded the goal level set for them. Nonetheless, the three
    statutory goals in place do not permit HUD to focus sufficient
    GSE attention to addressing some of the neediest segments of
    the mortgage market. Establishing an additional GSE home
    purchase goal and providing HUD with supplemental authority to
    set sub goals for GSE activity for particularly needs within
    the overall statutory goals, while not diminishing the ability
    of the GSE's to serve the needs of all consumers refinancing
    loans would enhance the overall effectiveness of this important
    mandate. Also, reform of the GSE's' housing goals should
    include provisions to expand opportunities for public input
    into this important area of regulation.
        Our strong interest in affordable housing extends to other
    aspects of regulatory restructuring as well. We are
    particularly concerned that proposals to shift general charter
    oversight and new program approval authority away from HUD to
    the Treasury Department will detract from the regulatory focus
    on the GSE's' performance of their housing mission. At the same
    time, funding the reasonable cost of this regulation through
    direct assessments of the GSE's and not through the
    appropriations process would go a long way in strengthening
    oversight capacity.
        We are also concerned with deliberations around two
    regulatory areas, capital requirements and the program approval
    process. First, the GSE's' capital requirement is one of the
    most critical and sensitive issues. We recognize that the
    establishment of appropriate capital requirements may at times
    involve tradeoffs, but we fear that unnecessary increases in
    capital requirements, particularly the minimum requirement,
    could result in a higher cost to homebuyers.
        Second, in evaluating any changes to the current program or
    approval process, a delicate balance is required between a
    careful
    examination of whether a new GSE product serves its important
    public mission and the need to not overburden these
    organizations' innovative efforts to provide new lending
    opportunities in the most difficult to serve communities. While
    there may be a need to improve the current approval process, we
    urge you to proceed cautiously and resist efforts to over
    encumber this process.
        While my testimony mainly focuses on regulatory oversight
    of Fannie Mae and Freddie Mac, we also offer the following
    comments on the regulation of the other GSE's, the Federal Home
    Loan Bank System. We believe the Federal Home Loan Bank system
    has evolved and must also have clear and specific housing goals
    that challenge lenders to better server underserved
    populations. Should Congress decide to abolish the Federal
    Housing Finance Board, the System's regulator, and transfer
    authority to another agency, we strongly prefer that mission
    oversight be transferred to HUD and that the Department also be
    provided with authority to establish new affordable housing
    requirements to ensure that activities undertaken by the
    Federal Home Loan Banks are targeted to low- and moderate-
    income housing and other underserved community needs.
        In closing, we thank you, Mr. Chairman, and Senator
    Sarbanes for your work and attempting to strengthen the
    effectiveness of the GSE's, to serve the housing needs of
    America's underserved populations. We urge that you support
    provisions to strengthen the housing goals requirement, but
    also proceed with caution and resist the urge to make changes
    to their status or their charter that might result in fewer
    affordable housing opportunities.
        Thank you for this opportunity to testify and I would be
    glad to answer any questions you have.
        Chairman Shelby. Thank you.
        Mr. Couch.

                      STATEMENT OF ROBERT M. COUCH

                 CHAIRMAN, MORTGAGE BANKERS ASSOCIATION

        Mr. Couch. Thank you. Chairman Shelby, Ranking Member
    Sarbanes, and distinguished Committee Members, thank you for
    inviting the Mortgage Bankers Association to speak at this
    important hearing.
        MBA members originate loans in the primary mortgage market
    and then sell those loans to Fannie Mae and Freddie Mac. MBA
    therefore has a keen interest in maintaining the safety and
    soundness of our country's real estate finance system.
        Fannie Mae and Freddie Mac play two important roles in the
    American home finance system. First, they provide market
    liquidity. Second, the buy affordable housing loans from
    lenders so that lower-income Americans and those living in
    underserved areas can get access to housing credit. Obviously,
    it is imperative to have effective oversight of the GSE's.
        The Mortgage Bankers Association endorses the principles
    for GSE regulation laid out by Secretary Snow and Secretary
    Martinez before the Committee earlier this month. Further, the
    Mortgage Bankers support certain core principles for effective
    regulation of Fannie Mae and Freddie Mac. First, effective
    safety and soundness oversight is vital. The Treasury
    Department successfully regulates both national banks and
    Federal thrifts and has successfully demonstrated its ability
    to fulfill the role of a financial safety and soundness
    regulator. The Mortgage Bankers support establishing Treasury
    as the safety and soundness regulator for Fannie Mae and
    Freddie Mac.
        Second, the GSE regulators, both within the Treasury and
    HUD, need to have adequate funding if they are going to live up
    to their important duties. The Mortgage Bankers Association
    urges this Committee to look at the Office of Thrift
    Supervision funding mechanism in drafting its legislation.
        Third, the safety and soundness regulator needs flexibility
    in setting capital standards. MBA does not mean to imply that
    today's capital requirements are inappropriate or inadequate in
    any way. Rather, MBA believes that the regulator needs the
    tools to respond to changing marketplace conditions. Capital
    standards are a fundamental tool in this regard. A statute
    should not unduly tie a regulator's hands.
        Fourth, a regulator needs adequate enforcement authority to
    correct any problems that may arise and more importantly, to
    deter problems in the first place. MBA believes that the
    banking enforcement tools have proven their effectiveness over
    the years and supports including such tools for the GSE
    regulator.
        Within these four core principles, one issue stands out to
    MBA as fundamentally important for the mortgage industry, the
    safety and soundness of GSE programs and activities. The
    activities of Fannie Mae and Freddie Mac have ramifications
    throughout the American mortgage market, and indeed throughout
    domestic and international economies.
        For these reasons all of their activities must be safe and
    sound, not just some. We believe that the approval of new
    programs and activities is fundamentally linked to financial
    safety and soundness. The safety and soundness regulator is in
    the best position to evaluate the appropriateness of new or
    proposed GSE programs. Congress should draw a clear line
    between the primary and secondary mortgage markets. In no event
    should the GSE's be permitted to encroach upon the mortgage
    origination process of use their Government-sponsored benefits
    to distort the competitive landscape of the primary mortgage
    market.
        MBA also believes that it is important that the regulator
    not micro-manage the GSE's, and that it not unduly constrain
    the GSE's' ability to innovate in a timely manner to meet
    marketplace needs. Fannie Mae and Freddie Mac have Government
    sponsorship so they can assist Americans with their housing
    needs. Effective safety and soundness oversight ensures that
    the GSE's are able to meet these needs. MBA strongly supports
    the affordable housing goals for Fannie Mae and Freddie Mac and
    endorses HUD's role in setting and enforcing those goals.
        MBA strongly urges Congress to reform the oversight of
    Fannie Mae and Freddie Mac in this manner so that they can
    continue their role in supporting housing, especially
    affordable housing.
        Thank you, and I am happy to answer any questions the
    Committee may have.
        Chairman Shelby. Thank you.
        Ms. Harrison.

                     STATEMENT OF IONA C. HARRISON

                 REALTY EXECUTIVES-MAIN STREET, U.S.A.

                              ON BEHALF OF

            THE NATIONAL ASSOCIATION OF REALTORS'

        Ms. Harrison. Chairman Shelby, Ranking Member Sarbanes, and
    Members of the Committee, good afternoon. I am Iona Harrison
    with Realty Executives Main Street USA, a real estate brokerage
    firm in Upper Marlboro, Maryland. As incoming chair of the
    National Association of REALTORS' Public Policy
    Coordinating Committee, thank you for the opportunity to give
    NAR's views on proposals to enhance regulation of the housing
    GSE's.
        Before I begin my statement, let me first thank you, Mr.
    Chairman, and Senator Allard, if he were here, for efforts on
    the American Dream Downpayment Act. The Senate Banking
    Committee unanimously approved this bill with two important
    amendments that increased the FHA multifamily loan limits in
    high cost areas and improved the FHA hybrid ARM program.
        NAR leads a coalition of supporters who are hopeful that
    the bill will come to the Senate floor shortly. By adopting
    this legislation, Congress will send a strong message
    supporting the Administration on increasing homeownership
    opportunities. This bill is evidence of the importance this
    Congress and Administration place on homeownership
    opportunities. Your GSE reforms can ensure that this commitment
    remains a high priority in future years. To do so, NAR believes
    that a new safety and soundness GSE regulator must be truly
    independent and that program approval and housing mission must
    remain at HUD.
        The National Association of REALTORS' supports a
    credible and vigorous GSE regulator. REALTORS' agree
    that Fannie Mae and Freddie Mac should have an independent
    regulator for safety and soundness. We recommend that a new
    regulatory agency in the Treasury Department should have
    necessary and sufficient firewalls to ensure its political and
    operating independence similar to those that currently exist
    for the OCC and OTS.
        The Administration proposal to place GSE regulatory
    oversight and new program approval under the Treasury
    Department is a major change. REALTORS' expressed
    opposition to moving GSE housing mission and program approval
    from HUD when the Administration's plan was first released. Our
    concern is that housing policy has not been the purview or
    expertise of the Treasury Department. This has been the purview
    of HUD. Housing and real estate industries naturally look to
    HUD to address housing mission, programs and affordable housing
    goals. HUD should maintain its primacy in these areas.
        REALTORS' recognize that new programs could have
    an impact on safety and soundness. Therefore, the new regulator
    should have a consulting role to HUD on any safety and
    soundness implications. Program approval must continue at HUD
    under current standards. Congress deemed the Government
    Sponsored Enterprise model as an appropriate vehicle to advance
    homeownership and housing
    policy as recently as 1992 when it adopted the Federal Housing
    Enterprises Financial Safety and Soundness Act. Since that
    time, Congress, homeowners, the housing finance system, and the
    Nation's economy have all benefited tremendously. The
    unprecedented expansion of homeownership rates is undeniable
    testament to the efficiency and liquidity of the secondary
    mortgage market and the housing sector.
        Although realtors support a strong regulator, we insist
    that regulatory reform does not imply and should not result in
    any weakening of the current housing finance system. Targeted
    reform for GSE regulation should strengthen our housing finance
    system.
        Mr. Chairman, in conclusion, realtors support your
    deliberate, thoughtful consideration of what measures should be
    taken to improve GSE oversight. We look forward to working with
    you and I will be happy to answer any questions you may have.
        Chairman Shelby. Thank you. We have a vote on the floor but
    I thought I would start a few questions. Senator Sarbanes and I
    will have to go vote, recess the Committee, and come back,
    because you are too important to let loose yet.
        Mr. Koch and Mr. Torpey, the minimum capital threshold that
    we keep talking about at 2.5 percent that Fannie and Freddie
    are subject to is often compared, as we know, to the 4 percent
    minimum capital standard that banks and thrifts must meet. Do
    you believe that this is a fair comparison given the riskier
    set of assets held by banks and thrifts?
        Mr. Torpey. I can start with that. I think given the
    limited assets that the GSE's have that it is probably
    adequate. I always say within the banks that we always want to
    have at least 10 percent of any entity coming in, and many
    times 20 to 30 percent. But on the other hand we are dealing in
    our area with agriculture, with small businesses, with that
    thing. So the risks are completely different as far as I am
    concerned.
        Chairman Shelby. Mr. Koch.
        Mr. Koch. I think the real issue here is what activities
    are they getting involved in and the need to have the minimum
    capital reviewed by their primary regulator. For example,
    Fannie Mae and Freddie Mac have secured approval to get
    involved in A&D lending. A&D lending is land development
    activity, which is highly risky, involving expertise
    significantly different than simply investing in one to four
    family owner-occupied properties, or even owner-occupied
    apartments. There are zoning issues, there are guarantor
    issues. These are high-risk investment types.
        So the 2.5 percent minimum really needs to be weighed in
    terms of what kinds of new activities are they getting involved
    in. That is the real issue here. As new activities expand, and
    they have expanded dramatically without significant regulatory
    oversight, that is where the capital really becomes critical.
        Chairman Shelby. Senator Sarbanes is not going to be able
    to come back. He has other commitments and we have to vote, so
    I am going to yield to him now.
        Senator Sarbanes. Thank you very much, Mr. Chairman. First,
    I want to thank the panel. We certainly appreciate not only
    your oral testimony but also the careful work which has
    obviously gone into your written testimony. I just want to ask
    one question. I apologize I will not be able to return because
    we did not expect this vote to happen.
        The Assistant Secretary of the Treasury spoke at the
    Heritage Foundation yesterday, which was reported--which
    actually affected the bond markets as I think you are aware.
    One of the fellow panelists, in fact the resident fellow at the
    American Enterprise Institute said, the only realistic answer,
    talking about the GSE's, is to provide more competition in the
    secondary market. I think the only answer is privatization.
        I would just very quickly like to get a response of the
    members of this panel to that proposal, and the concern on the
    part of some that that objective is floating behind a lot of
    the discussion on this issue. If I could just quickly get a
    response.
        Mr. Koch. Very quickly, housing in the United States is the
    best in the world. We are the global envy on housing.
    Substantially changing the process in terms of privatization,
    we would not support at this time. We would support additional,
    however, efforts to assist low-income and moderate-income
    individuals in this country for enhanced housing opportunities.
        Senator Sarbanes. Mr. Torpey.
        Mr. Torpey. We would oppose that. I think Senator Bunning
    asked the question about the harm to small banks. If you
    privatize the system, you would have large banks that may have
    access to that, but I think the real harm here would be the
    harm to small community banks where we are not going to have
    access to the same funding that a large national bank would.
    And quite frankly, these small community banks are so important
    to these small communities that to privatize that I think would
    do great harm to the system.
        Senator Sarbanes. Mr. Fishbein.
        Mr. Fishbein. The GSE's were established to perform a very
    important public mission, not the least of which is to direct
    increased financing to improve opportunities for affordable
    housing for low- and moderate-income households and underserved
    communities, and we think that public mission and need
    continues and therefore, so should the GSE's.
        Senator Sarbanes. Mr. Couch.
        Mr. Couch. First to your issue of competition, the Mortgage
    Bankers Association has a long-standing policy that more
    competition is good and that is why we are in support of the
    Federal Home Loan Banks activities in the mortgage markets.
    With respect to privatization, we would be opposed to
    privatization because, as several of the panelists, said the
    system right now is working well and we would like to keep it
    doing what it is doing so well right now.
        Senator Sarbanes. Ms. Harrison.
        Ms. Harrison. Again, NAR's position is to promote
    homeownership at every level and to continue to provide
    mortgage vehicles to effect that goal. The GSE's have this
    unique homeownership mission that we would continue to support.
    Quite frankly, I personally feel that private sector would not
    necessarily have this goal in mind since I would think making a
    profit would be their primary goal and underserved people would
    continue to be underserved.
        Senator Sarbanes. Thank you very much.
        Thank you, Mr. Chairman.
        Chairman Shelby. We do have a vote, and because I have
    about four or five complicated questions, I would like, if I
    could, to submit those for the record, give you time, all of
    you, this panel, time to answer these for the Committee. Would
    that be agreeable to you?
        With that, we are going to go vote. We do not know what is
    going to happen behind that. We thank you for your testimony
    and we look forward to the answers to these other questions.
    You help us immensely. Thank you a lot.
        We are adjourned.
        [Whereupon, at 12:16 p.m., the hearing was adjourned.]
        [Prepared statements, response to written questions, and
    additional material supplied for the record follow:]
                      PREPARED STATEMENT OF JOHN T. KORSMO
                    Chairman, Federal Housing Finance Board
                                October 23, 2003
        Good morning and thank you, Mr. Chairman, Ranking Member Sarbanes,
    and distinguished Members of the Committee.
        In December 2001, this Committee and the Senate honored me with
    confirmation to membership on the Federal Housing Finance Board
    (Finance Board) and President Bush entrusted me with the Finance
    Board's chairmanship. During my confirmation hearing, both Senator
    Sarbanes and former Senator Gramm impressed on me--indelibly--their
    concern over the Finance Board's inadequate performance.
        In response, I committed myself to leading the Agency to fulfill
    the intent of Congress in FIRREA and the Gramm-Leach-Bliley Act--that
    is, to create a credible arm's-length regulator for the Federal Home
    Loan Banks (FHLBanks). So, I testify today not as an apologist for the
    Banks and certainly not as a partisan for the Finance Board, but rather
    as a safety and soundness regulator who takes seriously his oath of
    office and his promise to this Committee.
        In that spirit, I offer today my experience as you seek to develop
    policy for the supervision of the Nation's housing Government Sponsored
    Enterprises (GSE's).
         Congress and the Administration are engaged in a worthy effort to
    ensure proper regulation of the GSE's, and this effort, I believe,
    would be well-served by seeking a broader context. That is, to craft an
    appropriate housing GSE regulator, policymakers should thoroughly
    consider what is to be regulated, both today and in the future. The
    first question to ask is what today's capital and mortgage markets look
    like, 70 years after the charters for housing GSE's were cast? What
    will these markets look like 10, 20, 30 years in the future? And what
    role or roles should Government Sponsored Enterprises play in those
    markets?
        Answering these questions I believe will require a thorough review,
    necessary to set the stage for a comprehensive reform debate in
    Congress, with participation by the executive branch, by the housing
    GSE's themselves and their competitors, and by the public.
        This review, of course, does not preclude immediate action with
    respect to the Office of Federal Housing Enterprise Oversight (OFHEO).
    OFHEO's mission could well benefit from budget independence and the
    granting of the same full powers in use by other banking supervisors,
    including the Finance Board under the Federal Home Loan Bank Act.
        The Federal Home Loan Bank Act grants the Finance Board the
    authority, the independence, and the executive branch voice needed for
    robust supervision of Government sponsored public trusts.
        Through FIRREA in 1989 and Gramm-Leach-Bliley a decade later,
    Congress drew on the lessons of the thrift crisis and the poorly
    conceived Federal Home Loan Bank Board to shape the Finance Board into
    a safety and soundness and mission watchdog for the Federal Home Loan
    Banks, granting the Finance Board all the authority and independence
    needed to be a world-class regulator.
        The Federal Home Loan Bank Act provides:

     Enforcement authority on a par with other Federal bank
        regulators;
     Flexibility to tighten capital standards and risk monitoring,
        if needed;
     Authority to review and approve new business activities in
        advance;
     Authority to define and monitor affordable housing programs
        conducted by Federal Home Loan Banks;
     Full authority to liquidate a Bank, to establish a
        replacement, or to merge weakened Banks;
     The freedom to garner budget resources from the Banks and to
        deploy them as most needed; and
     A direct voice on the Board for the executive branch in
        overseeing the Federal Home Loan Banks' role in capital markets and
        mortgage markets.

         None of these tools is found in OFHEO's statute. These tools
    should be considered for inclusion if Congress decides, after
    determining the appropriate future roles of housing GSE's, that a new
    regulator for some or all of the Enterprises is required.
    Overview
        To properly consider the effective oversight of housing GSE's, as
    now constituted, Congress should proceed on the basis of proposals from
    the Administration and several Members that seek to increase the tools
    available to supervise Freddie Mac and Fannie Mae.
        As mentioned, the Federal Home Loan Bank Act, as amended by FIRREA
    and Gramm-Leach-Bliley, equips the Federal Housing Finance Board with
    the full set of supervisory tools required for world-class oversight.
    Increasingly, these powers are aggressively and ably employed by the
    Finance Board.
        Because markets are sophisticated and place a premium on actual
    performance and verifiable information, I do not believe simply
    changing the name or status of the agency responsible for the Federal
    Home Loan Bank Act will result in more favorable treatment of FHLBanks
    by investors. I know of no study concerning Federal thrifts and
    national banks, for example, substantiating the premise that distinct
    but effective regulators affect the price of borrowing by Federal
    thrifts and national banks.
        As this debate refocuses on substantive and difficult questions, it
    will be necessary to distinguish the risks inherent in the housing
    GSE's banking functions, the unique risks associated with housing GSE
    status, and the nature of possible future problems.
        It is also important to recognize that remedying the known
    shortcomings in the 1992 GSE Act regulating Freddie Mac and Fannie Mae
    and/or transferring Federal Home Loan Bank Act authority to a new body
    will not, in and of themselves, reduce or dilute the potential risks
    posed by the housing GSE's to the taxpayers and the economy. The
    housing GSE's are banking enterprises, and banking is an inherently
    risky business. In the housing GSE sector, these risks and market share
    are highly concentrated in the two largest enterprises.
        The housing GSE's have grown exponentially in size, sophistication,
    and inherent risk as capital and mortgage markets have revolutionized.
    All 14 housing GSE's now play critical roles in domestic and global
    capital markets and in U.S. housing markets. That growth, together with
    the reality of a perceived taxpayer guarantee, make it imperative that
    the Freddie Mac and Fannie Mae oversight statute be brought up to
    world-class and that Finance Board administration of the FHLBank Act
    complete its rapid evolution to world-class.
    Unique Housing GSE Risks
        For holding companies, commercial banks, thrifts, and credit unions
    supervised by Federal banking agencies, the institutions' boards of
    directors determine the markets to be served, the products to be
    offered, and the pace of growth or retraction.
        For housing GSE's, the broad parameters of markets served, products
    offered, and growth are driven by Congressional charters.
        These charters were framed in the 1930's and charged the FHLBanks,
    Fannie Mae, and later Freddie Mac with providing liquidity for lenders
    making long-term amortizing home mortgages. The housing GSE's were part
    of a set of New Deal policy innovations, including Federal Housing
    Administration mortgage insurance and the activities now conducted
    under the aegis of Ginnie Mae, which have succeeded beyond all
    reasonable expectations in establishing the long-term amortizing
    mortgage as the industry standard, creating a secondary market in these
    loans, and creating a securitization market based on these products.
        The monopolies granted by both the FHLBank charter and the Freddie
    Mac and Fannie Mae charters also bear the seeds of systemic risk.
    Protection from broadly effective competition from other GSE's or fully
    private firms assists the housing GSE's in accomplishing their
    missions. But this benefit may also partially shield them from the
    harsher realities of the marketplace that tend to reward the best
    capitalized, best managed corporations in a given sector.
        Closely associated with monopoly privileges is the taxpayer
    guarantee that appears to flow from the bare fact of Government
    sponsorship and from the tax exemptions, securities law exemptions,
    Treasury ``line of credit,'' and other benefits of that sponsorship.
    Anecdotal but consistent and long-standing evidence indicates that the
    ``implied guarantee'' and ``agency debt'' status are extremely valuable
    attributes. This distraction from assessing the credit-worthiness of
    housing GSE's on wholly tangible grounds is another systemic source of
    risk unique to these 14 Enterprises.
        Moreover, because the GSE's are expected to serve all markets
    through all parts of the business cycle, and more importantly, because
    the fundamental missions and roles have not been recalibrated as fully
    private firms have successfully followed the GSE's into most mortgage
    finance products and services, housing GSE's tend to grow without
    meaningful restrictions.
        As housing GSE's acquire greater exposure to inherent banking risks
    through growth, they also are exposed to increased risk as a result of
    their participation in derivatives, securities, and debt markets which
    have become more global, more sophisticated, more innovative, and more
    rapidly-evolving.
        These factors, weighed with the systemic risks of GSE status, argue
    that housing GSE risk in the future can only be significantly reduced
    by curtailing inefficient protections from competition and/or by
    recalibrating the charters so that housing GSE's actually shrink as
    fully private firms successfully take over some of the mortgage finance
    products and services now dominated by GSE's.
        The safety and soundness regulators of the housing GSE's are not
    the appropriate bodies for designing or effecting these charter
    reforms. The Government Sponsored Enterprises, by definition, are
    charged with accomplishing public objectives through private ownership.
    Only the public's representatives, the Congress and the Administration,
    can validly assess the need for future GSE participation in housing
    finance and capital markets and assign the benefits and obligations
    consistent with that need. The Congress and Administration are also the
    only valid bodies for determining the amount of risk to taxpayers and
    the national economy appropriate to the contributions of housing GSE's.
        Once the future roles of housing GSE's are assigned and the
    appropriate risk level is determined, it should be, as it is now, the
    duty of the Finance Board, OFHEO, and the Department of Housing and
    Urban Development (HUD), or whatever successor agencies Congress and
    the Administration may create, to police their governance and
    operations in managing inherent risks and their fidelity to housing GSE
    charters.
    The Future of Housing GSE Supervision
        Mapping the future of housing GSE oversight, properly calibrated to
    match the future roles and risks of the Enterprises, begins with an
    honest assessment of the authorities governing the operation of OFHEO
    and the Finance Board.
        When Congress established a regulator for Freddie Mac and Fannie
    Mae in 1992, it did not provide OFHEO with all the tools and
    independence of the Office of the Comptroller of the Currency (OCC),
    Office of Thrift Supervision (OTS), the Federal Deposit Insurance
    Corporation (FDIC), or Federal Reserve.
        Even taking into account the new product and affordable housing
    portfolios assigned to HUD, these two housing GSE's are not supervised
    on fully comparable terms to Federal credit unions, national banks,
    Federal thrifts, bank holding companies, or, for that matter, the
    Federal Home Loan Banks.
        The 1992 GSE Act's deficiencies in funding and in supervision and
    enforcement tools and flexibility should be addressed.
        The Administration's proposals and some Congressional proposals
    largely bring to bear on Freddie Mac and Fannie Mae budget resources
    and supervisory tools fully comparable to those available to other
    Federal supervisors of financial institutions. The Administration also
    makes a common sense and plainly necessary proposal to give the public
    a role in shaping and overseeing Freddie Mac and Fannie Mae, which is
    similar to the executive branch participation on the Finance Board.
        As outlined above, the Finance Board already is endowed with the
    resources, strength, independence, and supervisory scope that mark
    world-class safety and soundness regulators.
        But until recently, the Finance Board was not fully discharging the
    mandates of the FHLBank Act or making full use of its independence and
    resources. Fortunately, these shortcomings are being rapidly and
    thoroughly rectified.
        Today, the Finance Board has more than double the number of
    examiners on staff when I took the oath of office in December 2001 and
    my Board colleagues and I began the process of rebuilding the
    examination and supervision functions at the Finance Board. This corps
    of 18 examiners will expand to 30 by this time next year and has been
    supplemented by additional financial analysts, accountants, and risk
    management specialists.
        The Finance Board is recruiting and hiring the best and brightest
    from other Federal banking agencies. The average Finance Board examiner
    has over 17 years of examination experience, and every examiner is a
    commissioned examiner, has a professional accreditation, or both.
        Finance Board oversight has improved in every way and the
    opportunity to work with the members of the Federal Home Loan Bank
    oversight team is now becoming a prestige career move.
         Attached to this prepared testimony is an appendix providing more
    detail on the new FHLBank supervision program being put in place and
    the progress made to date. The numbers provided in the appendix are
    impressive, but more important is the explanation of how the Finance
    Board has entirely revamped its approach to FHLBank supervision over
    the past 18 months.
        Certainly, the Federal Home Loan Bank Act already provides the
    Finance Board with power to meet any eventuality, and we are fast
    approaching world-class status in the size and skills, the capacity and
    sophistication, of our staff and their oversight of the 12 Banks.
        Mr. Chairman, you asked me to address other specific issues in my
    prepared testimony. Allow me to do so at this point.
    Funding Process
        Independent boards have advantages and disadvantages compared to
    both the OCC/OTS model and to a less autonomous bureau within Treasury.
    One strength of an independent board is that budgets set by action of
    the Finance Board, for example, in public meetings provide a suitable
    degree of accountability in resource allocation without compromising
    independence through Congressional or OMB review.
    Capital Regime
        The minimum leverage requirements and risk-based capital
    requirements now in force for FHLBanks appear to be appropriate.
    Importantly, the Federal Home Loan Bank Act permits the Finance Board
    to increase or tailor these standards if experience demonstrates a
    need.
    SEC Registration
        Only through conservative management and superior transparency and
    governance will all 14 housing GSE's maintain the highest measure of
    market confidence. I believe superior transparency requires that each
    FHLBank commit to voluntarily meet the quarterly and annual financial
    reporting requirements of Section 12(g) of the Securities Exchange Act
    of 1934, as administered and enforced by the Securities and Exchange
    Commission (SEC). SEC registration and disclosure will enable markets
    to place greater reliance on and maintain greater confidence in the
    balance sheets, business prospects, and corporate governance of the
    FHLBanks. That is why, at its September 10, 2003, meeting, the Finance
    Board unanimously adopted and subsequently published for comment a
    proposed regulation requiring FHLBank 1934 Act registration.
    Office of Finance
        Before closing this discussion of the possible or feared effects of
    housing GSE regulator reform on the funding of FHLBanks, I must alert
    the Committee to a question requiring considerable study before
    attempting any transfer of responsibility for administration of the
    FHLBank Act. The Act ratified the Federal Home Loan Bank Board's
    establishment of the Office of Finance (OF) to issue consolidated
    obligations (bonds and notes) on behalf of the FHLBanks. Several years
    ago, the Finance Board devolved authority over management of the OF to
    a board of directors appointed by the Finance Board. The OF has also
    been assigned the task of compiling and issuing combined financial
    reports for the 12 FHLBanks.
        But OF is an unusual corporate posture. It is not incorporated and
    has no balance sheet and no executive control of any FHLBank. OF
    instead acts as an agent for the FHLBanks and is the ``name and face''
    shown to capital markets--which are not offered obligations in the name
    of any specific FHLBank, but rather ``System'' obligations issued
    through OF and backed by the joint and several liability of all 12
    FHLBanks.
        Understanding Treasury's apparent wish to avoid providing any
    reenforcement of the perception of an implied taxpayer guarantee behind
    housing GSE debt, Treasury's views should be included in determining
    whether and how to shift authority over OF to Treasury.
    Conclusion
        Legislating the best set of tools and best structure for housing
    GSE supervision is an area of economic and housing policy that must be
    addressed.
        Before again locking into statute a system of supervision for some
    or all housing GSE's that is not world-class, policymakers from
    Congress, Treasury, HUD, and all 14 housing GSE's should begin the more
    comprehensive charter reform debate outlined above.
        That comprehensive reform debate should sort out--70 years after
    creation of GSE's and long-term amortizing mortgages--the most
    constructive role for housing GSE's in the mortgage finance marketplace
    of the 21st century. The questions policymakers should consider asking
    include:

     What is the right level of competition between housing GSE's
        and other mortgage financiers?
     What is the right level of competition among the housing GSE's
        themselves?
     What is the right level of risk to the taxpayers in proportion
        to the benefits the housing GSE's confer on the Nation's housing
        finance system?

        Once a coherent national policy clearly outlining Government and
    private roles in the future is in place, all parties to the debate will
    be fully equipped to design a world-class supervisor able to evolve
    along with housing GSE's appropriately sized and appropriately directed
    to best support but not interfere with the markets of tomorrow.
        I know of no immediate or imminent safety and soundness or
    liquidity imperative forcing us to do the job any way but the right
    way, and I think everyone is aware the stakes are high if the result is
    muddled.
        I suggest, therefore, that the housing GSE reform effort move in a
    logical, deliberate manner to define the roles Freddie Mac, Fannie Mae,
    and the Federal Home Loan Banks should play in a continually innovating
    mortgage finance market, to define the appropriate risks to assume in
    the institutions fulfilling those roles, and then to determine how best
    to regulate the roles and risks and innovations that result.
        Again, thank you for the asking me to speak to you today and for
    the attention this Committee gives to homeownership, housing
    affordability, and housing GSE issues.

                   PREPARED STATEMENT OF ARMANDO FALCON, JR.
            Director, Office of Federal Housing Enterprise Oversight
                                October 23, 2003
        Chairman Shelby, Ranking Member Sarbanes, and Members of the
    Committee, thank you for inviting me to appear before you today. I am
    pleased to provide my views on improvements that can and should be made
    to the regulatory oversight of Fannie Mae and Freddie Mac. My views are
    my own and are not necessarily those of the President or the Secretary
    of Housing and Urban Development.
        When I took office as Director of the Office of Federal Housing
    Enterprise Oversight (OFHEO) in October 1999, I quickly realized that
    the Agency's long-term success was jeopardized by inadequate resources,
    a constraining funding mechanism, and a lack of powers equal to those
    of other regulators. Over the past 4 years, I have been a consistent
    advocate of legislation designed to address those shortcomings, and so
    I was encouraged by the Administration's comprehensive proposal.
        I am in general agreement with it, but I do have a few concerns
    that I hope can be properly addressed.
    Guiding Principles
        I would like to outline my views in the context of five guiding
    principles. They are:

     The regulator should remain independent;
     The regulator should be permanently funded, outside the
        appropriations process;
     The regulator should have powers equal to those of other
        safety and soundness regulators;
     The regulator should have full discretion in setting capital
        standards; and
     Legislation should build on progress made.

        Adherence to each of these principles will strengthen supervision
    and the safe and sound operation of the Enterprises. Our ultimate goal
    and benchmark should be to establish a new regulator that is on an
    equal plane with the Office of the Comptroller of the Currency (OCC),
    and the Office of Thrift Supervision (OTS), both of which operate as
    independent safety and soundness regulators within the Treasury
    Department. I would like to elaborate on the five principles.
    Regulatory Independence
        First, the regulator should remain independent. The concept of an
    independent Federal agency to oversee Fannie Mae and Freddie Mac was
    established in the legislative history of the 1992 Act that created
    OFHEO. The need for regulatory independence was borne out of Congress'
    experience with the savings and loan crisis. I had the privilege of
    serving as Counsel to the House Banking Committee during that difficult
    period. One of the clear lessons learned was that all safety and
    soundness regulators should be objective, nonpartisan, and protected
    from political interference. This is especially critical at times when
    regulators must make difficult and sometimes politically unpopular
    decisions. In addition, independent regulation protects Congress'
    ability to receive the regulator's best judgment on regulatory matters
    unfiltered and without delay. With billions of dollars of potential
    taxpayer liability at stake, it is in everyone's interest that this
    important safeguard not be weakened.
        Like OFHEO, the Office of Thrift Supervision is another useful
    example of how a new independent regulator should be established as
    part of a Departmental organization. In 1989, Congress transferred
    responsibility for thrift regulation from the Federal Home Loan Bank
    Board to a newly created OTS within the Treasury Department. The OTS
    was established as a fully independent regulator. It has the same
    powers and unfettered ability to use those powers as the OCC.
        Congress should ensure that the new regulator has full statutory
    independence.
    Permanent Funding
        Second, the regulator should be permanently funded, outside the
    appropriations process. Currently, OFHEO is funded annually through the
    Federal budget and appropriations process, even though the Agency does
    not utilize any taxpayer funds. OFHEO is funded through assessments on
    the Enterprises, but those assessments cannot occur until approved by
    an appropriations bill and at a level set by the bill. OFHEO is the
    only safety and soundness regulator funded in this limited manner. At a
    minimum, this serious anomaly should be fixed. Permanent funding will
    enable the regulator to fulfill its budgetary needs on a more
    reasonable basis without the timing constraint associated with the
    annual appropriations process. There should also be clear language that
    the Agency has the authority to levy special assessments or to
    establish a reserve fund as needed, to meet emergencies. Currently, any
    additional funds required to meet urgent, unexpected needs can be
    obtained only after a supplemental appropriation is enacted. This can
    delay action by the Agency to resolve problems early, before they
    threaten the safety and soundness of an Enterprise. Permanent funding
    will contribute to operational independence and will allow the Agency
    to respond quickly to any crisis at the Enterprises.
    Enhanced Supervisory Authority
        Third, the regulator should have powers equal to those of other
    regulators. While OFHEO's regulatory powers are fairly comparable to
    those of other financial safety and soundness regulators, certain
    authorities need to be provided and others clarified. For example, a
    safety and soundness regulator should have independent litigation
    authority, enhanced hiring authority and a full range of enforcement
    powers provided to financial regulators. Also, the laws should be
    revised to provide clearly that the regulator is empowered to address
    misconduct by institution-affiliated parties and to exercise general
    supervisory authorities.
    Flexible Capital Regulation
        Fourth, the regulator should have full discretion in setting
    capital standards. Capital is one of the fundamental bulwarks of
    effective safety and soundness regulation. The regulator should have
    broad discretion to exercise his or her best judgment, using all the
    information available through the examination process and otherwise, to
    determine if capital adjustments are necessary. All other safety and
    soundness regulators have this discretion.
        Going forward, the Agency needs to have the authority to modify
    both minimum and risk-based standards. This authority would help meet
    the changing mix of Enterprise business, the market environment in
    which they operate, and the changing nature of risk measurements
    themselves. As Secretary Snow has said in testimony before Congress,
    ``Broad authority over capital standards and the ability to change them
    as appropriate are of vital importance to a credible, world-class
    regulator.'' I agree.
    Build on Progress
        Fifth, legislation should build on the progress we have made over
    the last 10 years. Regulating Fannie Mae and Freddie Mac requires a
    specialized skill set. The capacity to model the cashflows of all the
    mortgages, debt, and other financial instruments owned, issued, or
    guaranteed by the Enterprises, needed for the stress test, is unique
    among financial institution regulators. Expertise in how these two
    secondary mortgage market companies manage mortgage risk, including the
    broad use of sophisticated derivatives and collectible debt is vital
    for effective regulation. In addition, an understanding of how the
    Enterprises are affected by the markets in which they operate is
    extremely important.
        Over the past 10 years, OFHEO has developed the specialized
    expertise, from our examiners and financial analysts, to our
    researchers and capital analysts, that is necessary to supervise these
    two unique companies. The cost in terms of lost regulatory capacity
    spent while trying to rebuild that infrastructure would be substantial.
    That is why I recommend that, if a new regulator is established in the
    Treasury Department, OFHEO's personnel, regulations, and administrative
    infrastructure should be transferred intact to the new agency. It would
    be highly counterproductive to do otherwise.
    Additional Issues
        There are a couple of other matters I would like to briefly
    discuss. First, I agree with Secretary Snow that the Presidentially
    appointed board positions should be discontinued. This is not a
    reflection of current or former Presidentially appointed directors.
    Rather, I think corporate governance would be enhanced if the
    shareholders were allowed to select all members of the board. It is
    difficult for even the most conscientious director to fully contribute
    when their terms are limited to one year, unless reappointed, and last
    on average for only 15 months. Shareholder elected directors usually
    are reappointed for up to 10 years.
        I also support the granting of authority to the safety and
    soundness regulator to determine whether the activities of an
    Enterprise are consistent with its charter authority. This would mean
    that a single regulator would have the ability to review all of the
    Enterprises' activities--new and existing. This change will consolidate
    the supervision of the Enterprises in a manner consistent with
    authorities of other regulators. I appreciate the concern expressed
    about the primacy of the Enterprises' housing mission if and when the
    charter compliance responsibility is shifted. The goal, in fact, of
    enforcing charter compliance is to ensure that the Enterprises remain
    properly focused on their housing mission and not stray into extraneous
    ventures. Consistent with that goal, I think a mechanism can be
    instituted to ensure that a new regulator actively solicits and
    considers all views, including housing advocates, when exercising its
    authority. The importance of their housing mission is actually why the
    Enterprises exist. Strengthening their safety and soundness regulation
    supports that mission by ensuring that they are strong enough to
    provide the financial services that make that mission a reality.
    Conclusion
        Mr. Chairman, before concluding my testimony, I would be remiss in
    not noting my appreciation for the interest and support of Members of
    this Committee during last week's hearing with respect to the
    Administration's request of $7.5 million in additional appropriations
    for OFHEO in fiscal year 2004. I look forward to working with the
    Committee on this request, as well as legislation to strengthen
    regulation of the Enterprises. I will be happy to answer questions that
    you and the Committee may have.
                                   ----------
                   PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
                     Director, Congressional Budget Office
                                October 23, 2003
         Mr. Chairman, Senator Sarbanes, and Members of the Committee,
    thank you for this opportunity to discuss the Congressional Budget
    Office's (CBO's) work on the economics, costs, and regulation of the
    Government Sponsored Enterprises (GSE's) for housing--namely, Fannie
    Mae, Freddie Mac, and the Federal Home Loan Banks. Broadly speaking,
    that work leads to three main points:

     The Federal Government confers substantial benefits on GSE's
        through an implied guarantee of their debt and other financial
        obligations;
     In doing so, the Government necessarily exposes taxpayers to
        risks; and
     Effective regulation can reduce but not eliminate the risks to
        taxpayers from the GSE's.
    The Benefits of GSE Status
         The principal benefit of having the status of Government Sponsored
    Enterprise is the ability to borrow at lower rates of interest than any
    fully private firm holding the same amount of private equity capital
    and taking the same risks is able to do. Sponsored status also enables
    the GSE's to borrow far larger sums than would be available to private
    borrowers. Low-cost capital and easy access to the market is the direct
    result of an implied Federal guarantee of the GSEs' obligations.
         The implicit guarantee is communicated to investors in capital
    markets through a number of provisions of law that create a perception
    of enhanced credit quality for the Enterprises as a result of their
    affiliation with the Government. Those provisions include a line of
    credit at the U.S. Treasury; exemption from the Securities and Exchange
    Commission's (SEC's) registration and disclosure requirements;
    exemption from State and local income taxes; and the appointment of
    some directors by the President of the United States. In addition,
    although Federally chartered and Federally insured banks face a limit
    on the amounts that they can invest in other types of securities, that
    limit does not apply to the GSEs' securities. Taken together, those
    statutory privileges have been sufficient to overcome an explicit
    denial of Federal backing that the GSE's include in their prospectuses.
        GSE status and the benefits it conveys are no longer necessary to
    the functions that Fannie Mae, Freddie Mac, and the Federal Home Loan
    Banks perform. Those purposes include ensuring a reliable source of
    funds to housing and increasing access to mortgage credit by low- and
    moderate-income borrowers so that more families can own their homes.
    Private financial institutions that lack GSE status, such as Washington
    Mutual and Bank of America, currently maintain a reliable link
    between the wholesale capital markets and retail lenders who originate
    home mortgages not eligible for financing from the GSE's. Moreover, the
    Government has numerous more-direct policies to assist low-income
    homebuyers, including mortgage insurance offered by the Federal Housing
    Administration and other more-targeted programs administered by Federal
    agencies.

        Private financial intermediaries, however, cannot match the low
    funding costs of the GSE's. To approach the GSEs' borrowing rates, they
    would have to raise more private equity capital and other private
    credit enhancements than do the housing GSE's. In short, they would
    need to convince lenders that they could replicate the Federal
    guarantee through private means. However, private providers of risk-
    bearing or credit-enhancement services require compensation
    commensurate with the
    assumed risk. The requisite backing from private sources, therefore, is
    costly. By contrast, the Government, provides the benefits of low-cost
    funding without charge.
        Assisted by the implied Federal guarantee, the housing GSE's have
    grown into some of the largest financial institutions in the world.
    Their outstanding securities now exceed $4 trillion--or more than the
    entire U.S. public debt. In the process, Fannie Mae and Freddie Mac
    have come to dominate the U.S. residential mortgage market, accounting
    for almost 57 percent of residential mortgage debt (see Table 1).
        The value of the Federal subsidy to the GSE's can be approximated
    by comparing the Enterprises' actual funding costs with those they
    would face as private intermediaries. In May 2001, CBO estimated that
    difference--on the basis of a credit rating of AA-2 for the housing
    GSE's--to be $10 billion to $15 billion per year from 1998 to 2000.
    Adjusted for the growth of the Enterprises (but with any increases in
    risk ignored), the current annual subsidy is, at a minimum, above the
    upper end of that range.
    The Exposure of Taxpayers to Risks from the GSE's
         By supporting the activities of the housing GSE's through an
    implied guarantee, the Government has assumed, on behalf of taxpayers,
    the risk of losses that might exceed the Enterprises' holdings of
    private equity capital. The housing GSE's offer public assurances that
    their assumed risks, especially for credit or default losses, are low
    in relation to their private capital. As a result, taxpayers may
    conclude that their own risk exposure is also low.
         The housing GSE's appear to be principally exposed to interest
    rate, prepayment, and operations risks. Interest rate risk refers to
    the different effect that changes in interest rates can have on the
    value of a firm's assets and liabilities and thus on its net worth. For
    example, an increase in interest rates will reduce the value of both
    fixed-rate assets and fixed-rate liabilities, but the value of assets
    will be hit harder if the assets have a longer maturity than the
    liabilities do. A rise in interest rates, therefore, can wipe out a
    financial intermediary's equity capital.
         Entities that hold portfolios of fixed-rate mortgages are also
    subject to prepayment risk. Specifically, the value of a portfolio of
    fixed-rate mortgages declines when borrowers exercise their option to
    refinance and prepay their existing mortgages in response to a decline
    in market rates. In combination, interest rate and prepayment risks
    mean that the housing GSE's are potentially vulnerable to losses from
    both increases and decreases in interest rates.
         Even those firms that appear to be well-managed are subject to
    operations risk, or the adverse effects of errors in judgment by
    management in protecting the value of a firm. That threat can manifest
    itself in lapses in the integrity and performance of existing controls,
    systems, and practices.
         Private equity holders and other stakeholders in the housing GSE's
    have some incentive to manage and control risk, but overall those
    incentives are weaker than those for investors in other entities.
    Market discipline is weakened by the Federal guarantee, which reduces
    the need for bondholders to monitor and restrict the Enterprises'
    risks. Further, equity holders have diminished incentives to resist
    risk taking to the extent that they believe that the Government would
    intervene to sustain the GSE's. Member institutions holding equity in
    the Federal Home Loan Banks may undervalue the Enterprises' risks
    because they can withdraw some of their equity from a financially
    troubled bank to reduce their potential losses. Following severe
    losses, equity holders who cannot withdraw their capital can have an
    incentive to accept increased risks by the Enterprises because that
    approach may be their only means of recovering those losses. In sum,
    the Federal Government cannot count exclusively on non-Federal
    stakeholders to limit the risks to taxpayers from the housing GSE's.
         Nonetheless, the housing GSE's are managing prepayment risk and
    interest rate risk through such means as issuing debt securities that
    can be redeemed at par before maturity and using derivatives, including
    interest rate swaps. Also, the GSEs' internal monitoring and safeguards
    reduce operations risk. Finally, the housing GSE's are limiting their
    exposure to credit risk by requiring private mortgage insurance on
    loans with less than a 20 percent downpayment and by leaving some of
    that risk with the loan originators.
         As a practical matter, however, the Enterprises' risks cannot be
    eliminated, nor would doing so be in the interests of equity investors.
    The risks of financing and holding a portfolio of mortgages are simply
    too varied and complex to permit management to identify them all and to
    find another party willing to accept them at a reasonable cost. The
    more feasible objective of holding interest rate and prepayment risks
    within acceptable bounds is among the most complex and difficult tasks
    facing the managers of mortgage portfolios. At the housing GSE's, risk
    management is assigned a high priority and is reported to be vigorously
    pursued with state of the art systems and analytical procedures. Even
    so, best practices intended to achieve vital objectives occasionally
    fail and produce unpleasant surprises.
         Matters are complicated further by shareholders' desire to retain
    some risks. The return on riskless financial activity is close to the
    return on U.S. Treasury securities. In competitive markets, investors
    can obtain high rates of return only by assuming risks. Fannie Mae and
    Freddie Mac have consistently earned high rates of return on equity.
    For example, the average annual return on their equity from 1990 to
    2002 was over 23 percent. A comparison group of large financial
    services firms averaged returns of less than 14 percent during that
    period. One essential operating difference between those two GSE's and
    private firms is that the GSE's hold less than half as much private
    equity capital per dollar of assets as the comparison firms do (3.70
    percent versus 9.14 percent). If Fannie Mae and Freddie Mac retained
    about the same risks as private financial services firms, then their
    higher rates of return on capital could be explained by their lower
    levels of capital.
         Future losses from risks retained by the housing enterprises would
    be borne by the Enterprises' equity investors up to the limit of the
    GSEs' equity and reserves. Creditors could then look to the Federal
    Government to cover losses above those amounts. Some observers claim
    that the Government's commitment is only conjectural and therefore
    potentially illusory. However, when another GSE, the Farm Credit
    System, suffered threatening losses in the 1980's, the Congress
    authorized up to $4 billion in Federal financial assistance to avoid a
    default on bonds that carried a similar guarantee. In that case, at
    least, the implied Federal guarantee
    became real. In the event of future losses by the housing GSE's in
    excess of their private capital, the Government would face a choice
    between ignoring a financial shock of unknown magnitude or confirming
    that its guarantee would be honored. The significant difference in the
    expected short-term costs of those alternatives suggests that the
    capital markets are likely to be correct in supposing that the
    Government will not walk away from its implied guarantee when the need
    for Federal support arises.
         A rough indication of the likelihood of such an event is provided
    by the cumulative average historical default rate for corporate debt
    with a credit rating comparable to that of Fannie Mae and Freddie Mac.
    Standard & Poor's reports that for debt rated AA-, the cumulative
    average default rate over 15 years is 1.92 percent. By that indication,
    a default by Fannie Mae or Freddie Mac is highly unlikely over the next
    15 years. But it is not an impossibility.
    The Role of Regulation in Limiting Taxpayers' Risks
         By enhancing the housing GSEs' credit quality, the Federal
    Government gives the Enterprises substantial control over the risks
    faced by taxpayers and over the amount of the Federal subsidy. The
    Enterprises can increase that subsidy by expanding their volume of
    guaranteed debt, by engaging in riskier activities, by reducing their
    efforts to hedge existing risks, and by diverting income to activities
    outside their missions or distributing it to shareholders.
         Fannie Mae and Freddie Mac have two means of channeling funds from
    the
    capital markets to retail lenders: Investing in mortgages and
    guaranteeing mortgage-backed securities (MBS's). To invest in
    mortgages, the Enterprises issue debt obligations and purchase
    mortgages. Alternatively, they pool individual mortgages, insure the
    pools against credit risk, and sell undivided interests in the pools
    directly to
    investors in the form of mortgage-backed securities. Purchasing and
    holding mortgages as investments entails greater risks and returns for
    the GSE's than guaranteeing MBS's does. Fannie Mae and Freddie Mac have
    dramatically increased the size of their investment portfolios relative
    to their guarantees of MBS's since 1990 (see Table 2). In fact, Fannie
    Mae and Freddie Mac now hold in portfolio about one-third of their
    guaranteed MBS's. Similarly, the Federal Home Loan Banks have increased
    their portfolio holdings of mortgages from less than $1 billion in 1998
    to more than $60 billion in 2002 and to $90 billion by the middle of
    2003.
         When the Enterprises buy and hold mortgage assets in portfolio,
    they are retaining interest rate, prepayment, and credit risks on those
    loans. But when the GSE's sell mortgages to investors through
    guaranteed MBS's, they transfer interest rate and prepayment risks,
    retaining only the more transparent, manageable credit risk. As the
    GSE's move mortgages into their portfolios, they increase both the
    expected returns and risks to shareholders; for taxpayers, only the
    risks increase. The increase in risk is reflected in the statutory
    minimum for private capital to be held by Fannie Mae and Freddie Mac of
    2.5 percent for mortgages in portfolio and 0.45 percent for MBS's.
    Whether those differences in capital requirements accurately reflect
    true differences in the level of risk, however, is impossible to know
    because the Enterprises can vary the extent to which they hedge
    portfolio risks. Determining the adequacy of the Federal Home Loan
    Banks' capital is further complicated by the ability of members to
    redeem some capital at par. Redeemable capital is unlikely to be
    available to absorb the Banks' losses or to protect taxpayers.

         An important purpose of the regulation of GSE's is to limit
    taxpayers' risks and the size of the subsidy. To do so, regulators must
    understand, monitor, and assess the risks of the Enterprises virtually
    to the same extent that their management does. But some dimensions of
    risk are not easily transparent. Even world-class regulators--well-
    funded, well staffed, and politically independent--are unlikely to be
    able to maintain a complete understanding of the extent to which
    taxpayers are exposed to risks.
        Nonetheless, regulators can limit the GSEs' ability to leverage the
    value of the Federal guarantee. To do that, they need a range of
    capabilities to address the varied means by which the GSE's can
    increase the risk exposure of taxpayers. Those capabilities include
    being able to adjust capital requirements, to assess the extent to
    which the GSE's have retained interest rate and prepayment risks and
    the effectiveness of hedges against those risks, to hold management
    responsible for the adequacy of internal systems and controls, and to
    prevent a failed GSE from continuing to use the Federal guarantee.
        The regulators also need enough public support to enable them to
    exercise their authority to compel changes in risky behavior by the
    housing GSE's. Toward that end, increased public disclosure of the
    findings of regulatory oversight of the Enterprises could be useful.
    Freddie Mac has agreed to publicly report its fair-value, or mark-to-
    market, net worth quarterly. That practice increases transparency and
    might be usefully adopted by all of the GSE's.
        The Congress could facilitate the regulators' difficult task by
    setting statutory boundaries on the GSEs' ability to increase the value
    of the Federal subsidy. For example, the Congress could legislate a
    higher margin of safety in the minimum capital standards. It could also
    act to limit the growth (or profitability) of GSEs' portfolio
    investments and move toward more-equal treatment of the Enterprises and
    their potential competitors. Some Members of Congress have proposed
    requiring SEC registration of GSE securities, for example. A May 2003
    CBO report on that topic found that such a requirement would be
    unlikely to have a significant adverse effect on the GSE's or on the
    mortgage markets. Similarly, in the absence of evidence that
    Presidentially appointed directors have a unique advantage in defending
    taxpayers' interests, the selection of directors might be left entirely
    to private shareholders.
        Action by the Congress to bolster regulators' ability to ensure
    safe operation by the GSE's would better protect taxpayers.
    Furthermore, the GSEs' public mission does not appear to require them
    to sacrifice safety and soundness. Certainly, from the taxpayers'
    perspective, having the GSE's pursue a low-risk strategy is strongly
    preferable to tolerating a risky one.
                                   ----------
                       PREPARED STATEMENT OF JOHN D. KOCH
               Executive Vice President and Chief Lending Officer
                     Charter One Bank, NA, Cleveland, Ohio
            on behalf of America's Community Bankers, Washington, DC
                                October 23, 2003
         Mr. Chairman and Members of the Committee, my name is John D.
    Koch, Executive Vice President and Chief Credit and Lending Officer of
    Charter One Bank, NA in Cleveland, Ohio. I am also a member of the
    board of America's Community Bankers and chairman of its GSE Policy
    Committee. ACB appreciates this opportunity to testify on proposals to
    improve the regulation of the housing-related Government Sponsored
    Enterprises, Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
    ACB members include State and Federally chartered savings institutions
    and commercial banks. Our members are both stock- and mutually owned.
    As community bankers, many are specialists in mortgage lending. They
    are actively involved in the secondary market through Fannie Mae and
    Freddie Mac and other secondary market participants. Charter One
    services over $15 billion in home mortgages for Fannie Mae and Freddie
    Mac. ACB members are also substantial stockholders in and borrowers
    from the FHLBanks.
        ACB has long supported the traditional role Fannie Mae and Freddie
    Mac serve in the secondary mortgage market. They have provided great
    benefits to homebuyers and mortgage originators. In fact, they have
    significantly increased their commitment to community banks over the
    last several years. ACB helped initiate these changes by entering into
    business relationships with both companies that enable community banks
    to be more competitive in the marketplace.
        Similarly, ACB members depend tremendously on the advances provided
    by the FHLBanks. Our bank's FHLBank advances total nearly $10 billion.
    These advances make it possible for community banks to make sound home
    loans that may not conform to the strict criteria of the secondary
    market. FHLBank advances also provide an alternative funding source for
    community banks that choose to keep loans they originate--whether
    conforming or not--in their own portfolios.
        In addition, ACB members own more than half of the stock issued by
    FHLBanks and hold significant amounts of mortgage backed securities and
    other debt issued by Fannie Mae, Freddie Mac, and the FHLBanks. Charter
    One's investment in FHLBank stock totals $700 million, by far our
    largest single investment.
        Clearly, the continued financial health of all of these entities is
    critical to Charter One and other ACB members and their communities.
    Therefore, ACB strongly supports this Committee's effort to improve the
    regulatory system for the GSE's.
    Scope of the Agency
        The Administration has recommended that Congress establish a new
    agency that would regulate all of the housing GSE's. ACB agrees with
    the Administration that the regulatory structure for these entities
    should be substantially improved and supports proposals to create a new
    independent regulator for FHLBanks that is housed inside Treasury.
    However, ACB recognizes that we are involved in a fluid and dynamic
    legislative situation. For example, the Treasury Department has raised
    concerns about the establishment of a new independent agency within the
    Department. ACB differs with Treasury on this issue. As we emphasize
    later in our testimony, it is essential that the new regulator be
    independent. Therefore, as an alternative way to address Treasury's
    concerns, ACB would support formation of a new, independent regulator
    as a stand-alone agency.
        ACB continues to prefer a separate regulator for the FHLBanks.
    Nevertheless, ACB strongly supports an amendment drafted by
    Representatives Royce, Maloney, and Leach that would merge the Office
    of Federal Housing Enterprise Oversight and the Federal Housing Finance
    Board into a new, independent, and fully funded Treasury agency. We
    recommend that you strongly consider taking a similar approach in your
    legislation.
        The Royce Amendment recognizes the differences between the FHLBanks
    and Fannie Mae and Freddie Mac by establishing two deputy directors and
    maintaining separate funding for the costs of regulation. Under the
    amendment, the new agency would administer the unique statutory
    arrangements that apply to the FHLBanks and Fannie Mae/Freddie Mac.
        If the new agency does become the regulator for the FHLBanks, it
    should maintain the Banks' access to the capital markets and their
    current well-defined mission to support the mortgage finance,
    affordable housing, and community development activities of member
    banks. The advance programs of the FHLBanks ensure homebuyers have
    ready access to home mortgage financing through FHLBank members.
        ACB recognizes that the Finance Board has increased its commitment
    to safety and soundness regulation. However, we believe there is
    substantial room for improvement and change in the regulation of the
    FHLBank System. A merged agency would avoid a perception that any of
    these Government Sponsored Entities are subject to more effective
    regulation than any of the others. We also note that the FHLBanks,
    Fannie Mae, and Freddie Mac are all engaged in extensive interest rate
    risk management and believe a combined agency would be better able to
    supervise these risks.
        While dealing with concerns common to all of the entities, the
    legislation would have to ensure that the new regulatory structure
    recognizes the unique and successful business model of the FHLBank
    System. Unlike Freddie Mac and Fannie Mae, the System is a cooperative
    owned by its member institutions. The FHLBanks' stock is not publicly
    traded and does not fluctuate in value. In addition, each of the
    FHLBanks is jointly and severally liable to all the others. Each of
    these GSE business models has their strengths. Any revised regulatory
    system should continue to respect those differences, while advancing
    the common goal--to maintain their financial safety and soundness.
    Agency Structure, Funding, and Independence
        The Administration recommends that Congress eliminate OFHEO and the
    Finance Board and move their functions into an independent agency
    housed in the Department of the Treasury. This structure works for two
    key regulators, the Comptroller of the Currency and the Office of
    Thrift Supervision. A key element behind each agency's success is their
    high degree of independence from the Treasury, which insulates them
    from concerns about political influence.
        Additionally, both the OCC and OTS enjoy--and OFHEO does not have--
    the ability to fund its operations without resort to the annual
    Congressional appropriations process. ACB strongly endorses the
    repeated recommendation of OFHEO Director Falcon to eliminate this
    anomaly and allow the regulator of Fannie Mae and Freddie Mac to assess
    those companies without the cumbersome appropriations process. It is
    important that the final bill provide the new agency with a complete
    exemption from the appropriations process, similar to that provided to
    other financial regulators.
        Independence is the other characteristic of the various financial
    regulators that ACB strongly believes must also be in the regulator for
    Fannie Mae, Freddie Mac, and the FHLBanks. Again, this has served our
    financial system and consumers very well. If a new agency is created
    within Treasury, it should have autonomy in the following key areas:

     Appointment of Director. The director should be appointed by
        the President and confirmed by the Senate for a fixed term and be
        removable by the President only for good cause.
     Testimony. Congress should be able to count on receiving the
        agency's unvarnished views on all issues it faces.
     Rulemaking. There should be no opening for politically
        appointed officials to delay or prevent the agency from issuing
        rules it believes necessary.
     Supervision and Examination. All parties involved will benefit
        from a strict separation between political appointees and
        supervisory and examination staff.
     Enforcement. The agency's enforcement actions must be
        independent from any outside interference.
     Litigation Authority. The director should be able to act in
        his own name and through his own attorneys rather than have the
        Attorney General represent the agency.
     Employment Authority. The director should have the ability to
        employ officers and employees under authority comparable to that of
        other financial regulators.
    Authority over Mission and Programs
        The Finance Board has authority over all aspects of the FHLBanks:
    Ensuring safety and soundness and that they carry out their statutory
    housing finance mission. The Royce Amendment would continue this
    approach under the new agency.
        ACB strongly endorses the Administration's position that the new
    agency should have similar authority to ensure that Fannie Mae and
    Freddie Mac are also carrying out their secondary market mission. This
    agency must have the authority to review both current and future
    programs of Freddie Mac and Fannie Mae. In particular, new activities
    should be subject to an application and approval process similar to
    what is in place for bank holding companies today. For over a decade,
    the Department of Housing and Urban Development has not exercised its
    current program approval authority. As a result, Fannie Mae and Freddie
    Mac have engaged in or attempted to engage in activities inconsistent
    with their secondary market responsibilities.
        For example, both entities have issued retail debt instruments in
    denominations of as little as $1,000. These are being marketed by third
    parties to consumers with considerable emphasis on their implied
    Federal Government backing, when there is no such guarantee. Fannie Mae
    and Freddie Mac have responded to this problem by significantly
    improving disclosures. However, we doubt the public is adequately
    informed and protected. In addition to principal risk, these notes
    carry interest rate and call risk that relatively unsophisticated
    investors do not understand. Of course, these risks do not exist for
    traditional deposit products, such as certificates of deposit.
    Nevertheless, these small-denomination notes unfairly compete with
    CD's, weakening community banks' ability to meet housing finance and
    other community credit needs.
        ACB is concerned that these debt programs may be part of an attempt
    to create a ``name brand'' image for Fannie Mae and Freddie Mac in the
    mind of average consumers. Their extensive retail advertising is
    further strong evidence that this is a major goal for these entities.
        This branding effort could help Fannie Mae and Freddie Mac's
    efforts to move into the primary mortgage market. In one example of
    this, Freddie Mac entered into an agreement with an online mortgage
    company that attempted to reduce primary mortgage originators to, at
    best, a nominal role in the process. An effective mission regulator is
    needed to prevent Freddie Mac and Fannie Mae from using their
    Government-provided advantages to supplant private firms that compete
    in the primary mortgage market.
        The Administration's proposal makes clear that HUD would retain its
    mission
    authority to set affordable housing goals for Fannie Mae and Freddie
    Mac. As Secretary Mel Martinez testified, HUD would actually gain new
    regulatory clout to
    enforce those goals. However, ACB does not support the Administration
    recommendation that HUD be authorized to set new sub goals. Sub goals,
    while
    perhaps assuring a certain result, may lead to GSE purchase behaviors
    with unexpected and potentially undesirable consequences.
        Some housing advocates have expressed concern that, if HUD does not
    retain all mission and program oversight over Fannie Mae and Freddie
    Mac, their commitment to housing, particularly low- and moderate-income
    housing will suffer. However, Secretary Martinez testified in strong
    support of the Administration's proposal to shift these
    responsibilities, other than affordable housing goals, to the Treasury.
    If Congress provides for a substantial degree of independence for the
    new agency and affirms the companies' housing mission, there should be
    no decrease in their support for housing. In fact, we believe Fannie
    Mae and Freddie Mac must continue to be challenged to increase
    homeownership by minority families. And, as mentioned, under the
    Administration's proposal HUD's role would be enhanced in the area of
    affordable housing.
    Capital Requirements
        ACB strongly agrees with the Administration position that, while
    the existing capital regulation adopted by OFHEO should be the new
    agency's starting point for Fannie Mae and Freddie Mac, there should be
    no limit on its ability to adjust capital requirements for Fannie Mae
    and Freddie Mac if it finds that necessary. Capital is the foundation
    for the safety and soundness of our financial system. Therefore, the
    new agency must have complete authority to adjust all capital
    requirements as necessary, subject to rulemaking.
        The Finance Board already has this authority with respect to the
    FHLBanks. The Royce Amendment would maintain the new agency's authority
    to adjust the FHLBanks' capital requirements. The new regulator should
    respect genuine differences between the FHLBanks and Fannie Mae/Freddie
    Mac--including their very different capital structures. However, a
    regulator's ability to adjust capital levels is fundamental and must
    apply to all of the regulated entities.
        As Congress has recognized, the taxpayers are ultimately at risk
    when a major part of the financial system is undercapitalized. While
    there is no explicit Federal guarantee for Fannie Mae and Freddie Mac,
    it is impossible to believe the Government would stand aside if either
    of these companies faced serious difficulty. Requiring them to maintain
    adequate capital will provide vital insulation for the taxpayers.
        Community bankers are particularly sensitive to this issue. We are
    already concerned that the proposed Basel II Accords could result in
    lower or disparate capital standards for the large banks that will
    adopt the new system. We would be equally troubled if regulatory reform
    for Fannie Mae and Freddie Mac had a similar result. The capital
    requirements for Freddie Mac and Fannie Mae should reflect the specific
    financial risks facing each, including realistic treatment of
    counterparty risk and direct investment in mortgages.
    Enforcement Authority
        The Administration recommends that the new agency be given
    enforcement authority comparable to that of the banking agencies. ACB
    supports this point of view. However, we recommend that Congress
    carefully examine the current enforcement authority for OFHEO and the
    Finance Board to determine exactly which additional powers are needed
    and which banking agency provisions are not appropriate to deal with
    the unique features of the housing GSE's.
    Conclusion
        I wish to again express ACB's appreciation for this opportunity to
    testify on these important issues. We strongly support the Committee's
    effort to strengthen the regulation of Freddie Mac, Fannie Mae, and the
    Federal Home Loan Banks. We look forward to working with you as you
    craft legislation to accomplish this goal.
                                   ----------
                      PREPARED STATEMENT OF DALE J. TORPEY
              President and CEO, Federation Bank, Washington, Iowa
           on behalf of the Independent Community Bankers of America
                                October 23, 2003
    Introduction
        Chairman Shelby, Ranking Member Sarbanes, and Senate Banking
    Committee Members, the Independent Community Bankers of America (ICBA)
    appreciates this opportunity to present our views on proposals for
    improving the regulation of the housing Government Sponsored
    Enterprises (GSE's).
        I am Dale J. Torpey, President and CEO of Federation Bank, a $115
    million asset bank located in Washington, Iowa. I currently serve as
    Chairman of the Lending Committee of the ICBA. I am also currently
    Chairman of the Board of Directors of the Federal Home Loan Bank of Des
    Moines. My testimony today is delivered exclusively on behalf of the
    ICBA.
        Potential regulatory restructuring of the housing GSE's is a matter
    of critical importance to the community banking industry.
        As a general principle, we do not believe that the Treasury
    Department should direct the housing policy of our Nation just as it
    should not run the monetary policy of our Nation. In our view, should
    the Treasury Department be granted supervisory and regulatory oversight
    of either Fannie Mae/Freddie Mac or all three of the housing GSE's, its
    tax policy and fiscal policy responsibilities would likely present
    clear conflicts of interest with housing policy. ICBA also shares the
    concerns that have been expressed by others regarding the historical
    absence of expertise in housing policy at Treasury.
    Regulation of the Federal Home Loan Banks
        Since the passage of the Federal Home Loan Bank System
    Modernization Title of the Gramm-Leach-Bliley Act (Title VI of P.L.
    106-102) in 1999, which liberalized membership in the Federal Home Loan
    Banks (FHLBanks) and expanded the categories of eligible collateral for
    FHLBank advances, thousands of community banks are using FHLBank
    advances as a competitive and flexible funding source. The ability of
    community banks to continue to utilize this increasingly important
    funding source is crucial to safe and sound asset-liability management,
    as well as their ability to meet the lending needs of their
    communities. Similarly, the fact that Federal deposit insurance
    coverage levels have not increased since 1980 has given community banks
    further incentive to turn to FHLBank advances as a stable, alternative
    source of funding to meet Main Street's lending needs.
        ICBA continues to hold the view that the FHLBanks should be
    regulated by a separate and independent agency--a status that the
    existing Federal Housing Finance Board (FHFB) already enjoys. Under the
    regulatory guidance of the FHFB, the FHLBanks have a near-impeccable
    record of providing well-collateralized advances to thousands of
    institutions. The FHFB also has taken important steps, and continues to
    take steps, to upgrade its examination and supervision capacities
    focusing on safety and soundness.
        At its Fall meeting earlier this month, the 110-member ICBA Board
    of Directors, with representation from nearly every State, discussed
    the issue of FHLBank regulation at length. The ICBA board voted
    unanimously to oppose including the FHLBanks in any proposed new
    supervisory and regulatory structure for Fannie Mae and Freddie Mac in
    the U.S. Treasury Department.
        The ICBA Board did not discuss the concept of a new, independent
    regulatory structure outside the Treasury Department for Fannie Mae,
    Freddie Mac, and the FHLBanks--a concept which has been voiced by some
    in recent days.
        The ICBA has long supported independent financial regulatory
    agencies--for example, agencies such as the Board of Governors of the
    Federal Reserve System, the Federal Deposit Insurance Corporation
    (FDIC) and the Securities and Exchange Commission (SEC).
        While not our first preference, the ICBA may not oppose the concept
    of a new independent regulator for all three housing GSE's outside the
    Treasury Department, depending on how key details are fleshed out. The
    Federal Home Loan Bank Act could potentially serve as the legislative
    foundation for such a structure. However, two key issues would have to
    be worked out for such a structure to gain widespread support. First,
    the specific regulatory powers of such an agency would have to be
    determined. We note that the FHFB and the Office of Federal Housing
    Enterprise Oversight (OFHEO) do not currently have the same powers.
    Second, the unique ownership, operational and capital structure, and
    mission of the FHLBanks, which is distinct from that of Fannie/Freddie,
    would have to be recognized and preserved in constructing the new
    agency.
    Regulation of Fannie Mae and Freddie Mac
        Community banks are significant direct or indirect users of the
    Fannie Mae and Freddie Mac conduits into the secondary mortgage market.
    The sale of mortgages originated by community banks into the secondary
    market increases the liquidity of these locally owned- and operated-
    financial institutions, allowing them to better serve the lending needs
    of Main Street America. Our system of homeownership is the envy of the
    world and it has been the stalwart of the American economy during
    economically challenging times in recent years. The current system has
    enabled us to reach record homeownership levels and to accommodate
    consumer refinancing needs in the recent low interest rate environment.
    This must not be overlooked as part of the process when considering GSE
    regulatory restructuring.
        Regarding proposals to bring the regulation of Fannie Mae and
    Freddie Mac under the Treasury Department, ICBA reiterates its
    staunchly held view that any such entity must be politically
    independent in order to be regarded as a world-class financial
    regulatory agency. We firmly believe that the traditional political
    independence of our Federal financial agencies has immeasurably
    strengthened the U.S. economic and financial system. Currently, the
    Office of the Comptroller of the Currency (OCC)and the Office of Thrift
    Supervision (OTS) are protected from the Treasury's political
    influence.
        We strongly urge Congress to make certain that any potential
    legislation contain appropriate firewalls and independence between
    Fannie and Freddie and the Treasury's politically-appointed
    policymakers. Politicizing regulation is an ever-present danger, and we
    believe it is paramount to maintain the independence of any new
    regulator overseeing safety and soundness and Fannie and Freddie's
    Congressionally mandated missions to support home ownership.
    Other Key Issues
        In the letter of invitation for today's hearing, ICBA was also
    asked for its views on several other issues in the debate over housing
    GSE regulation.
        First, what is the appropriate capital regime for the housing
    GSE's? We support the continuing authority of each GSE regulator to
    establish, and modify, as necessary, the level of risk-based capital
    that the GSE's are required to hold. As market and risk factors change,
    the regulators must be able to adjust to these changes in a timely
    manner. However, ICBA does not support granting the GSE regulators the
    authority to modify statutory or minimum capital. Such new authority
    could confer on the regulators the authority to de facto adjust program
    levels by raising minimum capital, reducing the amount of resources
    available for program activities.
        Second, what should the funding mechanism be for the new regulator?
    To insulate the housing GSE regulators from undue political influence
    and enhance independence, ICBA supports removing funding of the GSE
    regulators from the appropriations process and funding them solely
    through a self-generated fee structure.
        Third, where should authority for new program approvals be placed?
    We believe that in order for the housing GSE's to continue to be
    innovative in the development and implementation of new products to
    meet the demands of the marketplace, there should be a smooth and
    seamless process for getting these products online. Clearly, if a
    FHLBank, Fannie Mae or Freddie Mac develops a program that is
    inconsistent with safety and soundness or with their Congressionally
    mandated missions, there must be a review process to make that
    determination. But there should not be disincentives for the GSE's to
    be innovative and adaptive to new market conditions. Our housing
    finance system has evolved rapidly over the recent past due to changing
    technology and changes in the demands of consumers. The FHLBanks,
    Fannie Mae, and Freddie Mac must have the flexibility to develop the
    housing finance products needed by consumers in a timely manner and not
    have new products, programs and activities be bogged down by
    bureaucracy.
        Fourth, what is the appropriateness of HUD's continuing role in the
    oversight of Fannie Mae and Freddie Mac? Because of its
    responsibilities and expertise, our preference is that HUD should
    continue to establish our Nation's housing goals and control the
    mission activities of Fannie/Freddie to achieve those goals.
    Conclusion
        In closing, ICBA would urge the Committee to carefully and fully
    consider the issues associated with regulation of the housing GSE's
    before rushing to action. The ICBA has long supported world-class,
    independent regulatory agencies such as the FDIC and the Federal
    Reserve, both of which are governed by boards that are independent of
    the U.S. Treasury.
        There is no shortage of opinions and strongly held viewpoints on
    these issues. We concur with the sentiments expressed by a number of
    Members of this Committee that it is imperative that any regulatory
    restructuring be done right given its potential impact on the crucial
    housing sector of our economy and on community banks' continued ability
    to meet the lending needs of Main Street America.
        Thank you for the opportunity to testify. I would be pleased to
    answer any questions.
                                   ----------
                    PREPARED STATEMENT OF ALLEN J. FISHBEIN
                     Director for Housing and Credit Policy
                         Consumer Federation of America
                                  on behalf of
                  National Association of Consumer Advocates,
                   National Community Reinvestment Coalition,
             National Congress for Community Economic Development,
       National Fair Housing Alliance, and Consumer Federation of America
                                October 23, 2003
        Good morning Chairman Shelby, Senator Sarbanes, and Members of the
    Committee. My name is Allen J. Fishbein, and I am the Director of
    Housing and Credit Policy for the Consumer Federation of America. I
    appreciate the opportunity to testify on proposals for improving the
    regulation of the Government Sponsored Housing Enterprises (GSE's). My
    written testimony today is also on behalf of the National Association
    of Consumer Advocates, National Community Reinvestment Coalition,
    National Congress for Community Economic Development, and the National
    Fair Housing Alliance.
        CFA is a nonprofit association of 300 proconsumer organizations,
    with a combined membership of 50 million, founded in 1968 to advance
    the consumer interest through education and advocacy. My own background
    in the area of GSE regulation includes my tenure at HUD, where I served
    as Senior Advisor for GSE Oversight. My responsibilities at HUD
    included assisting with the supervision of the rulemaking that resulted
    in establishment of the present affordable housing goals for Fannie Mae
    and Freddie Mae, along with the management of other areas of the
    Department's GSE regulatory oversight.
        As national consumer, community, and civil rights organizations
    committed to the promotion of fair and affordable housing for all of
    America's citizens, we watch with considerable interest the ongoing
    debate about possible changes to the regulatory structure for Fannie
    Mae and Freddie Mac and wanted to share a few of our observations.
        We appreciate those in Congress who desire to assure the adequacy
    of safety and soundness and mission-related requirements for the
    Government Sponsored Housing Enterprises--Fannie Mae and Freddie Mac
    (GSE's). We also urge that Congress be very careful in tinkering with
    the GSEs' basic overall regulatory structure. At a minimum, such
    changes to the regulatory structure should do no harm to the GSEs'
    housing mission. However, we also believe that the current debate
    provides an important opportunity to clarify those areas of the GSEs'
    affordable housing mission that should be expanded. Fannie Mae and
    Freddie Mac have fulfilled an important part of their mission by
    providing affordable housing capital for low- and
    moderate-income and minority households. Yet much remains for the GSE's
    to accomplish in expanding fair and affordable housing opportunities
    for the residents of our Nation's underserved communities, such as
    providing greater assistance to first-time minority, and low-income
    homeowners and securitizing multifamily rental mortgage products.
    Similarly, while the GSE's have been industry leaders in adopting
    policies to combat a number of predatory lending practices, such as
    their repudiation of the purchase of loans that included single premium
    credit insurance (SPCI), they have yet to address certain other
    egregious lending practices.
        More specifically, we believe that important improvements to the
    present affordable housing goals requirement are desirable. Clearly the
    establishment of these goals has served an important function,
    encouraging the GSE's to better serve the needs of underserved areas
    and low- and moderate-income housing households. In fact, both
    enterprises have consistently met or exceeded the goal levels set for
    them. Nonetheless, the three broad statutory goals in place do not
    permit HUD to focus sufficient GSE attention to addressing some of the
    neediest segments of the mortgage market, such as low-income, minority,
    and other underserved homebuyers, or certain rental and rural housing
    finance needs. Establishing an additional GSE home purchase goal, and
    providing HUD with supplemental authority to set subgoals for GSE
    activity for particularly pressing needs within the overall statutory
    goals, while not diminishing the ability of the GSE's to serve the
    needs of all consumers refinancing loans, would enhance the overall
    effectiveness of this important mandate.
        Also, reform of the GSE housing goals should include provisions to
    expand opportunities for public input into this important area of
    regulation. We favor improvements to the GSE public use database
    presently maintained by HUD to make the information available fully
    comparable with data reported by mortgage lenders under the Home
    Mortgage Disclosure Act. Opportunities for public comment should also
    be provided in the event that a GSE did not meet its annual performance
    requirement and HUD as a result required the GSE to submit a remedial
    plan.
        Our strong interest in affordable housing extends to other aspects
    of regulatory restructuring as well. We are particularly concerned that
    proposals to shift general charter oversight and new program approval
    authority away from HUD to the Treasury Department will detract from
    the regulatory focus on GSE performance of their housing mission. At
    the same time, funding the reasonable costs of this regulation through
    direct assessments of the GSE's, and not through the appropriations
    process, would go a long way to strengthening oversight capacity.
        We are also concerned with the deliberations around two regulatory
    areas, capital requirements and the program approval process. First,
    the GSEs' capital requirement is one of the most critical and sensitive
    issues. We recognize that the establishment of appropriate capital
    requirements may at time involve tradeoffs, but we fear that
    unnecessary increases in capital requirements, particularly the minimum
    requirement, could result in higher costs to homebuyers. Simply, we
    should not make it harder for minority and low-wealth families to be
    able to afford to become homeowners.
        Second, in evaluating any changes to the current program approval
    process, a delicate balance is required between a careful examination
    of whether a new GSE product serves its important public mission and
    the need to not over-burden these organizations' innovative efforts to
    provide new lending opportunities in the most difficult to serve
    communities. While there may be a need to improve the current approval
    process, we urge you to proceed cautiously, and resist efforts to over-
    encumber this process.
        While this testimony focuses mainly on regulatory oversight of
    Fannie Mae and Freddie Mac, we also offer the following comments on
    regulation of the other housing GSE, the Federal Home Loan Bank System
    (FHLB System). We believe the FHLB System as it has evolved must also
    have clear and specific housing goals that challenge the lenders to
    better serve underserved populations. Should Congress decide to abolish
    the Federal Housing Finance Board, the system's regulator, and transfer
    authority to another agency, we strongly prefer that mission oversight
    be transferred to HUD, and that the Department also be provided with
    authority to establish new affordable housing requirements to ensure
    that activities undertaken by the FHLBanks are targeted to low- and
    moderate-income housing and other underserved community needs. These
    new requirements should build on the existing Affordable Housing and
    Community Investment Programs (AHP and CIP) and also work to increase
    FHLB member support for these and other affordable housing and economic
    development initiatives.
        In closing, we thank you for your work in attempting to strengthen
    the effectiveness of the GSE's to serve the housing needs of America's
    underserved populations. We urge that you support provisions to
    strengthen the housing goals requirement, but also proceed with caution
    and resist the urge to make changes to their status or their charter
    that might result in fewer affordable housing opportunities.
        Thank you again, Mr. Chairman, for the opportunity to offer our
    views on this important topic. I am happy to answer any questions that
    either you or other Members of the Committee may have.
                                   ----------
                     PREPARED STATEMENT OF ROBERT M. COUCH
                     Chairman, Mortgage Bankers Association
                                October 23, 2003
         Mr. Chairman and Members of the Senate Banking Committee, the
    Mortgage Bankers Association appreciates this opportunity to express
    our views on the important issues surrounding improving the regulation
    of the housing Government Sponsored Enterprises (GSE's). The Mortgage
    Bankers Association (MBA) is the national association representing the
    real estate finance industry. We have approximately 2,700 member
    companies engaged in every aspect of real estate finance. MBA members
    originate loans in the primary mortgage market that Fannie Mae and
    Freddie Mac purchase. MBA, therefore, has a keen interest in
    maintaining the safety and soundness of our country's real estate
    finance system.
        Fannie Mae and Freddie Mac are the biggest participants in our
    country's secondary mortgage market. Their regulation has come under
    scrutiny lately, with many calls for improvement.
        Treasury Secretary John Snow and Housing and Urban Development
    (HUD) Secretary Mel Martinez presented the Administration's proposal
    for GSE regulatory reform in testimony before the House Financial
    Services Committee on September 10, 2003, and before the Senate
    Banking, Housing, and Urban Affairs Committee on
    October 16, 2003. The two Secretaries proposed to move safety and
    soundness regulation of Fannie Mae and Freddie Mac to a new agency
    within the Treasury Department. They further proposed to task the
    safety and soundness regulator with approving new and ongoing programs
    and activities, in consultation with HUD. And they proposed to
    strengthen the regulators' authority and funding.
        MBA reiterates its support of the Administration's proposals. MBA
    has long advocated strong and effective oversight of the GSE's. We
    believe effective safety and soundness regulation is critical because
    of Fannie Mae's and Freddie Mac's size and because of their importance
    to the housing finance system. MBA is pleased to see that the
    Administration and Members of Congress support strengthening the
    regulation of Fannie Mae and Freddie Mac.
        MBA supports the Administration's proposal to improve and
    strengthen the
    general regulatory, supervisory, and enforcement powers with respect to
    the GSE's. Further, MBA endorses giving the safety and soundness
    regulator appropriate flexibility in setting capital standards, instead
    of relying on a rigid, statutory stress test that does not allow the
    regulator to react adequately to changes in the financial marketplace.
    MBA also supports the Administration's proposal to fund GSE regulation
    independently, through assessments on Fannie Mae and Freddie Mac
    outside of the Congressional appropriations process.
        MBA also endorses the Administration's proposal on one of the most
    important aspects of safety and soundness, that is, program oversight.
    The GSEs' programs are a key determinant of their safety and soundness,
    and it is imperative that the programs be conducted safely and soundly.
    Only financially healthy, safe and sound GSE's can contribute to their
    housing mission. If, for example, a GSE were to embark on a program of
    purchasing especially risky loans, the GSE's safety and soundness would
    likewise be at risk. Or, if a GSE were to engage in a high-volume
    program that entails liquidity risks or systemic risks, the safety and
    soundness of such a program would be of critical concern to our housing
    and financial markets, and to a safety and soundness regulator. GSE
    programs and activities are intrinsically linked to safety and
    soundness.
        The safety and soundness regulator, for these reasons, is in the
    best position to evaluate the appropriateness of GSE programs. The
    regulatory approval system should be robust, and should have a clear
    definition of what requires regulatory review. Congress should draw a
    clear line between the primary and secondary mortgage markets. In no
    event should the GSE's be permitted to encroach upon the mortgage
    origination process. In no event should the GSE's be permitted to use
    their Government sponsored benefits to distort the competitive
    landscape of the primary mortgage market.
        MBA also believes that it is important that the regulator not
    micro-manage the GSE's, and that it not unduly constrain the GSEs'
    ability to innovate in a timely manner in response to marketplace
    needs. Regulatory approval for new programs must come in a timely
    manner, and should be based on clear and well-defined criteria.
        In exchange for the benefits of Government sponsorship, Fannie Mae
    and Freddie Mac have an affirmative obligation to meet certain housing
    goals. MBA very strongly supports the affordable housing goals for
    Fannie Mae and Freddie Mac because the goals require the GSE's to focus
    some of their activities on lower-income Americans and those living in
    underserved areas. MBA agrees that HUD is the appropriate agency to set
    and enforce the housing goals for Fannie Mae and Freddie Mac.
        The Mortgage Bankers Association strongly urges Congress to reform
    the oversight of Fannie Mae and Freddie Mac in this manner so that they
    can continue their role in supporting housing, especially affordable
    housing, in this country.
        The Mortgage Bankers Association appreciates the opportunity to
    present its views on these important issues. We would be happy to
    answer any questions the Committee may have.
                                   ----------
                     PREPARED STATEMENT OF IONA C. HARRISON
                     Realty Executives-Main Street, U.S.A.
         on behalf of the National Association of REALTORS'
                                October 23, 2003
    Introduction
        Chairman Shelby, Senator Sarbanes, and Members of the Committee, I
    am Iona C. Harrison, a broker with Realty Executives-Main Street,
    U.S.A. in Upper Marlboro, Maryland. I am here on behalf of over 950,000
    members of the National Association of REALTORS' to share
    our views on the important issue of GSE regulation and the housing
    finance system.
        For the record, REALTORS' want to thank Senator Shelby,
    Senator Allard and Members of the Committee for reporting the
    ``American Dream Downpayment Act.'' The Senate Banking Committee
    unanimously approved this bill with two important amendments. First,
    the bill increases the FHA multifamily loan limits in high cost areas.
    Second, the bill provides a technical correction to improve the FHA
    hybrid ARM program. NAR is a strong advocate for this program. In fact,
    NAR lead a coalition of supporters who are hopeful that the bill will
    come to the Senate floor shortly. By adopting the American Dream
    Downpayment legislation Congress will send a strong message supporting
    the Administration on increasing homeownership opportunities in the
    United States. This legislation is evidence of the importance this
    Congress and Administration place on homeownership opportunity in the
    United States. NAR believes that a new independent safety and soundness
    GSE regulator combined with continued HUD authority over housing
    programs and mission will ensure that this commitment remains a high
    priority in future years.
    GSE Regulatory Reform
        REALTORS' applaud Congress and the Administration for
    what we believe could
    become a measured, well-considered refinement to regulating the
    Government Sponsored Enterprises, Fannie Mae and Freddie Mac. The Bush
    Administration has outlined principles that will underscore the
    importance of the GSEs' mission, status, and safety and soundness
    oversight that make our housing finance system unique and so effective.
    Safety and soundness regulation would be lodged at the Treasury
    Department because of its financial expertise. REALTORS'
    support this move because it sends a clear message to housing finance
    and investor markets. But while safety and soundness regulation may
    move to the Treasury, REALTORS' strongly believe that the
    current housing mission should continue to be housed at the Cabinet-
    level Department of Housing and Urban Development. We strongly believe
    that HUD should continue to speak for housing, new GSE program
    oversight, and the GSEs' critical mission supporting homeownership.
        Over the past decade the housing sector and American homeowners
    have benefited significantly from the strength of the Nation's housing
    finance system. At the core of our housing finance system are the
    secondary mortgage market and the Government sponsored mission of
    Fannie Mae and Freddie Mac. The National Association of
    REALTORS' supports a credible and vigorous GSE regulator. A
    strong regulator reinforces President Bush's and Congress commitment to
    housing and homeownership, promotes confidence in Fannie Mae, Freddie
    Mac, and the real estate and housing finance industries, and protects
    U.S. citizens against systemic risk. Although realtors support a strong
    regulator, we insist that regulatory reform does not imply and should
    not result in any weakening of the current housing finance system.
        Congress deemed the Government Sponsored Enterprise model as an
    appropriate vehicle to advance housing and housing policy as recently
    as 1992. Fannie Mae and Freddie Mac were chartered as private
    corporations with publicly traded stock with the mission to bring new
    mortgage products to the market, and to use innovation and technology
    to continue simplifying the mortgage process. In exchange for the
    Federal charter to facilitate the residential secondary mortgage
    market, certain advantages were provided to Fannie Mae and Freddie Mac.
    Since enactment of the Federal Housing Enterprises Financial Safety and
    Soundness Act of 1992 (Title XIII of Public Law 102-550), Congress,
    homeowners, the housing finance system, and the Nation's economy have
    all benefited tremendously. The unprecedented expansion of
    homeownership rates is undeniable testament to the efficiency and
    liquidity of the secondary mortgage market and the housing sector.
    Administration Regulatory Recommendations
        In recent testimony to the Senate Banking Committee, Treasury
    Secretary John Snow and HUD Secretary Mel Martinez outlined the powers,
    duties, and authorities a new GSE safety and soundness regulator should
    have in a new agency within the Treasury Department and the
    relationship that HUD would have going forward. The proposed new
    supervisory agency would focus on safety and soundness, together with
    program and product approval, in consultation with HUD. Secretary Snow
    urged consideration of an agency that would be independent of the
    Congressional appropriations process, and that Treasury would have, at
    a minimum, clearance of new regulations and Congressional testimony.
        Secretary Martinez supported the Administration view that authority
    over new program approval be transferred from HUD to the new regulator
    in his testimony. Secretary Martinez advocated HUD retaining authority
    over the GSE affordable housing goals, and called for expanded
    authority to enforce the housing goals, impose civil penalties for
    failure to meet the housing goals, explicitly provide that the GSE's
    act to increase homeownership, and expand authority to set housing
    goals and sub goals.
        NAR would like to comment on key elements of the Administration's
    plan that are most relevant for the real estate industry.
    Independent Regulator
        REALTORS' would agree that Fannie Mae and Freddie Mac
    should have an independent regulator for safety and soundness. We would
    recommend that the new regulatory agency in the Treasury Department
    should have necessary and sufficient firewalls to ensure its political
    and operating independence similar to those that currently exist for
    the Office of the Comptroller of the Currency (OCC) and the Office of
    Thrift Supervision (OTS) regulatory models.
    GSE Capital
        In outlining the authority for the new regulator regarding GSE
    capital, Secretary Snow highlighted in his testimony a need for
    stability in capital standards. ``Capital,'' he said, ``is the
    fundamental element of the financial condition of an enterprise, and
    the capital standards should not become the subject of frequent
    change.'' REALTORS' agree with Secretary Snow on this
    general point regarding capital. These capital standards should be
    allowed to remain in place for a period of time sufficient to evaluate
    their effectiveness.
    GSE Mission, Program and Product Review
        The Administration proposal to place GSE regulatory oversight and
    new program approval under the Treasury Department is a major change in
    regulatory oversight of the housing GSE's. REALTORS'
    expressed opposition to moving GSE housing mission oversight from HUD
    when the Administration's plan was first released. Our concern is that
    housing policy has not been the purview or expertise of the Treasury
    Department; this has been the purview of HUD. The housing and real
    estate industries naturally look to HUD to address the housing mission,
    programs and products, and affordable housing goals that are central to
    the GSEs' existence. In the new GSE regulatory regime we strongly
    believe that HUD should maintain its primacy in these areas.
        Secretary Martinez proposed that HUD continue to consult with the
    Treasury Department on new activities requested by the GSE's.
    REALTORS' recognize that new programs and products could
    have an impact on safety and soundness considerations. But
    REALTORS' believe that new program approval should remain at
    HUD with the same approval standards in current law. There is
    ``substantial expertise,'' as stated by Secretary Martinez in his
    testimony on September 10 before the House Financial Services Committee
    regarding mortgage and housing markets programs. While
    REALTORS' have considerable respect for the financial
    expertise at Treasury, HUD expertise as our Nation's primary housing
    agency should not be relegated to a consultative role on matters of new
    programs approval or lines of business.
        Secretary Snow and Secretary Martinez outlined the Administration's
    principles in subtle terms. Consequently, REALTORS' are
    guarded about the direction of draft legislation that we understand
    will be the starting point for GSE regulatory reform. Significant
    revisions in the GSEs' role in the housing finance system could
    introduce uncertainties and unintended consequences that will have ill
    effects for the GSE's and the housing sector.
    Federal Home Loan Banks
        Secretary Snow's recent testimony to this Committee reiterated a
    call to create a credible, single regulator for Fannie Mae, Freddie
    Mac, and the Federal Home Loan Banks. REALTORS' do not have
    position on regulating the Federal Home Loan Banks.
    Targeted, Not Sweeping Reform
        REALTORS' firmly believe that targeted reform for the
    GSE regulatory system strengthens our housing finance system. We
    support a narrow bill that institutes safety and soundness regulatory
    reforms, and does no harm to the GSE housing mission, charter, or
    status. Given the fragility of the economy with mixed, weak signals
    about recovery, REALTORS' want to impress on lawmakers that
    safety and soundness concerns should not undermine the housing mission,
    programs and product innovations, or charter status of Fannie Mae and
    Freddie Mac. Targeted reform for the GSE regulatory system strengthens
    our housing finance system. REALTORS' expect that Congress
    will act judiciously to assure a critical role for HUD in GSE mission,
    program development and review. Congress should assure that under new
    regulatory oversight Fannie Mae and Freddie Mac would thrive and
    continue their critical roles in supporting American homeownership. In
    short order, these companies should have the best opportunities to help
    our citizens achieve homeownership.
    Conclusion
        We applaud the Committee's efforts to build a more robust GSE
    regulatory structure. The National Association of REALTORS'
    believes that an overarching principle guiding any consideration of
    regulatory reform proposals should assure that reform not become a
    reason or justification for rewriting the GSEs' housing mission or
    weakening the housing finance system.
        Congressional intent and the Nation's homeowners have been well-
    served since 1992 when the GSEs' charter, mission, and status were
    reaffirmed. What is needed is a strong, rigorous safety and soundness
    regulator, while HUD retains mission and new program oversight.
        The National Association of REALTORS' looks forward to
    reviewing the proposed legislation to reinvigorate GSE regulation.
    REALTORS' want to work with Congress to continue addressing
    housing and homeownership issues and supporting the mission and charter
    objectives of the housing GSE's.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                        FROM ARMANDO FALCON, JR.

    Q.1. In your written statement, you proposed that any new
    regulator be given ``full discretion in setting capital
    standards.'' For the record, what is the value of having both a
    minimum capital standard and a risk-based capital standard?
    That is, what purpose does each standard serve?

    A.1. Capital standards are designed to ensure that regulated
    institutions can survive periods of significant misfortune
    involving sizeable financial losses. In theory, a single
    standard that encompassed all relevant considerations would
    suffice to determine capital adequacy. In practice, that would
    be very difficult, and Congress has wisely required OFHEO and
    all depository institution regulators to implement both a
    leverage-based standard and a more finely tuned risk-based
    standard.
        Evaluation of capital adequacy entails a broad range of
    considerations including not only an institution's current book
    of business; but also the current and prospective risk
    environment, its business strategies and potential changes in
    those strategies, the strength of its customer and supplier
    relationships, the strength of its internal controls, potential
    fragility if the markets in which it buys and sells, the
    structure of those markets and potential changes in the way
    those markets function, the vulnerability of the institution's
    reputation, the systemic importance of the institution, and
    many other factors.
        Issues of practicality constrain the determinants of
    capital requirements to a small subset of these factors. Thus,
    for example, OFHEO's risk-based standard focuses on each
    Enterprise's, current book of business and two possible future
    risk environments. It requires sufficient capital to cover
    losses or current positions in extended, specific adverse'
    circumstances. This is a highly detailed rule that examines
    this aspect of capital adequacy in depth. It is important that
    the Enterprises be able to meet this requirement, but does not
    necessarily imply that capital is adequate. A high degree of
    protection against interest rate and credit risk can reduce the
    risk-based requirement to very low or zero levels, without
    addressing other risks.
        The minimum capital (leverage-based) standard is a fail-
    safe mechanism that ensures a substantial amount of capital
    regardless of measured interest rate and credit risks.
    Incorporating all other risks into the risk-based standard
    would be problematic. They generally do not fit well into the
    scenario format because the range of possibilities is
    essentially infinite. Also, the magnitudes of other risks
    generally are not easily quantifiable, but rather are more a
    matter of judgment.
        A separate standard that encompasses these judgments makes
    sense. While it would be possible to add the two requirements
    to make a single rule that would produce an overall requirement
    that would be considerably more volatile than the current
    combination, and might usually be higher than necessary. So
    far, the judgment exercised by Congress in setting the ratios
    used to determine the minimum capital requirements has worked
    satisfactorily. However, institutions and their business
    environments change over time. An expert safety and soundness
    regulator is best able to judge, if and when changes, to a
    leverage-based ratio should be made. Accordingly, Congress
    should give the regulator of Fannie Mae and Freddie Mac the
    same authority it has given depository institution regulators
    to adjust all capital requirements if necessary.

    Q.2. The Administration has suggested that the new regulatory
    agency should have more than the powers associated with
    conservatorship. Should one of the GSE's under your watch
    encounter serious financial difficulties, do you believe that
    the existing authority of your agency would be sufficient to
    manage the crisis?

    A.2. OFHEO has strong conservatorship authority that it may
    bring to bear should an Enterprise under its jurisdiction
    encounter problems that merit appointment of a conservator.
    This authority, while sufficient to manage a crisis, does not
    provide all the tools a safety and soundness regulator should
    have. OFHEO has supported legislative clarification of its
    authority to support its interpretation of the law.
    Additionally, OFHEO has called for legislative action to
    provide receivership authority that is available to other
    Federal financial regulators. It should be noted that existing
    statutory law permits the charters of the Enterprises only to
    be revoked by Congress, thus receivership would enhance the
    ability to oversee the Enterprises, and assure the markets of a
    full range of remedies available to the safety and soundness
    regulator while preserving Congressional control over charter
    termination.

    Q.3. OFHEO and the Finance Board clearly do not have the
    complete arsenal of Prompt Corrective Action tools that the OCC
    and other bank regulators have. In fact, the Finance Board has
    no statutory Prompt Corrective Action authority. Do you believe
    that a new regulator must have the same Prompt Corrective
    Action tools as the bank regulators?

    A.3. Yes, and OFHEO has an array of Prompt Corrective Action
    tools. Modeled on bank regulations, the Prompt Corrective
    Action regulations are broad and tied to capital levels.
    However, OFHEO has proposed legislative enhancements that would
    conform OFHEO's statutory authorities even more closely to the
    bank regulators; that is, express authority to act on safety
    and soundness matters.
        It also should be noted that OFHEO has added to its Prompt
    Corrective Action rules a section on prompt supervisory
    response. This section provides an orderly procedure for OFHEO
    to act in cases where capital may not be impaired and provides
    both a description of key situations as well as an order for
    OFHEO actions. Thus, OFHEO has a regulatory structure that
    provides for action before capital levels are reached that
    trigger Prompt Corrective Actions.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                        FROM ARMANDO FALCON, JR.

    Q.1. In your testimony, you suggested that the current minimum
    capital standard of 2.5 percent is sufficient to ensure the
    safety and soundness of the GSE's. However, you argued the new
    proposed safety and soundness regulator should have absolute
    discretion to change both the risk-based and minimum capital
    requirements, since, as you characterized it, the minimum
    capital standards acts as a ``fail-safe mechanism'' to capture
    risks that allegedly cannot be addressed in the risk-based
    role.
        Please explain in detail why the risk-based capital rule
    cannot address these alleged risks to the safety and soundness
    to the GSE's. If these risks cannot be quantified, on what
    basis would the regulator change the minimum capital
    requirements in order to act as a ``fail-safe mechanism?'' How
    would this basis for changing the minimum capital standard be
    different from the basis for determining the risk-based capital
    rule? Do you believe that it would harm the ability of Fannie
    and Freddie's regulator to perform its oversight functions if
    Congress placed restrictions on its ability to adjust the
    minimum capital standards? Why or why not?

    A.1. Capital standards are designed to ensure that regulated
    institutions can survive periods of significant misfortune
    involving sizeable financial losses. In theory, a single
    standard that encompassed all relevant considerations would
    suffice to determine capital adequacy. In practice, that would
    be very difficult and Congress has wisely required OFHEO and
    all depository institution regulators to implement both a
    leverage-based standard and a more finely risk-based standard.
        Evaluation of capital adequacy entails a broad range of
    considerations including not only an institution's current book
    of business; but also the current and prospective risk
    environment, its business strategies and potential changes in
    those strategies, the strength of its customer and supplier
    relationships, the strength of its internal controls, potential
    fragility if the markets in which it buys and sells, the
    structure of those markets and potential changes in the way
    those markets function, the vulnerability of the institution's
    reputation, the systemic importance of the institution, and
    many other factors.
        Issues of practicality constrain the determinants of
    capital requirements to a small subset of these factors. Thus,
    for example, OFHEO's risk-based standard focuses on each
    Enterprise's current book of business and two possible future
    risk environments. It requires sufficient capital to cover
    losses or current positions in extended, specific adverse
    circumstances. This is a highly detailed rule that examines
    this aspect of capital adequacy in depth. It is important that
    the Enterprises be able to meet this requirement, but does not
    necessarily imply that capital is adequate. A high degree of
    protection against interest rate and credit risk can reduce the
    risk-based requirement to very low or zero levels without
    addressing other risks.
        The minimum capital (leverage-based) standard is a fail-
    safe mechanism that ensures a substantial amount of capital
    regardless of measured interest rate and credit risks.
    Incorporating all other risks into the risk-based standard
    would be problematic. They generally do not fit well into the
    scenario format because the range of possibilities is
    essentially infinite. Also, the magnitudes of other risks
    generally are not easily quantifiable, but rather are more a
    matter of judgment.
        A separate standard that encompasses these judgments makes
    sense. While it would be possible to add the two requirements
    to make a single rule that would produce an overall requirement
    that would be considerably more volatile than the current
    combination, and might usually be higher than necessary. So far
    the judgment exercised by Congress in setting the ratios used
    to determine the minimum capital requirements has worked
    satisfactorily. However, institutions and their business
    environments change over time. An expert safety and soundness
    regulator is best able to judge if and when changes to a
    leverage-based ratio should be made. Accordingly, Congress
    should give the regulator of Fannie Mae and Freddie Mac the
    same authority it has given depository institution regulators
    to adjust all capital requirements if necessary.

    Q.2. Do you believe the current separation of regulatory
    authority that gives the power to oversee new GSE programs and
    activities to HUD, and safety and soundness to OFHEO, has
    undermined your ability to oversee the safety and soundness of
    Fannie and Freddie? Why or why not?

    A.2. The separate regulatory authority for new program review
    by HUD doesn't undermine OFHEO's safety and soundness
    authority.
        OFHEO has endorsed bringing new program authority into the
    safety and soundness regulator as this is the case with other
    financial regulators. This will also permit the examination and
    on-site expertise of OFHEO to be brought to bear in making
    decisions on new programs and potentially produce fuller and
    quicker review of new programs.
        All of these benefits may occur without any adverse impact
    on housing mission or safety and soundness. Congressional goals
    on Enterprise housing mission are in statute and must be
    followed by the safety and soundness regulator and indeed today
    in applying safety and soundness rules under its jurisdiction.
    OFHEO abides by Congressional housing policy in such areas as
    low- and moderate-income programs undertaken by the
    Enterprises.

    Q.3. You testified that while you have been OFHEO Director, HUD
    has never approved (or declined to withhold approval) a new GSE
    program or product that you believed would have undermined
    Fannie and/or Freddie's safety and soundness. In light of this
    history, why do you believe that the authority to approve any
    new GSE programs or products must be included in the oversight
    authority of the GSE safety and soundness regulator? What is
    wrong with the current GSE program and product review system,
    which includes OFHEO in a consultative role?

    A.3. HUD has addressed few new program proposals over the years
    since passage of the 1992 Act that required OFHEO to review the
    matters for safety and soundness consideration. Thus, our
    experience is not one of problems with the current situation
    insofar as safety and soundness is concerned, as noted in my
    response to Question #2 above.
        However, OFHEO's ``consultative'' role may create a
    potential conflict should a situation arise where HUD and OFHEO
    have differing views on a particular program. For the reasons
    stated in my response to Question #2, it is my belief that the
    benefits of a new structure are more than sufficient to review
    the existing separation of functions. It would be beneficial,
    as is the case with other financial regulators, to have
    independent authority to review new programs for charter
    compliance.

    Q.4. At the July 17, 2003, GSE oversight hearing, you testified
    that OFHEO would conduct a special investigation of the
    accounting practices of Freddie Mac. The report of the
    investigation is now expected to be completed in November. Has
    the investigation provided you with any insights or further
    recommendations about how Congress might improve the oversight
    of the GSE's?

    A.4. Yes, the investigation gave the Agency insights into
    additional authority OFHEO needs to be better able to
    accomplish its regulatory goals. These are included in the
    report of our special examination of Freddie Mac.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                        FROM DOUGLAS HOLTZ-EAKIN

    Conservatorship/Receivership Authority
        The Administration has proposed that the new regulator have
    all the receivership authority necessary to direct the orderly
    liquidation of assets.
    Q.1.a. What difficulties would you see in moving to
    receivership powers akin to those held by the FDIC?

    A.1.a. One purpose of receivership is to prevent a failing
    institution from continuing to incur losses after its equity
    capital has been exhausted. In the case of Federally insured
    banks and Government Sponsored Enterprises, the Government has
    a direct interest in preventing failed institutions from taking
    on additional risks in an attempt to win back their losses.
    Another purpose is to transfer the function of the failed
    entity to a new service provider. For the most part, the FDIC
    seems to have adequate authority to ensure an orderly winding
    down of the affairs of a troubled bank without exposing the
    Government to excessive additional risks. I would note,
    however, that the housing GSE's are far larger than the typical
    failed bank and that their greater size may present special
    challenges to a receiver's attempts to limit risk and transfer
    operations to another firm or other firms. But with that
    caveat, the receivership powers of the FDIC would seem to be a
    reasonable starting point.

    Q.1.b. What impact would receivership authority have on the
    ability of the GSE's to access the debt markets?

    A.1.b. Providing receivership authority to a regulator might
    cause investors in debt securities to consider how they might
    be affected by the exercise of such authority and then to
    monitor the financial condition of the Enterprises more
    carefully. While that increased attention to financial
    fundamentals could reduce the price that investors pay for GSE
    debt, it would not be expected to interfere with access to the
    debt markets by financially sound GSE's.
        For a failed GSE, appropriate receivership authority would
    preclude access to the debt markets, except as necessary to
    ensure an orderly transfer of functions to another financial
    institution.
    Office of Finance in the FHLBank System
    Q.2. If the regulator for the Federal Home Loan Bank System
    were to be moved into the Treasury Department, should the
    Finance Board's Office of Finance also be moved, or how would
    you suggest handling the Office of Finance?

    A.2. The Office of Finance, even though a part of the Federal
    Housing Finance Board, has no regulatory duty or authority.
    Rather, its role is to fund the lending operations of the Banks
    by issuing and servicing their debt securities as efficiently
    as possible. Given its purpose and function, it would be
    appropriate for the Office of Finance to continue to operate
    privately, outside of Treasury.

            RESPONSE TO A WRITTEN QUESTION OF SENATOR REED
                        FROM DOUGLAS HOLTZ-EAKIN

    Capital Standards
    Q.1. In your testimony, you mention that regulators can limit
    GSEs' risk exposure to taxpayers by having the capabilities to
    adjust capital requirements and other tools. Currently, the GSE
    safety and soundness regulator can adjust the risk-based
    capital standard. Why does the minimum capital standard need to
    be changed in addition to the regulator being able to change
    the risk-based capital standard? Please explain in detail.

    A.1. The risk-based capital standard is based on a complex
    computer-based effort to model the risk assumed by the GSE's.
    The minimum capital standard, by contrast, is intended to
    provide a margin of safety against unquantifiable risks,
    including systemic risks, and against errors and failures in
    the risk-based capital stress test. Indeed, the regulator who
    is responsible for setting the risk-based capital standard may
    be uniquely positioned to appreciate the limitations of that
    standard.
        Both standards could be useful in providing a measure of
    protection for taxpayers against the adverse consequences of
    assumed risk. Thus, I see no reason to restrict the authority
    of the safety and soundness regulator to setting capital
    standards based solely on quantified risks.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                          FROM DALE J. TORPEY

    Oversight of the FHLB Housing Programs
    Q.1.a. Your testimony addressed HUD's mission control for
    Fannie Mae and Freddie Mac. HUD, however, does not oversee the
    housing mission or affordable housing programs of the Federal
    Home Loan Banks. Do you believe that the Federal Home Loan
    Banks' affordable housing mission needs to be changed?

    A.1.a. ICBA believes that the Federal Home Loan Banks have
    performed extremely well in accomplishing their affordable
    housing mission. According to the FHLBanks' Office of Finance,
    during 2002, the FHLBanks contributed some $286 million to the
    Affordable Housing Program. Since the program's inception in
    1990, the FHLBanks have awarded over $1.7 billion in AHP
    subsidies helping to create nearly 359,000 housing units for
    low-income families. ICBA does not see any need to make changes
    to this program.

    Q.1.b. If a single regulator for the GSE's is created, should
    the FHLBanks' housing mission be treated differently than that
    of Freddie Mac and Fannie Mae?

    A.1.b. Congress established different ways for the FHLBanks to
    fulfill their housing mission compared to those established for
    Fannie Mae and Freddie Mac. Congress gave Fannie Mae and
    Freddie Mac goals for the purchase of mortgage loans for
    certain geographic areas and for certain consumers based on
    income levels. These goals are consistent with the secondary
    market function of Fannie Mae and Freddie Mac. Congress,
    however, created a very different program, the Affordable
    Housing Program, for the FHLBanks. This program funnels a
    specified portion of the FHLBs' net income to their members so
    they in turn can help their customers qualify for affordable
    housing loans. ICBA sees the difference in these programs as
    complementing the differences in the function, operation and
    structure of the FHLBanks that serve primarily as a source of
    funding to their members, versus the secondary market function
    of Fannie Mae and Freddie Mac.
    Prompt Corrective Action
    Q.2. OFHEO and the Finance Board clearly do not have the
    complete arsenal of Prompt Corrective Action tools that the OCC
    and other bank regulators have. In fact, the Finance Board has
    no statutory Prompt Corrective Action authority. Do you believe
    that a new regulator must have the same Prompt Corrective
    Action tools as the bank regulators?

    A.2. We believe that the GSE's should have strong regulatory
    oversight. ICBA has not yet concluded its analysis of the
    differences in regulatory powers of OFHEO and the Finance Board
    as compared to those of the bank regulators, and we have not
    yet determined if the GSE regulators should have the exact same
    powers as those of the bank regulators.
    Program Approval Authority
    Q.3. Do you believe that moving prior program approval from HUD
    to a new safety and soundness regulator would have any adverse
    impacts on the GSEs' housing mission?

    A.3. ICBA testified that for the housing GSE's to continue to
    be innovative in the development and implementation of new
    products to meet the demands of the marketplace, there should
    be a smooth and seamless process for getting these products
    online. As we stated, if a FHLBank, Fannie Mae, or Freddie Mac
    develops a program that is inconsistent with safety and
    soundness or with their Congressionally mandated mission, there
    must be a review process to make that determination. We
    continue to believe that there should not be disincentives for
    the GSE's to be innovative and adaptive to new market
    conditions. Our housing finance system has evolved rapidly over
    the recent past due to changing technology and changes in the
    demands of consumers. The housing GSE's must have the
    flexibility to develop the housing finance products needed by
    consumers in a timely manner and not have new products,
    programs, and activities be bogged down by bureaucracy. Because
    of its responsibilities and expertise, we prefer that prior
    program review for Fannie Mae and Freddie Mac remain in the
    hands of HUD. We would also reiterate our strong concern that
    given the Treasury Department's existing tax and fiscal policy
    responsibilities, moving authority for housing policy to
    Treasury would likely present clear conflicts of interest.
    Also, as we testified, we share the concerns expressed by
    others regarding the historical absence of housing expertise at
    Treasury.
    Capital Standards
    Q.4. Could giving the GSE regulator, be it the current
    regulator or a new regulator, greater discretion over minimum
    capital standards have any adverse consequences on the mortgage
    market?

    A.4. Congress has established the minimum capital standards for
    Fannie Mae and Freddie Mac, and the equivalent for the
    FHLBanks, while giving their regulators the responsibility to
    set risk-based capital standards. As ICBA testified, this
    should continue to be the case. Market factors and potential
    risks can change rapidly and it is appropriate for a regulator
    to have the ability to adjust risk-based capital standards and
    risk factors through the regulatory process. Congress should
    retain the authority to modify statutory or minimum capital or
    leverage standards as these standards can affect the amount of
    capital flowing to the housing sector.

            RESPONSE TO A WRITTEN QUESTION OF SENATOR HAGEL
                          FROM DALE J. TORPEY

    Minimum Capital
    Q.1. In your written testimony, you state that ICBA supports a
    ``politically independent,'' ``world-class'' regulator like the
    OCC and the OTS. However, you object to that new regulator
    having authority to adjust minimum capital, a power which is
    granted to the OCC and the OTS. Shouldn't a truly world-class
    regulator, like our Nation's bank regulators, have the
    authority to adjust minimum capital?

    A.1. When Congress wrote legislation governing the housing
    GSE's, it set the minimum capital standards for Fannie Mae and
    Freddie Mac and the minimum leverage ratio for the FHLB's, and
    also gave guidance for their regulators to establish risk-based
    capital ratios. We believe this has worked well so far and see
    no reason for change. ICBA has been concerned that a
    politically influenced regulator would use the minimum capital
    or leverage standards as a way to increase or decrease the
    capital flowing to the housing sector for political reasons
    rather than to control risk. If regulators see that the risks
    facing the GSE's warrant increases in capital, they have the
    ability to require higher levels based on a methodical, risk-
    measurement process. If warranted, regulators are able to set
    risk-based capital standards so that the entities hold more
    capital than would be required by minimum capital or leverage
    standards.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                          FROM DALE J. TORPEY

    Regulatory Restructuring
    Q.1. In your testimony, you argue that ``the FHLB's should
    continue to be regulated by a separate and independent agency''
    and that the ``ICBA Board (has) voted unanimously to oppose
    including the FHLB's in any proposed new supervisory and
    regulatory structure for Fannie Mae and Freddie Mac in the U.S.
    Treasury Department.'' However, you also state that ``the ICBA
    may not oppose the concept of a new independent regulator for
    all . . . housing GSE's outside the Treasury Department.'' How
    could GSE regulatory reform legislation be drafted to address
    the differences between Fannie and Freddie and the FHLB's but
    remain consistent enough so as to establish a level playing
    field between the housing GSE's? Do you have any specific
    recommendations?

    A.1. ICBA has only started to look at this very complex issue.
    We see many differences between the FHLB's and the other two
    housing GSE's and we have begun to identify them. For example,
    ICBA members place a great value on the regional structure of
    the FHLB System and would not want to see legislation that
    pushes the System toward consolidation so that its structure
    looks more like Fannie Mae's and Freddie Mac's for the ease of
    regulation and oversight. The FHLB System is a cooperative and
    its member users should continue to be eligible to hold seats
    on FHLB boards of directors. Yet, it is probably not
    appropriate for Congress to set aside a number of seats on the
    boards of public companies Fannie Mae and Freddie Mac for their
    seller/servicers. One idea that has already received some level
    of public discourse is the creation of a single, independent
    regulator for all three housing GSE's--but which would have two
    separate divisions, one for Fannie Mae and Freddie Mac, and the
    other for the FHLBanks. ICBA continues to study this and other
    ideas.
    Cost of Funds
    Q.2. Do you believe that if the FHLB System were not regulated
    by the proposed new regulating entity the cost of capital for
    the banks, relative to Fannie and Freddie, would eventually
    increase? Why or why not?

    A.2. We do not believe that cost of funds will be materially
    impacted by who the regulator is. Fannie/Freddie and the FHLB's
    have long had different regulators and this has not been an
    issue. More important to the capital markets is whether or not
    GSE status remains intact, and other factors that might affect
    the bond ratings of the individual GSE's.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                          FROM ROBERT M. COUCH

    Program Approval Authority
    Q.1. Do you believe that moving prior program approval from HUD
    to a new safety and soundness regulator would have any adverse
    impacts on the GSEs' housing mission?

    A.1. Moving prior program approval from HUD to a new safety and
    soundness regulator would strengthen the GSEs' housing mission.
    The GSE's are committed to their housing mission. Moving
    regulatory oversight of their programs will not change their
    commitment at all. It would merely ensure that they carry out
    their mission safely and soundly, something everyone supports.
        There is no question that the GSE's must operate their
    programs safely and soundly--they would fail in their housing
    mission otherwise, and that would be unacceptable to all.
    Safety and soundness is the core foundation upon which the
    entire GSE housing mission rests. GSE programs must be safe and
    sound for the very purpose of maintaining that core foundation.
        Some parties have expressed concern that safety and
    soundness review or oversight of GSE programs would interfere
    with the GSEs' housing mission. These parties are concerned
    that a safety and soundness regulator, such as an agency under
    the Treasury Department, would not be sufficiently concerned
    about the GSEs' housing mission. MBA does not share this view.
        In fact, we believe that Treasury has demonstrated
    repeatedly an ability to oversee program approval reviews
    without any adverse impact on housing. Treasury oversees all
    national banks and Federal thrifts in the country. The thrift
    industry, in particular, is a major participant in the housing
    industry, and the Treasury has successfully regulated thrifts
    since 1989. Treasury oversees new activities for thrifts,
    without any adverse affects on the housing industry, and with
    no interference with thrifts' ability to innovate and stay
    competitive. Further, Treasury's responsibilities include
    administering the Community Redevelopment Act for both banks
    and thrifts, ensuring that lending resources are available in
    communities.
    Capital Standards
    Q.2. Could giving the GSE regulator, be it the current
    regulator or a new regulator, greater discretion over minimum
    capital standards have any adverse consequences on the mortgage
    market?

    A.2. A financial regulator needs appropriate discretion to
    carry out its duties--ensuring adequate capital standards is
    typically a core component of that role.
        Today, OFHEO has no discretion in setting minimum capital
    standards. The minimum capital requirement is set entirely by a
    statute enacted in 1992, and cannot change as the marketplace
    changes or as the GSE's change. Even in the case of a
    financially distressed GSE or of a market crisis, OFHEO has no
    authority to alter the minimum capital requirement.
        MBA believes that the GSE regulator should have the
    necessary discretion to determine appropriate capital
    requirements, commensurate with the goal of ensuring financial
    safety and soundness and prudent risk management. Fannie Mae
    and Freddie Mac today appear to be well-capitalized, so no
    imminent change is foreseeable. Ultimately, the mortgage market
    benefits if the regulator is empowered to act to prevent a
    crisis, rather than just respond to one.

            RESPONSE TO A WRITTEN QUESTION OF SENATOR HAGEL
                          FROM ROBERT M. COUCH

    Q.1. MBA has published an issue paper in which you suggest
    standards for determining when a GSE activity is outside the
    boundaries of the secondary mortgage market. Can you summarize
    this document for us, and do you think we should use it as a
    guideline for the regulator in evaluating Fannie and Freddie's
    programs, products, and activities?

    A.1. MBA published an issue paper in 2001 entitled Defining the
    Boundaries of GSE Activity, available on our website at
    (control-click this link): http://www.mortgagebankers.org/
    library/isp/2003_4/03-03.pdf. Below is a summary of the issue
    paper, followed by an answer to your question about it.
        This issue paper arose out of concern on the part of many
    MBA member mortgage lenders that Fannie Mae and Freddie Mac
    have begun to insert themselves into the primary mortgage
    market. The issue paper describes the important role the GSE's
    play in the secondary mortgage market, and compares and
    contrasts that to the role of the originating mortgage lenders
    in the primary mortgage market. Congress created Fannie Mae and
    Freddie Mac to provide liquidity in the secondary mortgage
    market. The GSE's work together with primary mortgage market
    lenders to provide the American public with our highly
    successful residential mortgage market.
        The GSE's enjoy legal and financial benefits of Government
    sponsorship, designed to ensure the GSE's provide secondary
    market stability and liquidity. If the GSE's were to use their
    Government sponsored competitive benefits to expand their
    activities into the primary market, their competitive advantage
    could permit them to dominate the primary market. Consumers
    would be the ultimate losers. Primary market domination backed
    by competitive advantages would stifle competition, raise
    mortgage prices, and limit consumers' financing options.
        Many believe that the GSE's have been moving into the
    primary mortgage market. They have, for example, acquired
    interests in a range of nonlender primary market participants,
    begun advertising heavily directly to consumers (who do not
    participate in the secondary market), and they have worked to
    increase their market share by enforcing loan delivery
    standards that favor their proprietary technologies for primary
    market activities, to the detriment and demise of private
    market technology providers.
        Current law is vague, leaving the GSE's vulnerable to
    criticism that the existing regulatory system is unable to
    provide adequate oversight of the GSEs' mission and programs.
    Current law prohibits both GSE's from mortgage loan
    origination, but does not
    define loan origination. The issue paper provides a detailed
    description of the differences between the primary and
    secondary markets. In brief, primary market participants work
    directly with consumers. The secondary market is investment-
    related, involving a mortgage loan after it has been
    originated, and there is no consumer contact in the secondary
    market.
        The GSE charters were established decades ago. More
    recently, in 1992, Congress required the GSE's to meet
    affordable housing goals. Congress did not thereby alter the
    scope of the GSEs' mission and did not intend a wholesale
    rewrite of their charters. A link between meeting a housing
    goal and an otherwise-impermissible GSE activity does not
    justify GSE entry into the primary market. Every GSE initiative
    must promote liquidity in the secondary mortgage market.
        The issue paper further sets out standards and criteria for
    distinguishing between the primary and secondary markets.
    Generally, if an activity involves contact with borrowers or
    potential borrowers, or their agents or representatives, it is
    a primary market activity and is impermissible to the GSE's.
        MBA believes this issue paper would provide very useful
    guidance to Congress in considering Fannie Mae's and Freddie
    Mac's activities. MBA members are the lenders who originate the
    loans that Fannie Mae and Freddie Mac buy and guarantee. Our
    members have direct, hands-on experience working with the
    GSE's--that is what our members do every day. Further, MBA
    established this issue paper by convening a blue ribbon panel
    of industry leaders from among our members. The panel
    extensively analyzed and reviewed the spectrum of GSE
    activities and the primary mortgage market. The panel solicited
    and received extensive comment from both Fannie Mae and Freddie
    Mac in preparing this issue paper. The resulting issue paper is
    an expert, detailed, analysis of the distinctions between the
    primary and secondary markets, and an approach for determining
    whether particular activities are beyond the boundaries of the
    secondary market.
        It is important for Congress to address the boundaries of
    the secondary market. Currently, there are no clear boundaries,
    and the GSE's have been taking advantage of that lack of
    clarity to the detriment of the primary market. No regulator
    currently has the authority or capacity to address the problem,
    so it persists. MBA very strongly urges Congress to draw, and
    equip a regulator to enforce, very clear boundaries of GSE
    activity in the secondary mortgage market.

                            PROPOSALS FOR IMPROVING

                            THE REGULATORY REGIME OF

                        GOVERNMENT SPONSORED ENTERPRISES

                                  ----------

                           TUESDAY, FEBRUARY 10, 2004

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:01 a.m., in room SD-538, Dirksen
    Senate Office Building, Senator Richard C. Shelby (Chairman of
    the Committee) presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The hearing will come to order.
        This morning, the Committee meets to hold our third hearing
    on proposals to improve the regulation of Government Sponsored
    Enterprises. The intention of these hearings is to build a
    solid record as the Committee continues to pursue legislation
    to establish a strong and credible regulator for the GSE's.
        I would like to welcome Comptroller General David Walker
    from the General Accounting Office as our first witness this
    morning. Mr. Walker became the seventh Comptroller General of
    the United States and began his 15-year term when he took his
    oath of office on November 9, 1998. During Mr. Walker's tenure,
    the GAO has completed a number of important studies on the
    topic of GSE's. We are fortunate to have this body of work to
    draw from as we consider regulatory reform, and we look forward
    to discussing the broad array of issues with you today, Mr.
    Walker.
        Our second panel includes three witnesses: Mr. Alan Beller,
    Director of the Division of Corporate Finance and Senior
    Counselor to the Securities and Exchange Commission; Professor
    Richard Carnell, Associate Professor of Law at Fordham Law
    School; and Mr. James R. Rayburn, President of the National
    Association of Home Builders. These witnesses have
    distinguished professional backgrounds which will enable them
    to provide this Committee with sound insights on particular
    aspects of GSE regulation. Mr. Beller, the Committee will
    benefit from your expertise in the area of corporate financial
    disclosure as we consider how to improve transparency and
    ensure meaningful GSE financial disclosures.
        Mr. Carnell is a former Assistant Secretary for Financial
    Institutions at the Department of the Treasury and also a
    former Senior Counsel to this Committee. We will be
    particularly interested in your insights as to how to give a
    new GSE regulator the same stature and credibility as our bank
    regulators. Finally, Mr. Rayburn will provide us with some
    insights on any impact that GSE regulatory reform will have on
    our Nation's housing markets.
        Comprehensive regulatory reform deserves careful
    consideration, and this Committee will work very diligently to
    craft an appropriate reform package. The GSE's play a vital
    role in expanding homeownership, and I strongly support their
    mission. However, the Congress cannot sit idly by after the
    events of last year. It is our duty to maintain the continued
    strength of the U.S. home mortgage market. But we must also put
    in place, I believe, a GSE regulator that has the necessary
    independence, strength, and credibility to carry out its
    mandate. That mandate is to ensure that all the housing GSE's
    fulfill their public mission in a safe and sound manner. In
    order to create an improved regulatory structure, I believe we
    must have a full and open debate on a variety of issues, such
    as the structure of the regulator, authority for the program
    review, and capital requirements. These are not easy questions
    to resolve, but I am confident that this Committee can reach a
    consensus on these issues.
        I want to thank all the witnesses for appearing before the
    Committee today. We look forward to hearing your testimony and
    the discussion to follow.
        Mr. Walker, your written statement will be made part of the
    record--Jack, do you have an opening statement?

                      COMMENT OF SENATOR JACK REED

        Senator Reed. No, sir, I do not. I would just like to thank
    you for holding this important hearing and the witnesses for
    being here today.
        Chairman Shelby. Senator Sununu.

                   COMMENT OF SENATOR JOHN E. SUNUNU

        Senator Sununu. No, Mr. Chairman. I just want to echo the
    remarks of my collegue.
        Chairman Shelby. Okay. Your written statement will be made
    part of the record in its entirety. You proceed as you wish.

                      STATEMENT OF DAVID M. WALKER

                  COMPTROLLER GENERAL, ACCOMPANIED BY

                     TOM McCOOL, MANAGING DIRECTOR

              FINANCIAL MARKETS AND COMMUNITY INVESTMENTS

                     U.S. GENERAL ACCOUNTING OFFICE

        Mr. Walker. Thank you, Mr. Chairman and Senators. It is a
    pleasure to be here to talk to you today about oversight of
    Government Sponsored Enterprises. As you know, Government
    Sponsored Enterprises had combined obligations, including
    mortgage-backed securities and other debt obligations, of $4.4
    trillion as of September 30, 2003. In my view, our past
    experience in the savings and loan industry, the recent
    accountability breakdowns in the private sector, and the
    importance of gaining public trust and confidence in regulatory
    agencies that oversee our financial institutions and capital
    markets, these factors are directly relevant to the ongoing
    debate and appropriate regulatory oversight of GSE's.
        In our view, in order to ensure that GSE's operate in a
    safe and sound manner, it is essential that effective
    governance, reasonable transparency, and effective oversight
    systems are established and maintained. In particular, we
    believe the GSE's should lead by example in the area of
    corporate governance. The GSE regulators must be strong,
    independent, and have the necessary expertise in order to do
    their jobs, and GSE mission definitions and benefit measures
    need to be clearly established.
        However, our work has also found that GSE governance does
    not always reflect best practices, and some of these other
    areas require attention at this time as well. Furthermore, the
    regulatory structure for housing GSE's is fragmented, and
    serious questions exist as to the capacity of GSE regulators to
    effectively fulfill their responsibilities.
        To prevent the need for the Federal Government to ever have
    to provide financial support to a GSE and to minimize the
    financial risk of instability, it is critical to ensure that
    proper corporate governance, reasonable transparency, and
    effective oversight mechanisms are in place. Not only should
    GSE's be sensitive to good governance, but it is also all the
    more important that they lead by example in connection with
    accountability, integrity, and public trust issues.
        A regulatory system of GSE oversight must have the
    necessary strength, independence, and capability to protect
    against the significant risk and potential cost to taxpayers
    posed by the GSE's. We have consistently supported, and
    continue to believe in, the need for the creation of a single
    regulator to oversee both safety and soundness and mission
    issues associated with the housing GSE's. A single regulator
    could be more independent and objective than separate
    regulatory bodies and could be more prominent than any one
    alone. Further, a single regulator would be better positioned
    to consider potential trade-offs between mission requirements
    and safety and soundness considerations because such a
    regulator would develop a fuller understanding of the
    operations of these large and complex financial institutions.
        To be effective, the single regulator must have all the
    regulatory powers, enforcement authorities, technical
    expertise, and technological capabilities necessary to oversee
    GSE operations and compliance with their missions. In this
    regard, we believe that a hybrid executive director and
    coordinating board model, possibly similar to the one
    applicable to the Pension Benefit Guaranty Corporation, should
    be considered by the Congress.
        Irrespective of the regulatory model, without clearly
    defined measures of the GSE's benefits, it is not possible for
    Congress, accountability organizations, and the public to
    determine whether the Federal Government should be potentially
    subject to the financial risk associated with GSE activity. In
    some cases, there is a lack of measurable mission-oriented
    criteria that would allow for meaningful assessment of GSEs'
    mission achievement or whether the GSEs' activities are
    consistent with their public interest charters. In some cases,
    it is clear GSE's have contributed to their public missions for
    which they were initially created. In this regard, it is
    generally agreed that Fannie Mae and Freddie Mac's mortgage
    purchase activities have lowered the interest rates on
    qualifying mortgages below what they otherwise would have been.
        At the same time, additional studies may be necessary to
    more precisely estimate the extent to which GSE activities have
    benefited certain homebuyers, especially those who can least
    afford a home.
        In this and other areas, there is substantially greater
    uncertainty regarding the benefits of GSE activities, both
    individually, collectively, and as compared to private non-GSE
    lenders. As a result, more research is needed to clarify these
    issues.
        Additionally, the lines that initially existed between
    Fannie Mae and Freddie Mac, on the one hand, and the Federal
    Home Loan Bank System, on the other hand, have blurred over the
    years. This can lead to legitimate questions regarding how many
    GSE's do we need to get the job done. In some cases, the
    absence of specific criteria and guidance complicates the
    efforts to assess the need for and the benefits of GSE's.
        Finally, I would like to also point out that there are
    other limitations in the evidence and research on benefits
    provided by GSE activities. There is limited information as to
    the extent to which the Federal Home Loan Bank System's more
    than $500 billion in outstanding advances as of mid-2003 have
    facilitated mortgage activity. There is limited information
    available on the extent to which Fannie Mae and Freddie Mac's
    investments in nonmortgage assets, such as long-term corporate
    bonds, serve their public missions. And there is virtually no
    evidence available as to whether Farmer Mac's activities have
    benefited agricultural real estate markets.
        Without quantifiable measures and reliable data, Congress
    and the public cannot judge the effectiveness of GSE's in
    meeting their missions or whether the benefits provided by
    these entities are in the public interest and outweigh the
    potential financial risk.
        To improve the quality of information about GSE activities,
    we believe that the GSE's should have a single regulator
    dealing with safety and soundness and mission activities, and
    that additional research is necessary with regard to some of
    the items that I have noted in my statement.
        Mr. Chairman, that would conclude my opening statement. I
    would be more than happy to answer any questions that you and
    the other Senators may have.
        Chairman Shelby. Mr. Walker, the discussion, among other
    things, on the structure of a new GSE regulator has focused on
    two models: an independent bureau of the Treasury, like the
    OCC, for example, or a stand-alone independent agency, like the
    SEC or the FDIC or others.
        If the Congress chose to adopt the independent agency
    structure, how do we ensure that this regulator has sufficient
    stature and credibility to provide strong oversight of the
    GSE's?
        Mr. Walker. Well, obviously, the structure can be
    important. One has to ascertain what are the proper
    qualifications for a person who would end up leading and
    overseeing this entity whether or not they should be
    Presidential appointee with Senate confirmation, what type of
    authorities they should have, including from a regulatory
    standpoint and an enforcement standpoint. So, I think those are
    the substantive issues that one would have to look at.
        Mr. Chairman, I know there has been some controversy
    regarding the issue of whether or not to combine the safety and
    soundness mission issues. I think whether you go with an
    independent agency or whether you go with an entity within an
    existing department or agency, like the Treasury Department, it
    might merit considering having an executive director model with
    a coordinating board.
        Chairman Shelby. A board with prestige, right?
        Mr. Walker. Yes, a board with prestige. For example, you
    could have the Secretary of the Treasury, the Secretary of HUD,
    and other appropriate parties----
        Chairman Shelby. The Fed, the Chairman of the Fed.
        Mr. Walker. Potentially.
        Chairman Shelby. SEC Chairman, maybe.
        Mr. Walker. Potentially. But the idea is that, to the
    extent that you want to make sure that there are responsible
    authorities, knowledgeable parties who are concerned with and
    interested in safety, soundness, and mission, and who could
    help to make sure that all those issues were considered.
        Chairman Shelby. Could you describe some of the problems of
    Fannie Mae and the Farm Credit System during the 1980's, their
    underlying causes and the nature of the Government's
    assistance?
        Mr. Walker. I might get a little bit of help on that since
    that is before my time, Mr. Chairman, if you do not mind. This
    is Tom McCool, who is the Managing Director of our Financial
    Markets and Community Investment, with your indulgence.
        Mr. McCool. Mr. Chairman, yes, well, Fannie Mae was given
    forbearance. Fannie Mae was not actually given direct
    assistance, but they were in trouble and they were given
    forbearance from a capital and tax perspective. My
    understanding or my recollection is--it was actually before my
    time as well--that the Farm Credit System was actually given
    assistance as part of a bailout, and then it was also
    reengineered to hopefully be a more independent--the Farm
    Credit Administration was reengineered to be a more effective
    agency and a more stand-alone, arm's-length regulator.
        Chairman Shelby. Mr. Walker, your written testimony notes
    that OFHEO cannot place Fannie Mae or Freddie Mac into
    receivership. They can go in as a conservator, as I understand,
    which is different.
        Based on your analysis, do you believe that the existing
    statute authorizing the appointment of a conservator gives the
    regulator sufficient authority to resolve a troubled GSE?
        Mr. Walker. Based upon the past experience with the savings
    and loan industry, et cetera, we believe that consideration
    should be given to expand that beyond just a conservator, and
    in some usual circumstances to allow for receivership. That is
    not something that one would expect to happen. I would hope
    that it would not happen. But, on the other hand, we believe it
    is something that needs to be in the toolbox of the regulator.
        Obviously, that is something where it would be necessary to
    prescribe some type of guidance as to when and under what
    circumstances receivership would be used.
        Chairman Shelby. But you have to be ready for it.
        Mr. Walker. Correct. It should be in the toolbox, in our
    view, Mr. Chairman.
        Chairman Shelby. Would resolution procedures along the
    lines of those held by FDIC to form bridge banks or to deal
    with systemic risk issues also be advisable for a GSE
    regulator?
        Mr. Walker. We believe it is important for you to look at
    what types of authorities and tools other entities have, such
    as this, and really the question in our view would be: Why
    shouldn't they have it? In other words, the presumption would
    be that they should have these tools----
        Chairman Shelby. If you are going to have a regulator, you
    need a regulator. Is that correct?
        Mr. Walker. Right.
        Chairman Shelby. The last question I am going to touch on--
    we have a lot of other people here--is the impact of earnings
    per share as a corporate goal. Doesn't every public company
    focus on earnings per share?
        Mr. Walker. They clearly do, Mr. Chairman.
        Chairman Shelby. Does this attention to earnings per share
    measurements impact the holdings in the GSE portfolios, in your
    judgment?
        Mr. Walker. It can. As you know, there are certain holdings
    that can enhance value and potentially moderate risk, and such
    investments have the potential to do that. And I believe, Mr.
    Chairman, that one of the challenges that we have, not just
    with GSE's but in corporate America, is too much focus on
    short-term earnings rather than earnings over the longer-term,
    along with sustainable earnings, and quality earnings.
        Chairman Shelby. Senator Reed.
        Senator Reed. Thank you very much, Mr. Chairman.
        Thank you, Mr. Walker, for your testimony.
        Back in 1997, the GAO issued a report, ``Advantages and
    Disadvantages of Creating a Single Housing GSE Regulator.'' It
    rolls right off the tongue, a very good title. ``Our analysis
    of different regulatory structures indicate that an
    independent, arm's-length, stand-alone regulatory body headed
    by a board would best fit our criteria for effective regulatory
    agencies.'' Is that still your position today?
        Mr. Walker. We do believe there needs to be a single
    regulator to address safety, soundness, and mission
    considerations. I have now offered a possible hybrid model that
    we did not put forward in 1997 that I think the Congress should
    consider, an executive director but possibly a coordinating
    board involved with appropriate individuals to be able to help
    make sure that there is effective coordination of mission,
    safety, and soundness considerations.
        Senator Reed. What has changed since 1997 that would prompt
    this hybrid proposal?
        Mr. Walker. David M. Walker has become Comptroller General
    of the United States and has prior experience in dealing with
    entities that had these types of structures. It has worked
    pretty well. For example--and, by the way, the financial
    condition of the entity that I am going to talk about is not a
    model that we want to follow, but the Pension Benefit Guaranty
    Corporation has an executive director and has a board of
    directors comprised of the Secretary of Labor, the Secretary of
    Treasury, and the Secretary of Commerce. One of the reasons
    that that model was chosen was to be able to provide the
    executive director with the responsibility and authority to run
    this independent agency in a way to protect the public interest
    and to serve the mission purpose of the agency, at the same
    point in time recognizing that each of those three Cabinet-
    level Departments had an interest in the activities of the PBGC
    and the board served as a mechanism for them to periodically be
    able to convene and discuss issues of major public
    significance.
        It is not an activist board, but it is a mechanism that
    worked fairly well during my tenure and helped to deal with
    major public policy concerns.
        Senator Reed. Well, I must confess, one of the concerns I
    have is the notion of independence, and when you have Cabinet
    Secretaries who are effectively the board of directors, they
    are subject--and regardless of the Administration--to the
    current winds that are blowing through this town. And that to
    me is not something that is going to reassure the investing
    public and the markets that the decisions are being made on an
    independent basis based upon the financial conditions of the
    housing market in this case.
        You know, I think with that model you run the risk--and I
    will not even get into the financial condition of the Pension
    Benefit Guaranty Corporation--of conditions which, if not
    realistically problems, appear to be problems to people.
        Mr. Walker. Senator, I would respectfully suggest that one
    might want to look at who would be the appropriate members of
    the board. In my personal opinion, clearly you would want to
    have the Secretary of the Treasury and the Secretary of Housing
    and Urban Development. But you may want other individuals, such
    as the ones the Chairman suggested, to be involved who tend to
    be somewhat more independent and/or have term appointments that
    could help provide that check and balance.
        Chairman Shelby. It also would bring prestige to this
    board, would they not?
        Mr. Walker. Yes, Mr. Chairman, depending upon what
    positions and who the parties are, it could.
        Senator Reed. Well, again, a contrary view might be that
    some of our boards work very well because they have a term,
    they are removed from the day-to-day politics, the individuals
    have been in several administrations. Again, I think we should
    be very, very sensitive to the notion of independence because
    of the signals it will send to the marketplace.
        Let me ask something else, too. There is the notion with
    these GSE's that there is an implicit subsidy to their
    activities because of their perceived benefit of not failing,
    we will step in. What is your view on that?
        Mr. Walker. Well, various studies have been conducted over
    time that speak of this implicit subsidy, one recently
    conducted by the staff of the Federal Reserve Board. I think
    there is a general view that some people presume that if there
    was a failure at one of these institutions, the Federal
    Government would step in.
        As you know, the Federal Government is not obligated to
    step in. There are no appropriated funds involved at the
    present point in time. But quite frankly the Federal Government
    is not obligated to step in for the Pension Benefit Guaranty
    Corporation either. Nonetheless, perceptions of this----
        Chairman Shelby. Or large banks.
        Senator Reed. Or large banks.
        Mr. Walker. Or large banks. Nonetheless, there is a broad-
    based market perception that the Federal Government stands
    behind this entity, and that clearly has an impact.
        Senator Reed. I think your comments are useful because this
    perception is not exclusive to Fannie Mae and Freddie Mac. As
    the Chairman points out, I think most people in the market
    would assume we would not let our largest or second largest
    bank fail because of the consequences.
        Mr. Walker. That is correct. There are other important
    entities where the Government would be presumed to step in.
    Whether or not that will occur one can debate.
        Senator Reed. Thank you, Mr. Walker.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Crapo.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you very much, Mr. Chairman.
        Mr. Walker, if we were to proceed with legislation that
    would establish a new independent regulator for both Fannie and
    Freddie and the Federal Home Loan Banks, it seems to me that
    one area of obvious difference is the statutory capital
    structure for the GSE's. Do you have any insight that you could
    share with us with regard to how we might contend with that
    difference in the legislation that would be developed?
        Mr. Walker. Tom, I would ask if you have any thoughts on
    that based on our past work.
        Mr. McCool. I think that, again, it is different to have a
    capital framework written in statute. If you look at OFHEO's
    capital statute versus the Finance Board or the bank
    regulators, OFHEO has the one that is written in statute. I
    think that our view would be that Congress can write a capital
    standard and put it in the statute, but it would be useful to
    give the regulator some ability to have the flexibility to go
    above that minimum in cases where either new risks arise or new
    situations arise that were not foreseen by the legislation.
        Senator Crapo. So are you saying that we would have the
    same structure for all entities, or would the new regulator
    have the ability to have different structures?
        Mr. McCool. I believe that, again, the point would be that
    you want a risk-based capital approach that dealt with the
    risks that the entities were undertaking, and whether they are
    Home Loan Banks or Fannie and Freddie, for example, if you
    combine their reuglation, they would all have the same risks
    although not in the same combinations. But you would want the
    same capital to be applied to the same risk.
        Mr. Walker. Senator, I think you may want to have a
    statutory structure or framework. At the same time, I think it
    is important for the regulator, as we note in our testimony, to
    have reasonable flexibility to be able to make judgments about
    what the appropriate capital requirements should be given the
    risk involved. And one would have to assess that issue in
    connection with each of the various entities that they are
    being regulated. So it would be based on the substance or the
    nature of what the relative risk is. If the facts were the
    same, you would get the same answer. But the facts may not be
    the same between these different entities.
        Senator Crapo. So how would we have a statutory capital
    structure but then have the regulatory flexibility? Are you
    saying we would define the capital risk by statute and then
    have the regulator determine how to apply that risk?
        Mr. McCool. Well, actually, let me back up. It may be that
    the best thing to do would be not to have a statutory capital
    structure and to give the regulator criteria for applying
    capital to risk, which, again, is more or less the way it works
    for bank regulators. The bank regulators do not have a
    statutory capital structure, but they are supposed to provide a
    capital structure that is consistent with the risks that the
    institutions undertake. So rather than define broad criteria,
    it might be best to give the regulator flexibility within the
    context of particular activities to define capital in
    accordance with the risk undertaken.
        Senator Crapo. Mr. Walker, do you agree with that?
        Mr. Walker. I do. We are saying the same thing in a
    different way.
        Senator Crapo. All right. Thank you very much.
        Chairman Shelby. Senator Corzine.

                  STATEMENT OF SENATOR JON S. CORZINE

        Senator Corzine. Thank you, Mr. Chairman.
        Let me just pursue that question. I want to make sure I
    understand this correctly. You are talking about flexibility
    with regard to the definition of the risk-based capital rules
    that the regulator would provide. Are you distinguished between
    absolute minimum capital requirements and risk-based capital?
    Or are you underscoring the need for flexibility with one or
    both?
        Mr. McCool. Again, currently there is a statutory minimum
    for Fannie and Freddie in terms of their leverage ratios or
    effectively their minimum capital standards. I think that one
    could put in place, again, minimum capital standards in
    legislation that were not necessarily risk based, but the point
    would be you would want to give the regulator the flexibility
    to set risk-based capital standards that were, again,
    consistent with the level of risk undertaken by the entities.
    So that if different entities did similar things, they would
    face similar capital charges. And if they did different things,
    the differences would be reflected in the capital charges.
        Mr. Walker. Senator, a different way of saying it you may
    want to establish the floor, but you may not want to establish
    the ceiling, and make sure that you have criteria such that the
    regulator can apply the facts and circumstances to determine
    what the appropriate capital requirement would be given
    applicable those facts and circumstances.
        Senator Corzine. I think that is actually one of the
    difficult judgments that we are going to have to make, and, you
    know, how do you then figure out what is the appropriate
    minimum capital standard. It is true, though, that banks
    operate off of a risk-based system than these more modern
    regulatory structures that people are trying to appropriate.
        Let me ask, are there any clear or are there any objective
    standards on why one might think that a regulatory agency
    should be in a group of regulatory elements? I heard you talk
    about structure and authorities, but you left out synergies.
    When one would consider the model of it being within the
    Treasury, one might say that having a stand-alone entity does
    not allow for the synergies of staying current with the latest
    financial knowledge base in the same way that you would if you
    were in a broader organization that had a culture of dealing
    with regulation or the common use of software and other
    elements that may be appropriate. You are going to have to
    build a whole bureaucracy that would not otherwise exist.
        Are there objective standards or objective metrics that you
    would use to justify one versus the stand-alone agency that
    might be outside of just the structural issues and authorities
    that you spoke to?
        Mr. Walker. I think there are certain issues, Senator, that
    have to be addressed irrespective of whether you are within a
    particular department or agency like the Treasury or whether
    you are independent. I mean, do you have a critical mass? Do
    you have the right type of skills and knowledge? Do you have
    the right type of authorities? Do you have enough credibility,
    if you will, and capability to get the job done?
        I do, however, believe there is a difference between
    coordination and integration, and if you are an entity that is
    an independent entity within a larger entity, then the odds are
    you are going to end up having more ongoing interaction and
    more questions being asked as to there are opportunities to do
    things in the same way or in a synergistic manner, and there
    could be some incremental benefit that could be achieved.
        But I think the more important issues are the critical
    mass, the capabilities, the credibility, and the authorities.
    Those are the more important issues, I believe.
        Senator Corzine. Did you feel when you looked at OFHEO
    whether it failed in matching up against or at least was weaker
    than it would have otherwise been against those criteria,
    whether structure, critical mass, authorities, and maybe even
    synergies where there might be checks and balances within the
    system?
        Mr. Walker. We believe that there would be a significant
    plus to combine the regulators, to have a single regulator for
    safety, soundness, and mission, and that that regulator needs
    additional authorities above and beyond what authorities that
    OFHEO does not have right now.
        Tom, do you have anything to add?
        Mr. McCool. Again, that part of the issue is that I think
    we believe that having the Federal Home Loan Banks and Fannie
    and Freddie in the same entity, being regulated by this entity
    would create synergies. It would allow you to provide more of a
    career track for examiners. It could grow from more simple home
    loan banks, up through more complicated home loan banks, up to
    Fannie and Freddie, and would allow more cross-matching across
    various types of expertise within, again, a regulator with more
    critical mass.
        Senator Corzine. But coming back to that, you get that
    critical mass by combining the different regulators. Then it is
    a separate issue as to whether or not you get any additional
    synergy--you get synergy that way. You get critical mass and
    synergy that way. Then there is a debate as to whether or not
    you are going to get that much more synergy because it happens
    to be within a department or agency. So the most synergy you
    are going to get is going to be through combining the potential
    regulators into one. You could get some more by having it
    within a department or agency.
        Thank you.
        Chairman Shelby. Senator Sununu.
        Senator Sununu. Thank you, Mr. Chairman.
        Mr. Walker, as I understand it, the GAO has studied this
    issue and issued reports in 1991, 1993, and 1997. I might have
    missed one in there. In each of those cases, aside from the
    proposal that you spoke to Senator Reed about regarding the
    board structure and the directors that you have included this
    time, in each of those studies is it correct that the GAO,
    whoever the Comptroller happened to be, has recommended an
    independent regulator that has responsibility for overseeing
    safety and soundness, capital standards, the various business
    activities that these GSE's are involved in and regulating the
    mission? Have all of those things been consistent in all of
    these studies?
        Mr. Walker. Yes, Senator. Those are consistent
    recommendations throughout.
        Senator Sununu. And your recommendation is consistent with
    all of those other studies? It is not just because you are
    afraid to be different, is it?
        Mr. Walker. No. It is consistent, and in fact, we have had
    a number of serious subsequent events that have occurred since
    those reports, both within the public sector and the private
    sector that would lead me to believe it is even more important.
        Senator Sununu. I appreciate that. I am being a little
    facetious given your statements recently about other budgetary
    matters. I do not think anyone can claim you are not someone
    who is unwilling to speak their mind. And I appreciate that. I
    think that is extremely helpful for this Committee to have
    someone that is willing to at least step up on a somewhat
    political issue like this and speak their mind.
        You mentioned receivership and your feeling that some
    provision addressing receivership might be helpful or valuable.
    It is my understanding that this model was used in the S&L
    bailout and restructuring. Did it work reasonably well as a
    mechanism for the S&L crisis?
        Mr. Walker. Based on my experience--and I want to ask for
    Tom to comment because he was at GAO at the time--I believe it
    had mixed results with regard to what happened with the S&L
    situation.
        Mr. McCool. Right. But I think a lot of it had to do with
    when receivership was imposed as much as whether it was
    receivership versus conservatorship. I think what part of the
    issue has been, and to some extent still is, is the question of
    when you close down an institution. I think once you decide to
    close down an institution, receivership has a lot of advantages
    compared with conservatorship, but the question about when you
    make that call has always been an issue, and as I said, we have
    seen instances recently where it still is an issue.
        Senator Sununu. I mentioned the consistency in these
    evaluations by the GAO going back now more than 12 years,
    uniform
    recommendations that all the capital standards, all the
    business activities, all the mission-related activity as well,
    be included under an independent regulator.
        What about the issue of the type and the amount of
    nonmortgage-related assets held by the GSE's; should that fall
    within the scope of the independent regulator, and does your
    report include specific recommendations?
        Mr. Walker. We do reference the fact that that is an area
    that would be subject to oversight by these new independent
    entity. How does it relate to the related risk and the public
    purpose for these entities? Not a per se preclusion by any
    means, but it is something that I think the regulator has to be
    able to consider.
        Senator Sununu. Something that they should be able to
    consider.
        Senator Reed talked about or raised the concern of
    politics, and I think that is important, in the board
    structure, cabinet secretaries, Treasury, HUD, which you
    mentioned would naturally have an interest and an expertise
    here. But there are natural concerns because those are cabinet
    positions. In previous reports the GAO has recommended that the
    Chairman of the Federal Reserve be part of the board. Having
    the Chairman of the Fed as part of the board would seemingly
    address many of the concerns raised by Senator Reed. Is that a
    recommendation that you would stand by or support?
        Mr. Walker. I believe that is something the Chairman of the
    Federal Reserve may or may not want to do, but that would
    clearly be a positive step.
        I think the other thing, Senator, that one might want to
    consider--because I am on another board with the Chairman of
    the Federal Reserve right now dealing with the airline
    industry--the other thing you may want to consider is there are
    other board models out there that are hybrids. In addition to
    the one that I mentioned, I was a trustee of Social Security
    and Medicare for 5 years, and on that you have three cabinet
    secretaries and you have two people from the private sector who
    meet certain experience requirements. So in addition to the
    Chairman of the Federal Reserve and potentially others, you may
    want to think about whether or not you have some public members
    who are not Government employees.
        Senator Sununu. One final question about the mission. GAO,
    I think in the 1997 report, highlighted or discussed that when
    mission and safety and soundness regulations are performed by
    different regulators, even with some coordination there is the
    potential for the GSE's to try to pit the regulators against
    one another. Could you talk a little bit about examples, the
    specific examples where this had occurred, and whether that was
    behind your recommendation that it all be included in the new
    regulator?
        Mr. Walker. I will make a comment, then ask Tom for some
    specific examples. There is no question that to the extent that
    you have different regulators and they have different rules and
    different authorities, that there is going to be some human
    tendency to try to do that. That is just human nature. Our view
    is that for critical mass, for credibility, for capability,
    potentially for synergy and other purposes, that it makes sense
    to have one regulator for these types of entities.
        Tom.
        Mr. McCool. Again, I think that our experience with having
    a mission regulator without--under a different entity than the
    safety and soundness regulator, it was not so much that there
    were clashes, as that the mission regulator in the case of
    Fannie and Freddie, when it first set its goals in the mid-
    1990's, did not have much financial experience and did not have
    much ability to understand what pushing the goals a little
    higher would lead to in terms of potential risk or potential
    loss in profit, and I think that is what we think a regulator
    that understands the whole thing can do and do a better job of.
        So our view, for example, is the first set of goals that
    HUD set were fairly conservative because they were operating
    without the full knowledge of everything that one regulator
    could have. Since then HUD has ratcheted up the goals and one
    could argue that the goals are maybe getting to where they
    should be, but without seeing the whole picture it is very hard
    to make that judgment. And we think a single regulator could do
    that.
        Mr. Walker. If I can come back real quickly, Senator. To me
    this is an issue like so many issues: It is a combination of
    value and risk. How can we try to maximize value and manage
    risk? In doing that I think you need to integrate the mission
    issues with the safety and soundness issues because there are
    tradeoffs. We are trying to achieve certain public purposes
    through these entities, and those need to be considered. But to
    the extent that you push the envelope too far one way, it can
    have an adverse effect on the other. So by integrating these
    issues I think you have a better chance of being able to make
    more informed judgments on the value/risk tradeoff.
        Senator Sununu. Thank you.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Sarbanes.

                 STATEMENT OF SENATOR PAUL S. SARBANES

        Senator Sarbanes. Thank you very much, Mr. Chairman. I am
    sorry I was not here at the outset, and I want to join with
    others in welcoming the Comptroller General again. We always
    very much appreciate his appearances and his testimony. And Mr.
    McCool, it is good to see you again.
        Mr. Chairman, I do want to commend you for the very
    thorough and thoughtful way you are approaching this matter.
    This is the fourth hearing we have held on this issue. It is a
    very important issue, and I think we need obviously to build as
    strong and as thorough a record as we can as we consider moving
    ahead.
        Fannie Mae and Freddie Mac, along with the FHA, have been
    key players in making the mortgage market in this country the
    deepest and most liquid in the world, and actually it is the
    accumulation of housing wealth and the ability of homeowners to
    tap into that wealth because of the efficiency of our mortgage
    markets that have been a strong support for our economy.
        Most recently it is clear that the economy has been held up
    by people being able to draw on their housing wealth. So we
    have to be very careful, as we move ahead, that we do not
    impinge negatively on the secondary mortgage market to which
    Fannie and Freddie have contributed so much.
        One way to exercise that responsibility is to make sure
    these institutions are subject to strong, effective supervision
    and regulation, that they are within a framework that can
    assure their safety and soundness. I would apply the same
    thinking to the Federal Home Loan Banks. Of course, there is
    concern now about the adequacy of the supervision drawn to our
    attention by Freddie Mac's recent problems.
        I do, in fairness to OFHEO, want to say I do think they
    have responded appropriately, as I see it, to the Freddie Mac
    problems. They have moved ahead, and I am going to ask the
    Comptroller General whether they have a view on that particular
    current issue.
        But we do have these important questions as to whether the
    regulators have sufficient resources, expertise, and authority
    to provide the effective supervision. We are trying to balance
    two important goals: Increase scrutiny and more effective
    regulation, and commitment to the housing mission.
        I want to first ask the Comptroller General, what is your
    view about the adequacy of the housing mission of these
    institutions? How well is that being addressed? How important
    is it, and how do we ensure that if it is important that we are
    adequately addressing it?
        Mr. Walker. Senator, as you know, one of the primary
    reasons why these are GSE's is to promote homeownership in
    general, and also among those who can least afford to own a
    home. As Director McCool mentioned earlier, Housing and Urban
    Development has had the responsibility to set those mission
    goals, and they significantly increased what those goals were,
    I think in 1998, if I am not mistaken.
        I believe, as my testimony notes, that additional guidance
    might be necessary by this Congress on mission and what is
    trying to be accomplished. And I think that we have to keep in
    mind that in the case of Fannie Mae and Freddie Mac, they are
    public companies, and that therefore those who are on the board
    of directors of those entities have a fiduciary obligation to
    the shareholders.
        At the same point in time at least the statutory appointees
    who are being put on the board to protect the public interest,
    need to pay special attention to the public purpose of these
    entities, and that more needs to be done in order for them to
    be able to demonstrate, other than lowering the average
    mortgage by 25 to 40 basis points, what else is being done and
    to what extent are these GSE's are adding value above and
    beyond value that other GSE's are adding, and to what extent
    these GSE's are doing a better job than non-Government
    Sponsored Enterprises with regard to mortgage lending. I think
    there are some very serious issues that need to be explored
    further.
        Senator Sarbanes. How would you ensure that the housing
    mission was being adequately addressed in any structure that is
    developed here?
        Mr. Walker. That is why I think that you should consider
    this hybrid model. I really believe that it is important to
    consider some type of a hybrid model with regard to overseeing
    the regulator that provides the capability, the credibility,
    and the ability to look at both the public mission and also the
    safety and soundness issues. I believe that could help
    tremendously, in addition to other items that we laid out in
    the testimony.
        Senator Sarbanes. Mr. Chairman, I see my time is up. I have
    a couple more questions after the others finish.
        Chairman Shelby. Thank you.
        Senator Hagel.

                    STATEMENT OF SENATOR CHUCK HAGEL

        Senator Hagel. Mr. Chairman, thank you.
        Mr. McCool, Mr. Walker, thank you for coming before us this
    morning.
        I want to begin, Mr. Walker, with part of the exchange you
    had with Senator Reed regarding the concept of too big to fail.
    In your view, have the housing GSE's and their relevance to the
    housing market approached the ``too big to fail'' position?
        Mr. Walker. Well, first let me say I do not think any
    entity is too big to fail, but I do think that we have to be
    careful to make sure that they do not fail because if one of
    these entities did fail, it would have a significant adverse
    ripple effect throughout the entire financial markets.
        But, Tom, would you agree?
        Mr. McCool. I agree. I mean that the question of whether
    something is too big to fail is fundamentally, ultimately a
    political call I guess is part of it. But to the extent you can
    keep it from becoming--reduce the prospects of failure by
    having effective oversight and regulation, that is where we
    need to focus our attention.
        Again, we have not had to deal with a ``too big to fail''
    situation, at least in the financial sector in a while, and we
    do not know, for example, in the banking sector whether the new
    rules and procedures put in place by FDICIA will work. We hope
    they will or hope they will allow a large institution to be at
    least unwound in an effective way, if not protecting it from
    failure.
        But it is a concern because obviously when entities
    perceive themselves as too big to fail or are perceived as too
    big to fail, that has consequences for market discipline.
        Senator Hagel. Following up on your comments, your point
    about we need to do everything we can to assure that we do not
    get into a position like that. Would, for example, restricting
    the types and amounts of assets, be a useful regulatory tool,
    as we are thinking through possibilities as we start to develop
    a framework for a new regulator?
        Mr. Walker. I think that comes back to one of the questions
    that Senator Sununu and others mentioned, and that is, should
    the regulator have the ability to provide some type of
    restrictions on the amount or type of assets that they can hold
    including whether and to what extent derivatives are used to
    mitigate risk and to reduce risk, rather than to enhance
    earnings. I think these are things that should be within the
    portfolio of the regulator within reason.
        Chairman Shelby. Could you elaborate on that just a little
    bit? I know it is his time, but would you?
        Mr. McCool. Well, as we know, derivatives can be----
        Senator Sarbanes. The Chairman just gave him additional
    time.
        [Laughter.]
        Senator Hagel. My time is your time, Mr. Chairman. That is
    fine.
        Chairman Shelby. Senator Hagel and Senator Sununu both have
    taken a big interest in showing a lot of leadership in this
    are, so I think this is important to what you are touching on.
        Mr. Walker. I mean the fact of the matter is, derivatives
    can be used to mitigate or moderate risk through matching
    concepts and a variety of other things, or they can, if not
    properly used, serve to increase risk and volatility. We have
    seen examples of this in some of the recent failures in the
    private sector, where activities were being engaged in in order
    to increase earnings, but at substantial risk. It is important
    when you are dealing with an entity that is Government
    sponsored, of which there is a public purpose, that they be
    allowed reasonable flexibility to engage in certain types of
    investments and investment strategies, but hopefully, those are
    designed to moderate and mitigate risk rather than to enhance
    short-term earnings.
        Senator Hagel. Thank you. With regard to financial
    transparency--and we have dealt with that this morning in some
    detail, and there will be more of that exchange--what are your
    views as to mandatory compliance with prevailing SEC
    regulations?
        Mr. Walker. My understanding is at least some of the
    entities--I think it is Fannie Mae, if I am not mistaken--are
    voluntarily complying with--Fannie is voluntarily complying
    with some of the SEC requirements, and Freddie Mac is
    considering it, if I am not mistaken. These are public
    companies with significant shareholders with important public
    purposes, and I clearly believe that the concepts behind
    increased transparency are ones that these entities need to
    follow. Whether or not that means that they have to be subject
    to the same requirements under the 1933 and 1934 Act, there
    could be some issues with the 1933 Act, which I think the SEC
    representative can talk about, I think in substance they need
    to conform with the requirements. Whether or not it is by
    statute, that is up to the Congress.
        Senator Hagel. So you would say that they really should be
    mandatory?
        Mr. Walker. I would say they need to enhance their
    transparency, and one of the ways to do that is to subject them
    to these Acts.
        We have not taken a formal position on this in the past
    time? I think they need enhanced transparency, and I will not
    go as far as saying that they should be subject to the Act.
    That is for Congress to decide.
        Senator Hagel. Would then fair value disclosure be useful?
        Mr. Walker. Yes.
        Senator Hagel. Thank you.
        Chairman Shelby. Senator Carper.

                 STATEMENT OF SENATOR THOMAS R. CARPER

        Senator Carper. Thanks, Mr. Chairman.
        Welcome, General Walker. Good morning. Let me see if I
    understand what you said with respect to how you think the
    regulatory structure should be organized. Do I understand you
    believe that there should be an independent regulator, single
    independent regulator?
        Mr. Walker. That is correct, Senator.
        Senator Carper. Do you believe that a regulator should be
    housed within Treasury?
        Mr. Walker. It can either be within Treasury. There is some
    incremental synergy that could be attained that way, or
    independently, but we are not taking a position on that.
        Senator Carper. How would you recommend that we go about
    making that decision? What should we keep in mind as we try to
    decide?
        Mr. Walker. My personal view is the issues that are the
    most important are pulling together one single regulator that
    has responsibility for mission and safety and soundness, making
    sure that they have the appropriate amount of authorities, the
    appropriate capabilities in order to get the job done, and I
    think you can look to other models that are out there as to
    ones that have been totally independent in how they have
    worked, versus ones that have been within departments and
    agencies, and make a judgment based upon that.
        My view is, is that the issue that I think most people have
    talked about is how do you deal with balancing the mission and
    the safety and soundness issues. The reason that I threw out
    the idea of the possibility of a board structure is I think
    that is a good way to do that, and that could be accomplished
    whether it is within the Treasury Department or not. For
    example, the Pension Benefit Guaranty Corporation has a board
    of directors that I think could be built upon, and technically
    the Pension Benefit Guaranty Corporation is deemed to be within
    the Labor Department. It has separate facilities. It is within
    their budget, but in many ways it operates very independently.
    So look at past experience is what I would say, and what has
    worked and what has not worked.
        Senator Carper. I want you to talk with us--and you may
    have already done this, and if you have, I am going to beg your
    indulgence--but I would like to just pick your brain a little
    bit if I could with respect to who should be setting minimum
    capital levels? Should it be a regulator? Should it be
    something that Congress does through legislation? Talk to us
    about the pros and cons of doing either.
        Mr. Walker. One of the things we talked about earlier,
    Senator, is that the regulator needs to have the flexibility to
    be able to--
        Senator Carper. Wait a minute. Before you do that, just
    preface your response to my question by talking about the
    importance of the minimum capital levels. Why is it important?
        Mr. Walker. Minimum capital requirements are obviously very
    important in order to assure safety and soundness. It is one of
    the most fundamental elements to try to assure safety and
    soundness. In that regard, one of the things that we had talked
    about a little bit earlier was the possibility of Congress
    considering providing minimum requirements. In other words,
    setting the floor but not the ceiling, providing some guidance
    that the regulator would use, but allowing the regulator some
    flexibility to be able to employ risk-based concepts dealing
    with different entities to determine what the appropriate
    capital requirement should be, given the risk involved.
        Senator Carper. Do you see that as a compromise between one
    or the other? Is that a reasonable compromise?
        Mr. Walker. I see it as a reasonable and prudent course
    because the fact of the matter is, Congress may want to provide
    minimums. Congress may want to provide criteria or standards
    that the regulator must consider. Congress may want to assure
    that there is a regulatory process with appropriate
    transparency that the regulator must follow in setting these
    capital requirements. But I believe that the regulator is in
    the best position to make informed judgments, including
    exercising tradeoff considerations between mission goals and
    safety and soundness considerations.
        Senator Carper. Obviously, the Fannie Mae and Freddie Mac
    are a different breed of animal than the Federal Home Loan
    Banks, and with that in mind, how should we and how should this
    independent regulator approach the regulation of the Federal
    Home Loan Banks?
        Mr. Walker. Presumably, this single regulator would be
    responsible for overseeing all of these entities. It would be
    Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
    Presumably they would all be subject to a minimum capital
    requirement, but that the regulator would, based on facts and
    circumstances basis, be able to decide what the appropriate
    capital requirement would be for each type of entity.
        Tom, I would ask if you want to comment.
        Mr. McCool. Again, the point would be that you would set
    capital requirements that were based on different types of
    risks and we know that the Federal Home Loan Banks have
    different types of risk than Fannie and Freddie, but they also
    have similar types of risks; it depends on the activity. Some
    of the banks do different things than other banks, and so even
    within this system, the Federal Home Loan Bank System, there
    are different types of activities that would require different
    capital depending on the risk level. The same principles would
    apply across the Federal Home Loan Banks and Fannie and
    Freddie.
        Senator Carper. Thank you very much.
        Chairman Shelby. Thank you, Senator Carper.
        Senator Chafee.

                STATEMENT OF SENATOR LINCOLN D. CHAFFEE

        Senator Chafee. Thank you, Mr. Chairman.
        Mr. Walker, you have testified that there should be some
    kind of hybrid oversight, and in the second panel, Mr. Rayburn
    is going to testify that he believes that the Department of
    Housing and Urban Development is the appropriate agency to
    regulate the mission of Fannie Mae and Freddie Mac.
        What is the best argument you could use to convince Mr.
    Rayburn that it is better to have a hybrid?
        Mr. Walker. My view is that the Department of Housing and
    Urban Development clearly has a stake, and they clearly need to
    be involved.
        I believe that the hybrid option is one way to help assure
    that they will be involved, that they will have a seat at the
    table, and at the same point in time, recognizing that one has
    to balance the mission with the safety and soundness issues,
    and that is the way to get it done. That is my personal view.
        Senator Chafee. Thank you.
        My other questions have been asked already, and that is the
    only one I had, Mr. Chairman.
        Thank you.
        Chairman Shelby. Thank you, Senator Chafee.
        Senator Bennett.

                 STATEMENT OF SENATOR ROBERT F. BENNETT

        Senator Bennett. Thank you, Mr. Chairman.
        As we go through these hearings, the issues become clearer,
    and I congratulate you for your usual job of being very
    thorough in this but moving toward a goal. And I think it is
    pretty well summarized, General Walker, by your comment that we
    have the mission issue, and we have the safety and soundness
    issue. We want to be sure that the regulator keeps everything
    safe and sound, but not in such a way as gets in the way of the
    mission. Senator Sarbanes talked about how successful we have
    been--the most successful of any nation on Earth in stimulating
    homeownership by virtue of this structure we have built--and we
    do not want to damage that.
        Senator Sununu made reference to the savings and loan
    crisis. I came to the Senate in the midst of that crisis and
    had some period of time outside the Senate where I watched the
    regulators close down sound S&L's as well as failed S&L's in
    their zeal to make sure that everything was safe. And there
    were shareholders who lost their life savings and viable
    businesses that were shut down in the zeal of the Federal
    regulators to make sure there were not anymore loan losses. And
    we saw an example of that at the back end, which I saw when I
    came to the Senate in two ways--number one, when they started
    liquidating all of the things that they took over, they found
    that a lot of them were worth a whole lot more than they had
    thought, and therefore, the Government got a lot back--the
    shareholders were out and injured, but the Government seized
    these things--``seized'' is not the proper legal word, but it
    is in effect what happened--in an effort to get safety and
    soundness, shutting down, and then having good assets as they
    came around to liquidate them, and the S&L final bill was not
    as big as projected because the Government had all those
    assets.
        And then, the other aspect of it was financial institutions
    in that period, when I was just coming on the Banking
    Committee, were reluctant to loan because they saw how badly
    beat up people were when they took any kind of risk--in the
    name of safety and soundness you cannot do that--and we had
    problems where we were saying you have to get some liquidity
    into the economy to get it going. And it took a year or more
    before banks began to raise their heads enough to say, ``We
    will start to make some loans again, but we are fearful from
    the reaction of the regulators.''
        I give you that history because that is basically what you
    are talking about. If we decide that safety and soundness is
    the holy grail, we can tighten this thing down to the point
    that no more loans are made, and yes, your money is safe--it is
    all sitting there in Government securities rather than in
    loans--it is safe, but we are not fulfilling the mission.
        So as we hold these multiple hearings, we come more and
    more to that point--how can we assure safety and soundness
    without being so paranoid on that subject that we shut down the
    mission and ultimately damage the benefit to society that these
    groups are doing.
        There are a number of issues here, and you have talked
    about that one, but I want to introduce two more and just get
    your reaction. You say these are public companies, which in the
    case of Fannie and Freddie, they are. The Federal Home Loan
    Banks are not. So that becomes an additional wrinkle that a
    regulator has to deal with.
        Furthermore, the Federal Home Loan Banks are so structured
    that there is a joint and several liability situation built in.
    All of the focus has been on the implied Government guarantee.
    I still do not understand what that is. It is either a
    guarantee or it is not, and if there is an implied guarantee,
    where do I go to collect the implied guarantee on an investment
    that I have that went bad. To which window do I show up and get
    cashed in if I have an implied guarantee that my investment is
    okay, but there is nothing in writing? But okay, are we talking
    about the implied guarantee for Fannie and Freddie, but you
    have joint and several liability, which is in stone for the
    Federal Home Loan Banks?
        The SEC obviously has a role to play in a publicly traded
    company like Fannie and Freddie, but what does the SEC have to
    do here when you bunch in the Federal Home Loan Banks? Talk
    about that mix for a little while.
        Mr. Walker. First, the implied guarantee. Let me start with
    that, since you mention it. There are a lot of entities that
    the Federal Government is involved with that do not have
    express guarantees by the Federal Government. They are not
    backed by the full faith and credit of the U.S. Government. One
    example is the GSE's. Another example is the PBGC, the Pension
    Benefit Guaranty Corporation. Its insurance system is not
    backed by the full faith and credit of the U.S. Government.
        Implied guarantees I think presume something that Senator
    Hagel talked about, this ``too big to fail'' concept, that
    whether there is a legal commitment or not, from a practical
    standpoint, many people speculate, maybe rightly, maybe
    wrongly, they speculate that if something really bad happens,
    that politically, there would be a move to step in and that
    therefore, that is the ``implied guarantee.'' It is not
    expressed, it is not a legal commitment.
        Senator Bennett. The mix of the GSE's, Freddie, Federal
    Home Loan Bank, joint and several liability, SEC, public
    company, nonpublic. How does that all work out?
        Mr. Walker. Thank you, Senator, for refreshing my memory.
        I think we have to look at each based on the facts and
    circumstances. You are right that the Federal Home Loan Banks
    are cooperatives. They are not public companies. So therefore,
    I think having them subject to SEC regulation is obviously not
    the issue.
        On the other hand, as it deals with mission, safety, and
    soundness, it seems that there are a lot of common denominators
    that a single, integrated regulator would be able to consider
    and apply as appropriate involved with the Federal Home Loan
    Banks versus Fannie Mae versus Freddie Mac.
        So there are certain elements that would apply. There are
    other elements that would not. But from the regulator's
    standpoint when you are dealing with mission, safety, and
    soundness, it seems to me there are a lot of common
    denominators, and there are synergies.
        Senator Bennett. I agree with that, and my time is up, but
    it just occurs to me that it may well be that if you put the
    Federal Home Loan Bank boards into this pot, you have to
    eliminate the joint and several liability arrangement that they
    currently have and thereby change the structure of them so they
    become more like the other entities that are in the pot.
        Thank you, Mr. Chairman.
        Chairman Shelby. Thank you, Senator Bennett.
        Mr. Walker, I have a couple of questions following up on
    Senator Bennett's questions for the record. One has to do with
    the organizational structure of the new GSE regulator, keeping
    in mind the differences among Fannie Mae, Freddie Mac, and as
    he has pointed out, the Federal Home Loan Banks and so forth.
        The other question would relate to corporate governance and
    the Finance Board. We would like that answered for the record,
    and we will get this to you in a few minutes.
        We have been talking about risk here and mission, safety
    and soundness. What we are trying to do as I understand it--and
    I have been on this Committee for 18 years; Senator Sarbanes
    dates me here--but we both sat through the debacle of the
    thrifts. Senator Bennett came in the middle of it, I believe,
    on the Committee.
        Senator Sarbanes. And helped us to straighten it out.
        Chairman Shelby. Absolutely.
        But at the same time, what we are trying to do is balance
    the mission of the GSE's, which we mostly agree is sound--that
    is, the housing policy for the United States of America and the
    people, and homeownership--and the safety and soundness of the
    GSE's as financial institutions.
        Is that what we are trying to do?
        Mr. Walker. I agree, to balance those interests.
        Chairman Shelby. Absolutely.
        And we have been talking a lot about failures here, but
    what we are really trying to get at if we create a powerful
    regulator is to preclude failure, to stay away from failure, in
    other words, to make sure that these institutions are going to
    be there for the future.
        Is that a fair statement?
        Mr. Walker. That is correct, Senator. We want to prevent a
    failure, and we want to learn from the lessons of the past.
        Chairman Shelby. How important, Mr. Walker, is it for the
    regulator, whoever the regulator would be in the future, to
    know what the models are at Fannie Mae, Freddie Mac, or the
    Federal Home Loan Bank board--in other words, wouldn't they
    have to know what is going on there? It is a very complicated
    situation. They would have to have the personnel to know, and
    they would have to be hands-on, to know what was going on, so
    to speak.
        One of the problems that I have gathered here is that it
    was PricewaterhouseCoopers, inside accountants, that brought
    the Freddie Mac situation to a head and not OFHEO. I agree with
    Senator Sarbanes that the leadership at OFHEO since the
    revelations at Freddie Mac and Fannie Mae have been very
    diligent.
        Go ahead.
        Mr. Walker. OFHEO has not historically had many people with
    expertise in accounting and reporting issues. They recognize
    the need to beef up in this area. They are taking steps to do
    that, and I think that that is appropriate that they do. In
    addition, in fairness to OFHEO, I will also note that one of
    the things I mentioned was about the need to have model
    corporate governance practices. OFHEO has taken steps to try to
    make sure that at least in the case of Freddie Mac, the CEO is
    separated from chairman of the board, which is a best practice
    in that regard, and they are trying to become more active
    there.
        Senator Sarbanes. May I----
        Chairman Shelby. If I can finish up, Senator Sarbanes, of
    the securities that Freddie Mac, Fannie Mae, and the Federal
    Home Loan Bank Board, create--and this is the securitization of
    the whole organization--who owns or buys most of those
    securities? Isn't it the banks? Don't a lot of the banks, as
    investors, invest in the GSE securities?
        Mr. Walker. That is my understanding, Senator.
        Chairman Shelby. Is that correct?
        Mr. McCool. Yes. They are purchased by mutual funds, they
    are purchased by banks, but a lot of other entities purchase
    them.
        Chairman Shelby. Thank you.
        Senator Sarbanes.
        Senator Sarbanes. Mr. Chairman, I just wanted to follow up
    on the other point.
        An independent, assured source of funding for the regulator
    is a very important aspect of this, is it not? You were
    mentioning OFHEO's difficulties, but is not that one of them
    and something that needs to be addressed in any effort to
    strengthen the regulatory structure?
        Mr. Walker. It is important to assure that they have an
    adequate amount of resources in order to effectively do their
    job, and that is one consideration that I think you are going
    to have to give as to how should they be funded and the means
    by which they should be funded.
        Senator Sarbanes. Now, in your report, you point out that
    the FHFB just had 10 examiners as of about 18 months ago to
    examine the 12 Federal Home Loan Banks, and they have initiated
    a program to increase it up to 30. Of course, I think the
    Comptroller has 20 or 30 people at one or another of the major
    institutions that they are involved in as I understand it.
        So it is really falling way short of what is needed, is it
    not?
        Mr. Walker. They are clearly going to have to take a look
    at what they need to get the job done versus the current
    resources they have, and they are likely to need additional
    resources.
        Senator Sarbanes. Do you have any perception that the
    Federal Housing Finance Board has actually been acting more as
    an advocate for increasing the powers of the bank system rather
    than its safety and soundness regulator?
        Mr. Walker. I do not.
        Tom.
        Mr. McCool. We have not taken a position on that, Senator.
        Senator Sarbanes. Some have argued--and actually, it has
    come up here today--that you cannot put the Federal Home Loan
    Banks into the same regulatory structure as Freddie and Fannie
    because there are important differences. I take it your
    position is that the similarities more than outweigh the
    differences, and therefore it is sensible to put them all under
    the same regulatory structure. Is that correct?
        Mr. Walker. That is correct, Senator. There would be some
    differences, but there are more commonalities than differences,
    and with regard to mission, safety, security, soundness, there
    are more similarities than differences.
        Senator Sarbanes. Thank you.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Sununu, anymore questions?
        Senator Sununu. No, Mr. Chairman.
        Chairman Shelby. Senator Hagel.
        Senator Hagel. No questions.
        Chairman Shelby. Senator Chafee.
        Senator Chafee. No questions.
        Chairman Shelby. Mr. Walker, we thank you, and we look
    forward to your answers to those last questions and any others
    for the record. We appreciate your appearance before the
    Committee and your insights into what we are trying to do.
        Mr. Walker. Thank you, Mr. Chairman.
        Senator Sarbanes. Mr. Chairman, could I note that the GAO
    has built up quite a body of expertise on this issue, and I
    would hope we could be able to draw on the Comptroller General
    for his counsel and advice as we move forward.
        Mr. Walker. We have great staff, and we are happy to help.
        Thank you.
        Senator Sarbanes. You have a good head of a great staff,
    too.
        Mr. Walker. Thank you.
        Chairman Shelby. Our next panel will be Mr. Alan Beller,
    Director, Division of Corporate Finance and Senior Counselor to
    the Commission on Securities and Exchange; Mr. Richard Carnell,
    Professor of Law, Fordham University Law School; and Mr. James
    R. Rayburn, President, National Association of Home Builders.
        Gentlemen, we appreciate your patience dealing with the
    first panel. Your written statements, we have for the record,
    and we have reviewed them. We would appreciate it if you would
    sum up as soon as your can your top points here today.
        We will start with Mr. Beller.

                      STATEMENT OF ALAN L. BELLER

               DIRECTOR, DIVISION OF CORPORATION FINANCE

                U.S. SECURITIES AND EXCHANGE COMMISSION

        Mr. Beller. Thank you, Chairman Shelby, Ranking Member
    Sarbanes, and Members of the Committee.
        I am pleased to have this opportunity to testify before you
    on behalf of the Securities and Exchange Commission regarding
    the application of disclosure and reporting requirements of the
    Federal securities laws to Fannie Mae, Freddie Mac, and the
    Federal Home Loan Banks. These Government Sponsored
    Enterprises, or GSE's, issue marketable debt to the public. In
    addition, Fannie Mae and Freddie Mac have publicly held common
    stock and also issue guaranteed mortgage-backed securities. All
    of these entities and their securities are exempt from the
    registration and disclosure provisions of the Federal
    securities laws. None of the debt securities issued by any of
    these GSE's is backed by the full faith and credit of the
    United States.
        As to the Commission's historical views on GSE disclosure,
    since at least 1992, the Commission has expressed the view that
    because the GSE's sell securities to the public, including debt
    securities, and have public investors and do not have the full
    faith and credit backing of Government securities, their
    disclosure should comply with the disclosure requirements of
    the Federal securities laws. Mandatory compliance by the GSE's
    is the objective. Further, the disclosure quality that we seek
    for the GSE's can only result from becoming subject to the
    SEC's reporting system. The disclosure quality results not only
    from the Commission's rules, but also the Commission's and the
    staff's administration of these rules, including our review and
    comment processes and our enforcement program.
        A 1992 joint report of the Department of the Treasury, the
    Board of Governors of the Federal Reserve System, and the
    Commission on the Government securities market addressed
    attaining that objective through registration. However the
    means, mandatory registration or voluntary registration, for
    example, would appear to be less significant than the
    objective--mandatory compliance with SEC disclosure and other
    requirements.
        I would like to turn to a preliminary discussion of our
    registration requirements. For purposes of today's subject, two
    of the Federal securities laws are relevant--the Securities Act
    of 1933 and the Securities Exchange Act of 1934. Registration
    under the Exchange Act results in reporting companies providing
    for disclosure of detailed information relating principally to
    the company itself. Registration under the Exchange Act also
    subjects companies to the provisions of the Sarbanes-Oxley Act
    applicable to issuers.
        The Securities Act, by contrast, requires registration by
    issuers of transactions, namely public offerings of their
    securities. One result of registration under the Securities Act
    is required disclosure of essentially the same information
    regarding corporations as is required for reporting companies
    under the Exchange Act. Another result of registration under
    the Securities Act is disclosure regarding the securities being
    offered. Finally, because Securities Act registration
    statements are subject to review by the Commission staff,
    registration can affect the timing of offering transactions.
        With that summary, let me turn to Fannie Mae and Freddie
    Mac. On July 12, 2002, Fannie Mae and Freddie Mac announced
    that each would voluntarily register its common stock under the
    Exchange Act and thus become mandatorily subject to Commission
    reporting requirements. Fannie Mae's registration statement
    under the Exchange Act was declared effective on March 31,
    2003. Freddie Mac has stated that it intends to conclude the
    Exchange Act registration process after it completes its
    restatement and audit of the financial statements. I think
    Freddie Mac's latest information is that they intend to become
    subject to registration in 2005.
        The Office of Federal Housing Enterprise Oversight has also
    adopted rules requiring the officers and directors of Fannie
    Mae and Freddie Mac to file with the Commission the insider
    transaction reports required by the Exchange Act and requires
    the companies to file with the Commission all proxy documents
    that are also required pursuant to the Exchange Act.
        It has been our focus to date that investors who purchase
    and sell stock or debt of the GSE's are entitled to the
    corporate information required under the Exchange Act.
    Registration under the Securities Act would not result in
    disclosure of additional corporate information.
        Registration of securities transactions by Fannie Mae and
    Freddie Mac under the Securities Act, especially offerings of
    their mortgage-backed and other mortgage-related securities,
    does require consideration of factors not implicated by
    registration under the Exchange Act. The Commission did not
    recommend in 1992 removing the exemption from the Federal
    securities laws for the offer and sale of mortgage-backed and
    mortgage-related securities of Fannie Mae and Freddie Mac. We
    seek the achievement of the benefits for investors of
    registration under the securities laws, but we also recognize
    that these other factors need to be examined in connection with
    considering registration.
        First, as noted earlier, the review process of the Division
    of Corporation Finance of registration statements under the
    Securities Act means that the timing of offerings can be
    affected.
        Second, Fannie Mae's and Freddie Mac's mortgage-backed and
    other mortgage-related securities are backed by their
    respective guarantees. Exchange Act filings already would
    contain important corporate information necessary to analyze
    those securities as a credit matter.
        And finally, registration of offerings of the GSEs'
    mortgage-backed and related securities under the Securities Act
    may raise another significant and complex factor--the impact on
    the U.S. mortgage market--that we believe should be considered.
    In particular, a substantial portion, and recently a majority
    of the GSEs' mortgage-backed securities have been sold into the
    so-called ``To Be Announced'' or TBA, market. These
    transactions involve forward sales of mortgage-backed
    securities made up of pools of mortgages not yet identified and
    in many cases not yet even in existence. Therefore, in a TBA
    transaction, actual mortgage pool characteristics cannot be
    disclosed at the time of registration or offering. The TBA
    standards that those mortgage pools must meet, which have been
    established by market participants, are already available to
    the market independent of registration.
        In addition, we understand that the TBA market is used to
    set or ``lock in'' mortgage rates in the U.S. housing market. A
    decision to require registration under the Securities Act of
    offers and sales of mortgage-backed securities should therefore
    take into account whether and if so, how such registration
    might impact the mortgage market and especially the operation
    of the TBA market.
        I would now like to turn to the Federal Home Loan Banks.
    The Federal Home Loan Bank System was created in 1932 and is
    comprised of the 12 banks. The Federal Home Loan Bank System
    through the Office of Finance is one of the largest issuers of
    debt securities in the world into the public markets.
    Approximately $716.9 billion was outstanding as of September
    30, 2003.
        The Federal Home Loan Banks are exempt from the Federal
    securities laws because they are GSE's. In the absence of their
    GSE status, they would be required to register, and the fact
    that they issue only public debt and do not have public equity
    would not change their status as required to register as issues
    of public debt securities. The Banks, because they are exempt,
    are also not subject currently to the provisions of the
    Sarbanes-Oxley Act. In September 2003, the Federal Housing
    Finance Board proposed for comment a rule to require
    registration with the Commission by the Banks under the
    Exchange Act. The comment period for that rule ended on January
    15, 2004.
        The Federal Home Loan Banks have many of the same
    disclosure issues as any financial institution whose debt
    securities are issued to, and held by, the public. As discussed
    earlier, we believe investors in the Banks' debt securities are
    entitled to the same type of information as that provided by
    other issuers of public debt. As also discussed earlier, we
    further believe that the Commission's detailed disclosure rules
    and filing requirements, review and comment process, and
    enforcement mechanisms provide the best framework for
    disclosing information to which investors are entitled.
        As is the case with Fannie Mae and Freddie Mac, the focus
    to date for mandatory disclosure has been the corporate
    disclosure required under the Exchange Act. Registration of
    offers and sales of securities by the Federal Home Loan Banks
    under the Securities Act has not been the focus to date and is
    not the subject of the proposed Finance Board rule. In
    particular, as with Fannie Mae and Freddie Mac, disclosure of
    corporate information following Exchange Act registration is
    the same as would be required under the Securities Act.
        Because of the structure of the Federal Home Loan Bank
    System, including the Office of Finance, however, there are
    some issues that may be unique to the Banks that should be
    taken into account in considering registration. The staff of
    the Commission has met with members and staff of the Finance
    Board, representatives of the Banks, and a group of directors
    of certain Banks, in each case at their request, to discuss the
    issues that registration under the Exchange Act may raise.
        In addition, insofar as registration under the Exchange Act
    is being considered, we believe there would be no impact on the
    timing or other aspects of offering transactions as a result of
    registration.
        We have also indicated to the Banks that we would work with
    them to determine if there were certain requirements, such as
    the proxy rules, from which it should be clear the Banks are
    exempted because the publicly held securities that implicate
    registration and disclosure issues are their debt securities.
    This would produce the same results as would be the case for
    corporate issuers whose only public securities are debt
    securities. And there is a very significant number of very
    large corporate issuers who fall into that category.
        In addition to these items, there have been certain
    accounting-related issues that have been identified as
    significant for the Banks in terms of ascertaining our staff's
    view prior to any registration process. We have met with
    representatives and advisers of the Banks to resolve those
    issues, and the resolution is discussed in detail in the
    written testimony that I have submitted; I do not intend to go
    into those right now.
        In conclusion, the individual and institutional investors
    who hold debt securities of the banks depend for repayment on
    the Banks under their joint and several liability, and not a
    Government guarantee. We therefore believe that applying the
    Commission's disclosure requirements and processes is the
    preferred method of helping to ensure that these investors
    receive the materially accurate and complete disclosures they
    deserve. If registration by the Banks is pursued, we are
    committed to achieving that result with maximum protection for
    investors and maximum efficiency for registrants, consistent
    with our mission to protect investors.
        Thank you again for inviting me to speak here today on
    behalf of the Commission. I would be pleased to answer any
    questions that you may have.
        Chairman Shelby. Thank you, Mr. Beller.
        Mr. Carnell, welcome back to the Committee.

                    STATEMENT OF RICHARD S. CARNELL

             ASSOCIATE PROFESSOR OF LAW, FORDHAM UNIVERSITY

                   SCHOOL OF LAW, NEW YORK, NEW YORK

        Mr. Carnell. Thank you, Mr. Chairman.
        Mr. Chairman, Senator Sarbanes, Members of the Committee, I
    am pleased to have this opportunity to discuss how to improve
    the regulation of the housing GSE's and particularly how to
    structure a new GSE regulator.
        I commend you, Mr. Chairman, for your leadership in
    focusing attention on these issues, on the weaknesses of
    current law and the weaknesses of the current structure of
    OFHEO, and for your resolve to move legislation to correct
    these problems.
        A new GSE regulatory agency should regulate all three
    housing GSE's. It should be responsible for keeping GSE's safe
    and sound and for making sure that GSE's carry out their
    housing mission. It should have permanent funding. It should
    have the same safety and soundness authority as the Federal
    bank regulators, including authority to raise capital standards
    and take enforcement action. It should also be able to appoint
    a receiver for an insolvent GSE.
        I want to focus now on three specific issues--first, the
    governance of the new agency; second, the need to have an
    adequate mechanism for handling an insolvent GSE; and third,
    the double game that GSE's play in talking about their
    relationship to the Federal Government.
        First, governance of a new agency. In structuring the
    agency, the paramount goal should be to assure the agency's
    independence from the GSE's and thus to maintain the new
    agency's integrity, objectivity, and effectiveness. One
    approach would be to make the agency an autonomous bureau of
    the Treasury Department, like the OCC and OTS. The Treasury has
    an institutional commitment to safety and soundness and has the
    will and institutional credibility to stand up to the GSE's.
    The GSE's would find the Treasury harder to bully than any of
    the alternatives, including a new, independent agency.
        The GAO has suggested a hybrid approach with an executive
    director and a coordinating board. I would like to think more
    about that but also to offer some initial impressions.
        I like the idea that the coordinating board would consist
    of people with other major Government responsibilities. That
    will help you get capable people. If you want to find somebody
    for a board position that does not have other
    responsibilities--that is, where you are not the chair of the
    agency, and you do not have any other position in Government--
    you are going to have trouble getting really qualified people
    to take those jobs and stay there. There is just not enough
    challenge.
        So if the coordinating board does consist of people like
    the Secretary of Treasury, the Secretary of HUD, the Chair of
    the SEC, and the Chair of the Fed, I think that is a
    composition that makes sense.
        I would caution, though, about trying to have the
    coordinating board actually run the agency. Big boards may
    sound good on paper, but they often work badly. Without a
    strong executive director, I do not think a five-member board,
    no matter who was on it, would be up to the job over time. I
    think it would be vulnerable to manipulation by the GSE's. I
    think that having so many members blurs accountability and
    impedes decisionmaking. So I think the executive director, if
    you went that route, should have considerable power to make
    policy.
        The second topic I want to address is receivership. Current
    law provides no adequate mechanism for dealing with Fannie and
    Freddie if they become insolvent, that is, if their liabilities
    exceed their assets. We have mechanisms like this for the
    Federal Home Loan Banks, we have it for business corporations.
    We do not have it for Fannie and Freddie. The Bankruptcy Code
    does not apply. OFHEO could appoint a conservator, but the
    conservator would have no power to resolve the shortfall
    between the liabilities and the assets.
        So this lack of an orderly receivership mechanism is a
    serious gap in current law, with potentially serious
    consequences for financial markets. Congress could fill the gap
    by authorizing the GSE regulator to commence a bankruptcy
    proceeding against an insolvent GSE, or it could take a
    different approach, like the banking law, and authorize the
    regulator to appoint a receiver to deal with it under a
    specialized body of law. That is what we do with the FDIC.
        I want to point out, by the way, that receivership is not
    something special to the thrift debacle. Bank regulators have
    done probably a thousand bank failures and a thousand
    receiverships in the last two decades, and that has worked well
    in that context.
        A receivership mechanism, by providing an orderly means for
    dealing with a failed GSE's debts, would help limit and contain
    the harm resulting from a GSE's failure.
        Third, I want to talk about what I call the GSEs' double
    game, about their relationship to the Government. Fannie and
    Freddie play an extraordinarily successful double game in
    dealing with this relationship. They deny that they have any
    legally enforceable Government backing. They leave the
    impression that they have no Government backing at all, yet at
    the same time, they also work to reinforce the market
    perception that the Government implicitly backs them.
        Critics of GSE's did not make up the idea of an implied
    guarantee. Fannie and Freddie themselves have propagated that
    idea for decades. For example, in my written statement, I give
    several examples. One of them is where Fannie Mae said in an
    official comment letter to the OCC, it emphasized the ``implied
    Government backing of Fannie Mae,'' and it goes on to say that
    this backing makes Fannie's securities ``mere proxies for
    Treasury securities.''
        Think about that. Fannie says its implied Government
    backing is so strong that its securities are almost as good as
    U.S. Treasury securities. So this double game lets the GSE's
    have it both ways. It is like telling Congress and the press,
    ``Don't worry, the Government is not on the hook,'' and then
    turning around and telling Wall Street, ``Don't worry, the
    Government really is on the hook.''
        The GSE's play this game unchallenged, year after year. No
    reporter exposes it. No committee investigates it. No executive
    branch official criticizes it. So in a world of global
    information, the GSE's still get away with saying one thing to
    Washington policymakers and saying something fundamentally
    different to New York bond traders and financial analysts.
        Last week, Fannie Mae's CEO seemed to question the
    existence of any implied guarantee. I urge the Committee to
    follow up on this point, an important point, by having Fannie
    and Freddie answer three simple questions which I list in my
    written statement.
        For example, if Fannie and Freddie were to default on their
    debts, would the Federal Government have any moral obligation
    to ensure that Fannie and Freddie's creditors get paid? I think
    it would really move the process along to get some clarify
    here.
        Finally, I want to say a word about affordable housing.
        Chairman Shelby. Mr. Carnell, what were the other
    questions?
        Mr. Carnell. Oh, they are in my prepared testimony.
        Chairman Shelby. Share them with the audience.
        Mr. Carnell. Oh, certainly. I appreciate your interest, Mr.
    Chairman.
        Chairman Shelby. Absolutely.
        Mr. Carnell. The other questions are: Do capital market
    participants err in perceiving the Federal Government as
    implicitly backing Fannie and Freddie?
        And, do you believe that the Government in any way
    implicitly backs Fannie and Freddie?
        So they are related questions, but I think to get clear,
    unequivocal answers from the GSE's would be very beneficial.
        Finally, I would like to say a word about affordable
    housing. Fannie and Freddie receive very valuable benefits from
    the Government, but they do very little considering their size
    and special privileges that would otherwise get done.
        Studies have indicated that they do less, proportionately,
    than banks and thrifts. The basic problem is that the current
    affordable housing requirements are not targeted. Fannie and
    Freddie can satisfy these requirements by doing lots of middle
    class and lower middle class housing that they have a profit
    motive to do anyway.
        So as long as Fannie and Freddie retain their Government
    sponsorship, they should be required to do much more for
    affordable housing.
        Thank you, Mr. Chairman, and I will be glad to answer
    questions at the appropriate time.
        Chairman Shelby. Thank you.
        Mr. Rayburn.

                     STATEMENT OF JAMES R. RAYBURN

            PRESIDENT, NATIONAL ASSOCIATION OF HOME BUILDERS

        Mr. Rayburn. Good morning, Chairman Shelby, Ranking Member
    Sarbanes, and distinguished Members of the Committee.
        My name is Bobby Rayburn, and I am a builder of affordable
    housing in Mississippi, Louisiana, and Alabama. I am also the
    President of the 215,000-member National Association of Home
    Builders, which I represent today.
        Thank you for holding this hearing on the regulatory
    framework of the housing GSE's.
        NAHB believes that the focus of the GSE regulatory reform
    must remain, to use your words, Mr. Chairman, on their vital
    role of providing liquidity and stability for the Nation's
    housing finance system. This has been clearly demonstrated by
    housing's critical job-producing role as an economic engine in
    an otherwise faltering economy.
        It is safe to say that the record one million-plus new home
    sales last year would not have occurred without the liquid and
    vibrant secondary market that is supported by the housing
    GSE's. I want to emphasize that no one believes there is an
    imminent crisis within the GSE system. There is time to take a
    careful and thoughtful approach to these issues. An ill-
    conceived change could seriously damage housing and the
    economy.
        Regulation of the GSE's involves two key aspects--one,
    enforcing compliance with safety and soundness principles, and
    two, ensuring unwavering mission orientation. The purpose of
    the safety and soundness regulation is to ensure that the
    housing GSE's are adequately capitalized and to ensure
    appropriate governance structures and procedures.
        NAHB would support transferring the safety and soundness
    oversight of the GSE's to a strong and credible regulator that
    possesses adequate authority and resources, such as the
    Treasury Department.
        The purpose of mission regulation is to ensure that the
    GSE's fulfill their Congressional mandate and operate within
    their charters. Safety and soundness is a very relevant element
    but should not dominate program oversight. That would severely
    retard the development of programs needed to fulfill the GSEs'
    housing mission.
        NAHB maintains the program approval activities that are
    currently conducted by HUD should not be transferred to the
    Treasury Department.
        Innovative solutions to increase homeownership will
    continue only if mission oversight is regulated by an agency
    which has a housing mission, housing expertise, and housing
    experience. We believe that HUD should also continue to set and
    enforce Fannie Mae's and Freddie Mac's affordable housing
    goals.
        We agree that more needs to be done to encourage the GSE's
    to increase their activities in some market segments and
    believe that the best way to do this is through the bonus point
    incentives within the existing goals. We have laid out some
    specific recommendations within my written statement, Mr.
    Chairman.
        Mr. Chairman, you also asked me to touch on the capital
    requirements of the GSE's. NAHB supports a strong capital
    system for GSE's. We also believe that there is a need for
    stability in capital standards. NAHB therefore cautions against
    any immediate changes in either the GSEs' risk-based or minimum
    capital standards.
        Over the longer-term, we believe that the safety and
    soundness regulator should have the flexibility to adjust
    capital standards as necessary. However, a significant increase
    in the GSEs' minimum capital standard requirements would not be
    justified unless there is a measurable change in their risk
    profile. Overcapitalization of the GSE's beyond a level of
    reasonable risk would have unintended consequences for the
    housing markets by reducing the level of capital for housing
    and increasing mortgage rates.
        You also asked for feedback on the idea of a stand-alone
    independent regulator. While not our first preference, NAHB
    would be open to exploring the concept depending on how the
    details are implemented. NAHB's primary concern in any
    regulatory scenario is that the mission regulator must have a
    housing focus and expertise. The safety and soundness regulator
    must have sufficient respect and authority to satisfy Congress
    and the capital markets. NAHB recommends such an agency should
    be governed by a board of directors rather than by a single
    agency head. In order to ensure a housing focus, the board must
    have a HUD representative among others with housing expertise.
        It is also imperative to recognize the differences between
    Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. This
    can be done by establishing two divisions and maintaining
    separate funding for the cost of regulation.
        In conclusion, NAHB appreciates the opportunity to share
    our views on the regulatory framework for the housing GSE's. We
    look forward to working with the Committee on fashioning a
    solution to the oversight of these important housing
    institutions.
        Thank you.
        Chairman Shelby. I will start with Mr. Beller. Thank your
    appearance and for your detailed statement a few minutes ago.
        Some people contend, Mr. Beller, that requiring the GSE's
    to register their debt under the Securities Act of 1933 would
    be impractical given the frequency with which the GSE's go to
    market.
        The concern has been raised that registration of securities
    under the Securities Act of 1933 would be disruptive to funding
    practices because they would have to wait for the SEC to
    approve their filings.
        Can you please comment on these concerns regarding the
    registration of GSE debt, and how has the SEC accommodated
    other large financial institutions that go to market on a
    regular basis? In other words, is that a real concern, or is
    that just something that people are putting out there?
        Mr. Beller. There are certainly issues that are implicated
    by Securities Act registration that are not implicated by
    Exchange Act registration, and that is I think one of the
    reasons the focus of attention to date has been on the Exchange
    Act regulation, because from our point of view, it is
    essentially issue-free with respect to the things you are
    talking about.
        Having said that, if the question is restricted to the
    straight debt, that is, the nonmortgage-backed debt of Fannie
    and Freddie, and to the debt of the Federal Home Loan Banks,
    their issuance would raise issues of timing. We do sometimes
    review registration statements. It is a fact of life that
    large, frequent corporate issuers face and live with on a
    frequent basis.
        I will say to you, I guess, one that our self-registration
    process has made it much easier for large, frequent issuers to
    access the markets on what they consider to be a timely basis,
    and there are many, many large issuers, including financial
    institutions who, if they are not in the market every day, are
    certainly in the market very frequently.
        We have in process some thoughts about modernizing our self
    system further that would accommodate large corporate issuers
    and the GSE's if they were to become registrants under the 1933
    Securities Act.
        But the timing issue is the principal question that I think
    one has to get comfortable with. My own view is that if you are
    talking about straight debt, it is manageable. The other side
    of that equation is you really do not get much more
    information, and as to the corporations themselves, you get no
    more information with Securities Act registration than you
    already get with Exchange Act registration given our integrated
    disclosure system.
        The final point I would make is that--and my testimony
    reflects this--we are in no way opposed to Securities Act
    registration. We believe in the benefits that the securities
    laws and our processes provide for investors. But we do believe
    when it comes to the mortgage-backed securities and the
    mortgage-related securities of Fannie Mae and Freddie Mac that
    we would note that the Commission recommendation in 1992 in the
    joint report did not extend to the mortgage-backed securities,
    and we believe that this Committee and the Congress in
    considering whether to extend Securities Act registration to
    those securities should properly take into account what the
    impact would be on the mortgage market and particularly on the
    TBA market. We are not experts in being able to determine that
    impact, but we do believe it is one of the subjects that should
    be on the table because of the importance of the TBA market
    particularly in setting mortgage rates.
        Chairman Shelby. Thank you.
        Professor Carnell, your statement earlier of having a
    strong executive regulator that would be able to run the
    regulatory structure, I totally, totally agree with you on. You
    reference maybe a three-person board. While we are doing these
    hearings thoroughly and measured, because this is important
    legislation, as you well know, I had thrown out the idea--and
    this is just an idea--of maybe having an independent board,
    having the Secretary of the Treasury on that board, having the
    HUD Secretary on that board because of the housing issue,
    having perhaps the Federal Reserve Chairman on that board and
    the SEC Chairman on that board. I believe that would be four. I
    did not think about it until we had the GAO Comptroller General
    here; he serves on some boards, and of course, we will discuss
    this ourselves.
        But I think it is very important, as you pointed out, to
    have a strong executive, to have, as Senator Sarbanes
    mentioned, and he is absolutely right on this, independent
    funding and maybe a five-person board.
        Do you want to elaborate a little?
        Mr. Carnell. Well, if you were going to go the route of a
    five-member board, I like your composition--that is, to have
    the Treasury and HUD on there, I think is fundamental. And of
    course, there would be an appointed chair, I presume, a chair
    appointed by the President an confirmed by the Senate, who
    would be the executive head of the agency.
        Chairman Shelby. Sure.
        Mr. Carnell. That would be my approach with a three-member
    board.
        If you were going to go to a five-member board, having the
    two additional people be from the SEC and the Fed I think is
    excellent, because these are people who have existing
    Government responsibilities.
        Chairman Shelby. Knowledge base, too.
        Mr. Carnell. Knowledge base, and those are prestigious
    agencies. Those are good jobs. So you are going to be able to
    get capable people to come and do that, as opposed to having
    somebody come to essentially be a drone, an extra couple of
    wheels on an agency, and if they try to do anything, they will
    be doing back door diplomacy with the GSE's or trying to
    micromanage the agency staff. It is just not a good idea.
        Chairman Shelby. We have talked all morning and in other
    hearings, and we will have some more hearings here before we
    move on proposed legislation, on the ambiguity in the
    Government, our relationship with the GSE. It is there, as you
    pointed out so aptly. I do not know how we resolve that
    ambiguity, but clear language is important.
        Mr. Carnell. One suggestion, Mr. Chairman, would be that in
    my testimony I point out how the existing disclaimers of
    Government liability that, for example, the GSE's have to put
    in their securities, and there are also disclaimers in law--all
    three of them are fundamentally flawed because they do not
    speak to the real question here. In other words, they look like
    they are answering the question, but they are answering a
    different question.
        So, I do not think they do what Congress meant for them to
    do.
        Chairman Shelby. Okay.
        Mr. Rayburn, in your testimony, you suggest that removing
    any of the GSEs' legal exemptions would diminish their ability
    to meet their mission. How would greater transparency of their
    financial activities impede the mission? It looks to me like it
    would strengthen their mission--if they have nothing to hide.
        Mr. Rayburn. Mr. Chairman, we are for transparency in this
    whole issue. I think the central focus here is an issue that
    this Congress decided already some 50, 60, 70 years ago when
    the Congress decided that housing should have a special
    preference, housing should have the utmost and have the ability
    of the American people to be able to get into homeownership and
    the creation of wealth.
        We are for a strong regulator. We are looking for a
    regulator also separately, as my testimony points out, that
    adheres to the mission of housing and housing affordability as
    well as additional affordable housing goals.
        Chairman Shelby. Well, a lot of us are committed to the
    housing goal, but we are also committed to safety and
    soundness, and I think that with balance, we can have both.
        Mr. Rayburn. One reason, Mr. Chairman, that we believe
    there should be a division or something outside of Treasury as
    far as mission and the affordable housing goals is because we
    believe that Treasury has a bias against housing, as has been
    proven over the years.
        Chairman Shelby. Well, my suggestion was an independent
    regulator outside of Treasury.
        Mr. Rayburn. But you put the Secretary of Treasury on
    there.
        Chairman Shelby. And also I would put some others on there
    with a lot of expertise. You would also create a strong
    executive.
        Mr. Rayburn. I think we could agree with that, and I have a
    concept paper here that I would like to leave with you----
        Chairman Shelby. We will take that.
        Mr. Rayburn. --but as long as the central mission of this
    whole process dealt with housing and affordable housing.
        Chairman Shelby. Okay.
        Mr. Beller, should Congress be wary--those of us up here--
    of applying to the banks a disclosure scheme that was intended
    for public companies--in other words, the Federal Home Loan
    Banks?
        Mr. Beller. I think very strongly that you should not be
    wary or words.
        Chairman Shelby. Not be; okay.
        Mr. Beller. As I said before, we have very significant
    numbers of companies who are registered and report with us
    solely because they issue public debt securities--over 100.
        Senator Sarbanes. Mr. Chairman, could I pipe in right
    here----
        Chairman Shelby. Senator Sarbanes.
        Senator Sarbanes. --because I think that is a very
    important question. There have been these activities going on
    under certain rules, and it seems to me that the transition
    over is important.
        I have information here that says that, ``In the first 6
    months of 2003, the Federal Home Loan Banks went to the market
    7,000 times and raised $349 billion.''
        Chairman Shelby. Seven thousand times.
        Senator Sarbanes. ``A large market debt issuer and SEC
    registrant, GE, raised $42 billion in 249 bond issues. Ford
    Motor Company raised $8.5 billion in 236 bond issues. Total
    debt issuance in 2003--the U.S. Treasury, $625 billion, Federal
    Home Loan Banks, $550 billion, in 11,500 separate deals.''
        I am concerned about these figures with respect to the
    Federal Home Loan Banks. It is one of the things we are
    wrestling with. But it does seem to me that this order of
    magnitude of difference gives me some pause or concern with
    respect to your assurance that there is not a problem, that it
    is not something we need to think through and worry about.
        Mr. Beller. With respect to Exchange Act registration which
    would get investors the information about the Banks that we
    believe they deserve to have, the number of offerings and
    issuance is really not a relevant consideration. They would
    file annual reports, they would file quarterly reports, they
    would file current reports, as any other registrant. But the
    actual offering of securities would not trigger a registration
    requirement, and that is why I said earlier the Exchange Act
    registration issue is really issue-free as to straight debt.
        As Chairman Shelby pointed out, and as you are both very
    correctly focusing on, the issue of timing of offering
    transactions by the Federal Home Loan Banks, while I believe we
    could use our existing processes to make it manageable, does
    raise issues with respect to timing and filings the Exchange
    Act registration proposal does not raise, and at the same time,
    with Exchange Act registration, you are getting basically all
    the corporate information that you would get under Securities
    Act registration anyway.
        Senator Sarbanes. But you are drawing a distinction, then,
    or a line between--you would not apply, or at least have
    concern about just applying full-scale, what applies to a
    private corporation; is that right?
        Mr. Beller. We would have no issues applying Exchange Act
    registration and all the requirements of the Exchange Act to a
    debt-only issuer to the Federal Home Loan Banks.
        Senator Sarbanes. What would you have a problem with?
        Mr. Beller. We believe, as my testimony indicates, that
    this Committee and the Congress should consider, and we are
    happy to consider with you, the timing issues that would be
    raised by extending the registration requirement to Securities
    Act registration as well as Exchange Act registration.
        Senator Sarbanes. I see. Okay.
        Thank you, Mr. Chairman. Sorry.
        Chairman Shelby. These are very important questions, and I
    know Senator Sununu has been very patient, and I have a couple
    of other things I want to touch on.
        Financial statements of the Federal Home Loan Banks--could
    you touch on how the SEC would treat, if you thought this out,
    the combined financial statements of the Federal Home Loan
    Banks and what authority would the SEC have to address material
    misstatements in the combined financial statements?
        Mr. Beller. That is an issue that we have been thinking
    hard about and talking to the Finance Board about, because
    there is no registrant, there is no issuer with respect to the
    combined financial statements. They roll up the financial
    statements of the 12 Federal Home Loan Banks.
        What we have proposed to the Finance Board--the Finance
    Board has the right to review and approve the combined
    financial statements under its current regulations is a
    mechanism whereby they would--and I think this would be
    workable with any regulator who had that authority--in
    connection with their approval provide us with an opportunity
    to review and give comments on the combined financial
    statements and raise issues with them before they were approved
    based in large part, presumably, on our familiarity with the
    individual statements of the banks.
        I suppose the last thing I would say to that is that while
    there is no issuer with respect to the combined financial
    statements, they would nonetheless be subject to our antifraud
    jurisdiction and enforcement processes.
        Chairman Shelby. Thank you.
        Mr. Rayburn, one last question for you, if I could, on
    program approval versus regulation approval. In regard to the
    independence of any new regulator, your testimony argues for a
    high level of independence, which I support. You specifically
    suggest in relation to rulemaking--and these are your words--
    ``The agency's policy justifications for issuing regulations
    should be devoid of interference from politically appointed
    officials.'' You also argue that program approval should remain
    at HUD.
        I am curious as to why you believe the issues of safety and
    soundness should be insulated from political pressures, but
    program approval should not be. Why the difference--just for
    the record.
        Mr. Rayburn. Well, for example, the program approval left
    at HUD would do some of the good things that HUD has done in
    the new programs that have been approved with both Fannie and
    Freddie. The regulatory side is one that, while we certainly do
    not like interference with the political environment in
    anything--we would hope not to have that there; we would hope
    that those programs in regulation would be based on a just and
    fair system.
        But in addition to that, I think one of the most important
    things that still has to be said here--and I really want to
    take just a moment, Mr. Chairman----
        Chairman Shelby. Yes, sir.
        Mr. Rayburn. --and thank you for having me here today
    representing the Home Builders' Association, because I think
    thus far in your panelists, I am the only person who is a home
    builder who sees the face of America out there, and I
    appreciate that.
        Chairman Shelby. Your appearance here today on this panel
    is very important.
        Mr. Rayburn. Thank you.
        I want to share also with you that while we in the Home
    Builders try very hard to produce those 1.8 million units that
    we did last year, we are fulfilling a need not only in the
    environment of our country, but we are also fulfilling a need
    with the demand that is out there today. Today in our country,
    we have some one million immigrants coming in, we have 1.3
    million household formations, we have between 400,000 and
    500,000 units that get burned down, blown away, or torn down in
    this country every year. So the need and demand is going to be
    there for the next 10 years.
        If you create a regulator to regulate housing that the
    Congress has said is very important, and you have said the same
    thing, Mr. Chairman, and others here today, if you create a
    regulator that messes up the system, that as some would have it
    moves capital away from housing to other places, then you have
    really injured a key part of this economy as we know it today.
    Housing has propped up the economy for over 3 years now, and
    hopefully, the economics of what is taking place right now will
    kick in gear and take off. But I can assure you that we will
    continue to try to help, but we need your help. We need the
    help of those strong, vibrant GSE's, Fannie Mae, Freddie Mac,
    and the Federal Home Loan Bank System, and we need it done
    outside of politics as far as the regulation is concerned, but
    with help on the affordable housing goals and the
    allowance of new programs to take place in a very clean and
    unfettered environment.
        Chairman Shelby. I think we share the same goals.
        Senator Sununu.
        Senator Sununu. Thank you, Mr. Chairman.
        Thank you, Mr. Rayburn, and to your point, which is an
    important one, we are not in the business, or our goal should
    not be to move capital toward housing or away from housing.
    What we want to focus on here is establishing a regulatory
    structure that makes sense, a regulatory structure that is
    focused, that has the powers it needs in order to ensure safety
    and soundness within this area of business, of finance, that
    affects the housing industry.
        I also appreciate your perspective in the real world. I do
    not know if you use those terms, but I like that term. You are
    out there in a business, taking risks, making decisions every
    day, and I think we should all appreciate that.
        How many members are there in the Home Builders?
        Mr. Rayburn. Two hundred fifteen thousand member firms and
    over 800-plus local and State associations, employing some 8
    million people in this country.
        Senator Sununu. You mentioned that you deal with affordable
    housing. I assume some of those members, deal let us say
    exclusively in single-family or higher-end stuff ?
        Mr. Rayburn. Certainly.
        Senator Sununu. And you even build on spec?
        Mr. Rayburn. Certainly.
        Senator Sununu. And you even build million-dollar houses on
    spec?
        Mr. Rayburn. Certainly.
        Senator Sununu. Some of them refuse to build on spec?
        Mr. Rayburn. Yes, sir.
        Senator Sununu. I know I have dealt with some that have
    refused to build on spec.
        Do any of them provide financing for their customers in any
    particular way?
        Mr. Rayburn. Some of our large production, high production
    builders do.
        Senator Sununu. Or, I suppose in a more personal or
    informal way, you can stretch out the payables and payment
    schedules; they set their own payment schedules with the people
    they are doing business with, don't they?
        Mr. Rayburn. I would say that a few do, not a lot--not with
    the housing finance system in this country the way it is today.
        Senator Sununu. Do all the members in your association have
    the same risk profile, or do these choices they make affect
    their business risk?
        Mr. Rayburn. I think choices affect everybody's business
    risk. I touched on moving capital away from housing and some of
    the programs that have come out in the last 10 years to
    positively affect the production of affordable housing. For
    example, Fannie Mae recently got approval from HUD after a 10-
    year pilot program at HUD to do AD&C lending. AD&C is
    acquisition, development and construction lending. I know that
    I was around in the early 1980's and the early 1990's when
    construction financing dried up for one reason or another in
    this country.
        Senator Sununu. An interesting point. Naturally, the point
    I am making is in part that the business activities, the
    business lines that you are involved in, your business
    practices, all affect the risk and the safety and the soundness
    of an institution. You mentioned development and construction.
    There again is a good point. I assume getting involved in the
    financing of a commercial development on spec in Houston
    probably looks a lot different than getting involved in a
    commercial development in San Diego, Seattle, or Manchester,
    New Hampshire. Again, the business or program activity has a
    big impact on the safety and the soundness of whatever
    institution might be involved, whether it is a GSE or the
    Federal Home Loan Bank or an independent home builder like
    yourself.
        So it would seem to me that we would want the regulator
    responsible for the safety and soundness of these very
    important institutions to have some ability, not just some
    ability but the ability, to make good decisions about these new
    lines of business or program activities, but this is something
    that the Home Builders have opposed. Why is that?
        Let me be more pointed. It seems inconsistent to me that
    you would oppose putting this type of regulatory authority into
    the regulator responsible for soundness when you have the
    direct business experience that reinforces this perception that
    business activity, program activity, really does affect risk
    profile.
        Mr. Rayburn. Senator, we would always separate the two
    because of the fact that we want to keep housing as a central
    focus and mission. If you give veto power over the safety and
    soundness regulator, then all of a sudden, the safety and
    soundness regulator is controlling the production of housing in
    this country. If we are going to have a referendum on housing,
    then that is what we should do. But some of the GSE detractors
    have thrown up other issues.
        That is why we believe that the central focus on any
    regulator should not be tied to safety and soundness being
    inclusive of mission, programs, as well as the affordable
    housing goals.
        Senator Sununu. Even if those programs have a direct effect
    on risk profile and the safety and soundness of the
    institution?
        Mr. Rayburn. They should be considered by the safety and
    soundness regulator, but it should not have veto power over it,
    no, sir.
        Senator Sununu. But you do not want to give them any power
    to limit or regulate the areas of business or programs or lines
    of activity that these institutions can be involved in?
        Mr. Rayburn. I believe if Congress in its wisdom sets up
    this regulator in the right way that it can be done in a manner
    that it can be handled effectively and still keep housing's
    central focus and mission out there so the American public can
    continue to access the American Dream of homeownership.
        Senator Sununu. In your written testimony, you suggest that
    most of the proposals that you have seen ``often make no
    reference to the responsibility of the regulator to ensure that
    the GSE's fulfill their Congressionally mandated purpose.''
        Which of the proposals that are out there make no reference
    to the responsibility of the regulator to ensure that GSE's
    fulfill their mandated purpose?
        Mr. Rayburn. The proposal by the White House, as an
    example, that Treasury be the regulator. Everything would be
    inside Treasury, totally controlled by Treasury.
        Senator Sununu. I think you mentioned this earlier. How has
    Treasury proven its bias against housing?
        Mr. Rayburn. In the mortgage revenue bond program, there
    has been no increase in the single-family limit since 1994,
    even though we have repeatedly asked the Treasury to take a
    look at that and move it upward. It is causing a problem in so
    many areas in so many States.
        The Low-Income Housing Tax Credit Program on the
    multifamily production side, with what is called the TAM's, the
    Technical Advice Memorandums, we have repeatedly asked Treasury
    to take a look at those and solve some of the problems that are
    created by their going in and giving these private rulings and
    not letting it happen. Those are the examples, Senator.
        Senator Sununu. So you are citing the proposals in this
    case to put the regulator in Treasury, not necessarily the
    proposals to put it somewhere outside Treasury, as Senator
    Shelby has described in many of this proposals and remarks.
        Mr. Rayburn. That is correct.
        Chairman Shelby. Senator Sununu, your time is up. We will
    give you another round.
        Senator Sununu. I am sorry, Mr. Chairman. I am over time.
        Thank you very much, Mr. Rayburn.
        Chairman Shelby. Senator Sarbanes, thank you for your
    patience.
        Senator Sarbanes. Thank you, Mr. Chairman.
        Mr. Rayburn, perception of your testimony today is that if
    you could be assured that an independent regulator would be
    balanced in terms of harmonizing safety and soundness in the
    housing mission, that would address a lot of your concerns,
    would it not?
        Mr. Rayburn. Yes, sir, it would. How would you do that?
        Senator Sarbanes. Well, I am going to try to follow along
    with you here now.
        Let me put some permutations to you. If you had the HUD
    Secretary on there, presumably as a champion for housing--
    although that presumption is not always borne out, I regret to
    say, which is another problem--but if you had the HUD
    Secretary, the Treasury Secretary, and then had an independent
    chairman appointed by the President and confirmed by the
    Senate, which would create a dynamic to try to get somebody of
    stature, presumably, who would be able to balance these things
    out, and also wrote in some pretty strong housing mission goals
    or requirements, that might do it--I do not know. What is your
    reaction to that?
        Mr. Rayburn. It might.
        Senator Sarbanes. I think the thing that Rick Carnell
    wanted is a loaded deck for you all----
        Mr. Rayburn. I concur whole-heartedly, Senator.
        Senator Sarbanes. --a little bit for the housing mission,
    but we are struggling here to find some way to make sure we get
    safety and soundness and also get appropriate attention to the
    housing mission.
        First of all, would you regard the HUD Secretary and the
    Treasury Secretary as an even-Steven arrangement, a
    counterbalance one with the other?
        Mr. Rayburn. I do not know whom you give veto power to over
    what, but I would be interested to see on paper how you would
    structure this thing. But I would also point out something you
    said a while ago, Senator. You know, whether the HUD Secretary
    and what is taking place at HUD right now is really focused
    where it should be, I certainly cannot speak to, but I know
    that the Department of Housing and Urban Development is the
    only Cabinet-level agency that talks about housing at all, that
    is focused on housing.
        Even as late as yesterday, I was at HUD visiting with Under
    Secretary Bernardi on a number of different housing issues. I
    as President of NAHB this year, am appointing inside of our own
    trade association a housing task force that is going to look at
    the operations of HUD. Under Secretary Bernardi told me he
    would be glad to help us and participate, as Secretary Weicher
    did also, in our efforts, because we are on the front line,
    using the housing programs at HUD on an everyday basis. Whether
    it be the FHA insure mortgages, whether it be on the
    multifamily side or through the home grant programs of the
    CDBG, we are out there front-lining every day, working to find
    better ways to work with HUD as the central focus of housing in
    this country, as well as the GSE's, in order to be able to
    produce more and better affordable housing.
        Senator Sarbanes. Yes. Well, I have to say to you in all
    candor that my perception of HUD in recent times is that it has
    not been a very forceful advocate for housing, and in fact I
    think there are people within the HUD hierarchy who are really
    not carrying out the housing mission, they are constraining it.
        Mr. Rayburn. We hope to work to change that.
        Senator Sarbanes. In fact, the former Secretary Martinez
    came here with John Snow and in effect abdicated, I thought,
    the HUD Secretary's role as far as being a clear spokesman or
    advocate for housing. So, I think there is a problem, but that
    is a bigger question and must reflect where the Administration
    is placing its priorities. It still leaves us wrestling with
    the question of how do we get a regulator who adequately
    addresses the safety and soundness, but at the same time, we
    ensure that the housing mission receives appropriate attention
    and is not simply submerged in the process.
        Mr. Rayburn. We are looking for the same thing, Senator.
        Senator Sarbanes. That is why the Chairman is holding these
    hearings.
        Mr. Rayburn. But also I would like to point out in the
    entire process that in this country, we still have so many
    families and so many individuals who are left out of affordable
    housing and housing ownership in this country. This year, the
    theme of NAHB is going to be ``housing America's working
    families.'' Working families are defined as the teachers, the
    firemen, the policemen, the public service providers in the
    communities that you and I live in that teach our children,
    protect our streets, keep our homes safe, and provide the
    necessary services that we have to have in those communities
    that we depend on--but yet at night, they go to another
    community to live, 50, 60, 70 miles away a lot of the time, or
    they live in underhoused conditions, housing that does not meet
    their needs, is not something that most families would want to
    live in.
        Working with the Congress and working with HUD and our
    friends at the GSE's, we hope to continue to try to find more
    and better ways to help those working families in this country
    to become homeowners and move toward the wealth creation
    scenario that we would all like to see continued.
        So, Senator, we would like to see your continued help and
    support, sir.
        Senator Sarbanes. Mr. Chairman, let me just say in closing
    first that I welcome the Home Builders' initiative that you
    have just outlined for us about housing the working families.
    The Home Builders over the years have made a very important
    contribution, I think, to the economic and social strength in
    this country. First of all, you do it directly in helping to
    provide housing for our families. I think homeownership
    contributes to strong communities. Every study has shown that
    once people are invested in homeownership, their investment in
    their community, their concern for maintaining the community,
    strengthening the schools, and so forth and so on takes a
    significant leap forward. Of course, there is the broader
    macroeconomic impact of housing in this country and the
    strength that that brings overall to the economy.
        We are mindful of that mission. We are also, of course, as
    Chairman Shelby pointed out, having sat here through the
    savings and loan--well, I cannot find an adjective----
        Chairman Shelby. Debacle.
        Mr. Rayburn. I was on the business side of that, too, and
    it was not fun.
        Senator Sarbanes. --it was rough, it was rough, no question
    about it--so we want to make sure that----
        Chairman Shelby. Senator Sarbanes and I have a little
    institutional history here.
        Senator Sarbanes. Yes, we have some memory on that.
        Thank you very much for your testimony.
        Mr. Rayburn. Thank you.
        Chairman Shelby. I would just like to make a point. I did
    not read in Professor Carnell's statement that he is
    antihousing but he is sound housing.
        If we are committed--and we are--to a housing program for
    all Americans, we want to make sure that that has the financial
    footings underneath it. Otherwise, it will be a crisis, and we
    will have real problems, more so than we have ever seen. What
    we are trying to do is balance that, as I see it, to avoid
    that, to make sure that the institutions that finance our
    housing for the most part are sound and safe and mission-
    oriented. That is my goal, anyway.
        Professor Carnell, do you want to touch on that?
        Mr. Carnell. It is certainly mine as well, Mr. Chairman.
        I might add that in 6 years as Assistant Secretary of the
    Treasury, I head no words spoken against housing. And if you
    think more broadly about what are the incentives for
    policymakers, housing has a special place in American policy,
    American values, and American politics. We have a large, well-
    organized prohousing lobby. We have no antihousing lobby. There
    is no incentive for elected officials to be antihousing.
        And this notion that the Department of the Treasury is
    populated by these venomous gnomes who want people to be ill-
    housed is simply untrue, and I would note that it is a way of
    talking that we saw from the savings and loan lobby 20 years
    ago when they were basically resisting being brought into
    modern regulation.
        So, I agree with you, Mr. Chairman, that we need to strike
    a balance here, and I just want to point out that I do not see
    the incentives for elected officials or major political
    appointees to be antihousing.
        Mr. Rayburn. As a follow-up----
        Senator Sarbanes. Do you think there is a place in the
    scale, short of being a venomous gnome who wants the population
    to be ill-housed, where someone might be perceived as not being
    a forceful advocate for housing?
        Mr. Carnell. Certainly that is possible. Mr. Rayburn
    pointed to some tax issues, and there are disagreements about
    how tax benefits should be adjusted. But I never saw these
    people.
        Senator Sarbanes. Yes. I do not have to see the Treasury
    people as venomous gnomes in order to maybe have a little
    concern about how sympathetic they are to an active housing
    program, do I?
        Mr. Carnell. I do not see them as unsympathetic. I
    understand your point about wanting balance. So in that sense,
    the answer to your question is yes. But you talked about, for
    example, if you had a multimember agency. If you have Treasury
    and HUD on there, I think you are going to have balance. It may
    be from one Administration to another, we may disagree with
    policies. In a democratic government, that is just something we
    have to deal with, that sometimes people with power are people
    who are not going to share our values. But I think that
    structurally, it makes sense and that there is balance there.
        Chairman Shelby. Mr. Carnell, what if we created a
    regulator whose term would be longer than, say, a 4-year term?
        Mr. Carnell. I think more than 4 years would be----
        Chairman Shelby. Give some independence, maybe.
        Mr. Carnell. --yes--and I would say, too, that something
    that has been done with some agencies is you just appoint
    somebody to fill the unexpired term of their predecessor. I
    would not suggest doing that here.
        Chairman Shelby. No, that is not a good situation.
        Mr. Carnell. You want more continuity. You want this to be
    a good job.
        Chairman Shelby. You have a temporary deal there, and it
    just does not bode well.
        Mr. Carnell. Exactly.
        Chairman Shelby. Mr. Rayburn.
        Mr. Rayburn. Senator, if I might follow up on that, I would
    share that we would welcome Mr. Carnell as well as all of the
    Treasury Department over on the prohousing side, but we would
    like a little proof----
        Chairman Shelby. Mr. Carnell is a Professor at Fordham Law
    School now.
        Mr. Rayburn. --I know, but his track record was over there,
    though--but we would like a little proof that that would take
    place, and it certainly has not based on their track record.
        Chairman Shelby. Well, gentlemen, we thank you for a
    spirited discussion and your insights into all of this.
        The hearing is adjourned.
        Thank you.
        [Whereupon, at 12:25 p.m., the hearing was adjourned.]
        [Prepared statements and response to written questions
    supplied for the record follow:]
                  PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
         As everyone knows, Fannie Mae and Freddie Mac were created to help
    more Americans own their own homes. Their mission--as set forth by
    Congress--is to promote home mortgage financing by bringing liquidity
    to the secondary mortgage market and making more funds available for
    Americans to buy homes. Today, their outstanding securities now exceed
    $4 trillion--or more than the entire U.S. public debt.
         In order to carry out this mission, Congress granted Fannie and
    Freddie privileges that have not been extended to other participants in
    mortgage financing. Among these privileges is a line of credit with the
    U.S. Treasury to which the GSE's could turn for short-term capital
    needs. This line of credit demonstrates this Nation's commitment to the
    mission of the institutions, and also the special relationship between
    these institutions and the Treasury.
         This relationship allows Fannie Mae and Freddie Mac to borrow
    money at a rate as much as 40 basis points below other well-capitalized
    financial institutions. In addition, the GSE's are exempted from State
    and local taxes and from registering with the SEC or paying the fees
    associated with such registration, exemptions not enjoyed by other
    privately held businesses and financial institutions. As a result of
    enjoying these advantages, Fannie and Freddie now have virtually
    unlimited market power in any activity they choose to enter.
         A growing consensus has recently emerged that Congress should
    establish a regulator over Fannie Mae and Freddie Mac with adequate
    resources, staff, and authority to monitor new and ongoing activities
    of the GSE's.
         A prime example demonstrating the need for such a regulator is the
    announcement by Fannie Mae last fall that an accounting error had
    resulted in a $1.1 billion understatement of shareholder equity. Upon
    reviewing reports, it appears this was an honest mistake made while
    complying with the Federal Accounting Standards Board's new rule number
    149. As a result of this announcement, and the subsequent reaction in
    the markets, over $4 billion of market capitalization disappeared
    overnight.
         Our financial markets also have additional concerns about Fannie
    Mae and Freddie Mac. For example, the ability of Fannie Mae and Freddie
    Mac to aggressively hedge against interest rate risks. While no one is
    questioning their ability to provide effective hedges--they
    successfully managed over $1 trillion dollars of interest rate swaps in
    2002--I would note that a great deal rests upon their ability to
    properly manage such risks and we need only to look at the last few
    months to see that both Fannie Mae and Freddie Mac make mistakes.
         Such concerns intensify market sensitivity, which will continue
    until Congress establishes a new regulator over these entities and its
    powers are implemented.
         As Fannie Mae and Freddie Mac continue to grow in order to
    carryout their missions, I believe we must have a regulator empowered
    with sufficient authority to prevent fraud and mistakes that can easily
    add up to the loss of billions of dollars, and thereby protect the
    American tax payers.
         Any new regulator must be able to determine whether or not new
    programs and products contemplated by the GSE's help them fulfill their
    mission or whether those areas cannot be filled by private industry.
    Further, such authority cannot be limited solely to safety and
    soundness concerns--it is certain that actions exist that are safe and
    sound, but which nonetheless are inappropriate for Fannie and Freddie
    to take.
         Last summer, Senators Hagel, Sununu, and I introduced S. 1508, the
    Federal Enterprise Regulatory Reform Act of 2003. Our legislation gives
    the regulator authority to approve new products and thereby ensure
    Fannie Mae and Freddie Mac
    remain focused on their core mission of promoting affordable home
    mortgage financing, especially for those Americans who have never owned
    their home before. I hope my colleagues will join us in support of this
    important initiative.
         Mr. Chairman, your dedication to this issue is greatly appreciated
    and I look forward to our continuing work on this important issue. The
    need for proper regulatory oversight of the GSE's is a high priority
    and I am committed to working through these issues with you.

                      PREPARED STATEMENT OF ALAN L. BELLER
                   Director, Division of Corporation Finance
                    U.S. Securities and Exchange Commission
                               February 10, 2004
    Introduction
        I am pleased to have this opportunity to testify before you on
    behalf of the Securities and Exchange Commission regarding the
    application of disclosure and reporting requirements of the Federal
    securities laws to Fannie Mae, Freddie Mac, and the Federal Home Loan
    Banks. These Government Sponsored Enterprises (GSE's) issue marketable
    debt to the public. In addition Fannie Mae and Freddie Mac have
    publicly held common stock and also issue guaranteed mortgage-backed
    securities to the public. All of these entities and their securities
    are exempt from the registration and disclosure provisions of the
    Federal securities laws. None of the debt securities issued by any of
    these GSE's is backed by the full faith and credit of the United
    States.
    Commission's Historical Views on GSE Disclosure
        Since at least 1992, the Commission has expressed the view that,
    because the GSE's, most prominently Fannie Mae and Freddie Mac, but
    also including the Federal Home Loan Banks, sell securities to the
    public and have public investors, and do not have the ``full faith and
    credit'' Government backing of Government securities, their disclosures
    should comply with the disclosure requirements of the Federal
    securities laws. The Commission participated with the Department of the
    Treasury and the Board of Governors of the Federal Reserve System in a
    1992 Joint Report on the Government Securities Market (1992 Report)
    that addressed these issues, among other things.\1\ Mandatory
    compliance by the GSE's with these disclosure requirements and the
    Federal securities laws is the objective. While the 1992 Report
    addressed registration, the manner by which mandatory compliance is
    achieved--including through voluntary registration with the
    Commission--may be less significant. Further, the disclosure quality
    that we seek for the GSE's can only result from becoming subject to the
    SEC's reporting system. The disclosure quality results not only from
    our disclosure rules but also the Commission's and the staff's
    administration of these rules, including our review and comment
    processes and our enforcement program.
    ---------------------------------------------------------------------------
        \1\ Department of the Treasury, Securities and Exchange Commission,
    Board of Governors of the Federal Reserve System, Joint Report on the
    Government Securities Market, January 1992.
    ---------------------------------------------------------------------------
    Preliminary Discussion of Registration
        For purposes of today's subject, two of the Federal securities laws
    are relevant--the Securities Act of 1933 (Securities Act) \2\ and the
    Securities Exchange Act of 1934 (Exchange Act).\3\ The Exchange Act
    requires, or allows for, registration by issuers of classes of their
    public securities. Registration under the Exchange Act results in
    reporting requirements providing for disclosure of detailed information
    relating principally to the issuer. Under the Exchange Act and the
    Commission's rules, required information includes financial statements,
    management's discussion and analysis, description of business,
    information regarding directors and management and compensation,
    information regarding related party transactions and other
    information.\4\ This corporate information is the information on which
    the Commission and staff have focused in urging disclosure by GSE's.
    Registration under the Exchange Act also subjects reporting companies
    to the provisions of the Sarbanes-Oxley Act applicable to issuers.\5\
    These provisions include CEO and CFO certification requirements,
    internal control requirements, prohibition on loans to insiders,
    restrictions on the use of proforma or non-GAAP measures and enhanced
    disclosure requirements, for example regarding off-balance sheet
    transactions.
    ---------------------------------------------------------------------------
        \2\ 15 U.S.C. Sec. 77a et. seq.
        \3\ 15 U.S.C. Sec. 78a et. seq.
        \4\ See generally Regulation S-X, 17 CFR 210 and Regulation S-K 17
    CFR 229.
        \5\ Pub. L. 107-204 (2002) 116 Stat. 745 (2002).
    ---------------------------------------------------------------------------
        The Securities Act, by contrast to the Exchange Act, requires
    registration by issuers of transactions, namely public offerings by
    issuers of their securities. One result of registration under the
    Securities Act is required disclosure of essentially the same corporate
    information as is required for reporting companies under the Exchange
    Act. Another result of registration under the Securities Act is
    required disclosure regarding the securities being offered.\6\ Finally,
    because the Securities Act registers securities offerings, review by
    the Commission staff of Securities Act registration statements can
    directly affect the timing of those transactions.
    ---------------------------------------------------------------------------
        \6\ Registration of sales under the Securities Act also results in
    an automatic requirement to file Exchange Act reports for at least some
    period of time.
    ---------------------------------------------------------------------------
    Fannie Mae and Freddie Mac
        On July 12, 2002, Fannie Mae and Freddie Mac announced that each
    would voluntarily register its common stock under the Exchange Act and
    thus become subject to Commission reporting requirements. This decision
    took the form of a public announcement, along with press releases
    issued by each company. Fannie Mae's registration statement under the
    Exchange Act was declared effective on March 31, 2003. Freddie Mac has
    stated it intends to complete the Exchange Act registration process
    when it completes its restatement and audit of its financial
    statements. As noted above, registration and reporting also trigger
    applicability of the provisions of the Sarbanes-Oxley Act that apply to
    reporting companies.
        The proxy and insider transaction reporting requirements of the
    Exchange Act (Sections 14(a) and 16(a)) by their terms specifically
    apply only to nonexempt equity securities. The classes of common stock
    of Fannie Mae and Freddie Mac remain exempt securities even if
    registered under the Exchange Act and thus not subject to either
    section. In order to obtain the disclosure that would be required by
    officers and directors of the companies under the insider transaction
    reporting requirements of the Exchange Act and compliance by the
    companies with the Commission's proxy rules, the Office of Federal
    Housing Enterprise Oversight adopted rules effective April 30, 2003
    requiring the officers and directors of Fannie Mae and Freddie Mac to
    file with the Commission all reports and forms that would be required
    by Section 16(a) and the companies to file with the Commission all
    reports required pursuant to Section 14(a).
        As I noted, Fannie Mae has registered its common stock under the
    Exchange Act. Fannie Mae is now fully subject to the Commission's
    disclosure rules and the requirements of the Sarbanes-Oxley Act.
    Freddie Mac has not completed the process. Fannie Mae has filed with
    the Commission its 2002 annual report on Form 10-K including audited
    financial statements, quarterly reports on Form 10-Q containing
    unaudited financial statements, its proxy statement relating to its
    annual meeting of shareholders and numerous current reports on Form 8-
    K. In addition, officers and directors of Fannie Mae have filed dozens
    of Statements of Changes in Beneficial Ownership on Form 4.
        Our attention to date in seeking disclosure by the GSE's that meets
    our requirements has focused on corporate information. It has been our
    priority that investors who purchase and sell stock or ``straight''
    debt (that is nonmortgage-backed debt) of the GSE's are entitled to the
    corporate information required to be disclosed under the Exchange Act.
    While Fannie Mae and Freddie Mac continue to be exempt from the
    requirements to register the offer and sale of securities under the
    Securities Act of 1933, the information about the corporation that
    would be required to be disclosed in a prospectus contained in a
    registration statement under the Securities Act is the same as Fannie
    Mae is, and Freddie Mac will be, required to provide as a result of
    their voluntary registration under the Exchange Act.
        Registration of securities transactions by Fannie Mae and Freddie
    Mac under the Securities Act, especially offerings of their mortgage-
    backed and other mortgage-related securities, requires consideration of
    factors not present with the more easily accomplished registration
    under the Exchange Act. The Commission did not recommend in the 1992
    Report removing the exemption from the Federal securities laws for the
    offer and sale of mortgage-backed and mortgage-related securities of
    Fannie Mae and Freddie Mac. While we seek the achievement of the
    benefits for investors of registration under the securities laws, we
    recognize that these other factors need to be examined.
        First, as noted above, the review process of the Division of
    Corporation Finance of registration statements of transactions under
    the Securities Act means that the timing of transactions could be
    affected. This is not the case as a result of Exchange Act
    registration, which requires the filing of periodic and current reports
    with company information rather than filings tied to the timing of
    offerings.
        Second, because Fannie Mae's and Freddie Mac's mortgage-backed and
    other mortgage-related securities are backed by their respective
    guarantees, important information in analyzing these securities as a
    credit matter includes their financial and other corporate information.
    Exchange Act filings would contain this information without regard to
    Securities Act registration.
        As to other information regarding mortgage-backed and related
    securities, in late 2002, staff of the Commission, Department of the
    Treasury, and OFHEO conducted a joint study of disclosure regarding
    mortgage-backed securities with a view to ensure that investors in
    mortgage-backed securities are provided with the information that they
    should have. The task force issued a report in January 2003.\7\ The
    report notes that market participants found the mortgage-backed
    securities market extremely efficient. The report concluded that some
    additional disclosures would be both useful and feasible in the
    mortgage-backed securities market. These include:
    ---------------------------------------------------------------------------
        \7\ Department of the Treasury, Office of Federal Housing
    Enterprise Oversight, Securities and Exchange Commission, Staff Report:
    Enhancing Disclosure in the Mortgage-Backed Securities Market, January
    2003.

     Loan purpose (that is, whether a purchase or refinance)
     Original loan-to-value (LTV) ratios
     Standardized credit scores of borrowers
     Servicer for the pool (this may not always be the seller or
        originator)
     Occupancy status (owner-occupied or investor)
     Property type (for example, detached, condo)

        Both Fannie Mae and Freddie Mac have implemented these new
    disclosures.

        Finally, registration of offerings of the GSE's mortgage-backed and
    related securities under the Securities Act may raise another
    significant and uniquely complex factor--the impact on the mortgage
    market--that should be considered. In particular, a substantial
    portion, and recently a majority, of the GSE's mortgage-backed
    securities have been sold into the so-called ``To Be Announced,'' or
    TBA, market. These transactions involve forward sales of mortgage-
    backed securities comprised of pools of mortgages not yet identified
    and in many, if not most, cases not yet in existence. The parameters
    which the securities and the mortgages in the pools must meet are set
    forth in standards established for the TBA market by market
    participants and discussed in the January 2003 report. Because actual
    mortgage pools are not established at the time of the forward sale
    transactions, there can be no disclosure of mortgage pool
    characteristics at the time of registration of the offerings. The TBA
    standards the mortgage pools must meet are already available to the
    market.
        In addition, we understand that the TBA market is used to set or
    ``lock in'' mortgage rates in the U.S. housing market. A decision to
    require registration under the Securities Act of offers and sale of
    mortgage-backed securities should properly take into account whether,
    and if so, how such registration might impact the mortgage market and
    the operation of the TBA market. I believe that similar considerations
    formed at least a portion of the background for the conclusion
    expressed in the 1992 Report.
    Federal Home Loan Banks
        The Federal Home Loan Bank System was created prior to enactment of
    the Securities Act and the Exchange Act and the creation of the
    Securities and Exchange Commission in 1934. The System was created in
    1932 to restore confidence to the Nation's financial institutions and
    improve the supply of funds to local lenders.\8\ The System is
    comprised of 12 banks. The Federal Home Loan Bank System through the
    Office of Finance is one of the largest issuers of debt securities in
    the world with $673.7 billion outstanding as of December 31, 2002. We
    believe that the holders of debt issued by the Office of Finance, for
    which the 12 Banks are jointly and severally liable, are entitled to
    the same type of information that is provided to investors in other
    public debt securities. Our interest is in assuring that public
    investors in this debt are provided with sufficient information when
    they are making their investment decisions.
    ---------------------------------------------------------------------------
        \8\ Federal Home Loan Bank Act, Pub. L. No. 72-304, 47 Stat. 725
    (1932)
    ---------------------------------------------------------------------------
        The Federal Home Loan Banks are also exempt from the Federal
    securities laws. The Banks prepare financial statements based on
    regulations of the Federal Housing Finance Board, which refer to
    Commission disclosure regulations. However, the staff of the Commission
    does not review these financial statements or any other disclosure
    documents of the Banks. The Banks are also not subject to the
    provisions of Sarbanes-Oxley Act of 2002 applicable to issuers, as
    discussed above. However, the Banks are subject to general antifraud
    restrictions prohibiting false or misleading statements of material
    facts or the omission of material facts necessary to make the
    statements made, in light of the circumstances under which they are
    made, not misleading. In September 2003, the Finance Board proposed for
    comment a rule to require registration under the Exchange Act by the
    Banks with the Commission. The comment period for that rule ended
    January 15, 2004.
        The Banks, although Federally chartered entities, have many of the
    same disclosure issues as any financial institution whose securities
    are issued to, and held by, the public. Consolidated obligations for
    which each Bank is either primarily or secondarily obligated are sold
    to the public in underwritten offerings. As discussed above, we believe
    investors in those debt securities are entitled to the same type of
    information as that provided by other issuers of public debt. As also
    discussed above, we further believe that the Commission's detailed
    disclosure rules and filing requirements and the staff review and
    comment process provide the best framework for disclosing information
    to which investors are entitled.
        Because the debt of the Banks does not carry the full faith and
    credit backing of the United States and investors in the Banks' debt
    must therefore look only to the Banks for repayment of the debt,
    disclosures by the Banks should give the holders of its debt a
    materially complete and accurate picture of the Banks' financial and
    operational situation to evaluate an investment. As is the case with
    Fannie Mae and Freddie Mac, the focus for disclosure has been the
    corporate disclosure required for a reporting company that registers
    under the Exchange Act. Registration of offers and sales of securities
    under the Securities Act has not been the focus and is not the subject
    of the proposed Finance Board rule. In particular, as with Fannie Mae
    and Freddie Mac, corporate disclosure resulting from Exchange Act
    registration is the same as would be required as a result of Securities
    Act registration.
        Because of the structure of the Federal Home Loan Bank System,
    including the Office of Finance, however, there are some issues that
    may be unique to the Banks. Staff of the Commission has met with
    members and staff of the Federal Housing Finance Board, representatives
    of the Banks and a group of directors of certain Banks, in each case at
    their request, to discuss the issues that registration under the
    Exchange Act may raise.
        Very early in our discussions with all of these parties, we sought
    to clearly and carefully address concerns raised by the Banks about
    whether registration would require the structure of the System to
    change. The Commission has no regulatory interest in changing the
    structure of the System. Registration under the Exchange Act of each of
    the 12 Banks would not alter the structure of the Federal Home Loan
    Bank System. In addition, insofar as registration of a class of each
    Bank's securities under the Exchange Act is being considered, there
    would be no impact on the timing or other aspects of offering
    transactions as a result of registration.
        Because our focus on disclosure relates to the debt issued by the
    Banks and not to their common stock, Commission staff had initially
    considered with the Finance Board and the Banks the possibility of the
    Banks registering a class of debt securities. Under the Exchange Act
    the corporate disclosure required of a company is the same whether the
    security registered is debt or common stock. However, registration of
    equity could implicate additional requirements for the Banks, such as
    the proxy rules. Therefore Commission staff suggested the Banks
    register a class of debt securities. In our discussions with the Banks,
    each Bank expressed a preference for registering a class of its stock,
    if any security was to be registered under the Exchange Act. Because
    the corporate disclosure is the same, this is acceptable to us. Staff
    have also indicated to the Banks that we would work with them to
    determine if there were certain requirements, such as the proxy rules,
    from which it should be clear the Banks are exempted because the
    publicly held securities that implicate registration and disclosure
    issues are their debt securities. This would produce the same result as
    would be the case for corporate issuers whose only public securities
    are debt securities.
        In addition to these items, there have been four accounting related
    issues that have been identified as significant for the Banks in terms
    of ascertaining our staff's view prior to any registration process. We
    have met with representatives and advisers of some of the Banks to
    resolve these issues. Those issues include: The accounting treatment of
    the payment to REFCORP, the role of the combined financial
    statements of the 12 Banks, the accounting classification of redeemable
    capital stock, and the accounting treatment related to the joint and
    several nature of the Banks' obligations:

     The Financial Institutions Reform, Recovery, and Enforcement
        Act of 1989 \9\ obligated the Banks to make an annual $300 million
        payment to the U.S. Treasury until 2030 for the partial payment of
        interest on bonds issued by the Resolution Funding Corporation, or
        REFCORP. The Gramm-Leach-Bliley Act \10\ in 1999 changed how
        REFCORP payments are calculated and due. Each Bank is now obligated
        to pay 20 percent of earnings annually until these amounts for the
        whole system are equivalent to a $300 million annual annuity with a
        final maturity date of April 15, 2030. The Banks view the REFCORP
        payments as similar to a tax and accordingly, no obligation for
        future payments is recorded on their balance sheets. The Commission
        staff has indicated to the Banks that we would not object to this
        current presentation of the treatment of REFCORP payments.
    ---------------------------------------------------------------------------
        \9\ Pub. L. No. 103-73 (1989).
        \10\ Pub. L. No. 106-102 (1999).
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     Each Bank is a separate corporation with its own management,
        employees, and board of directors. The Office of Finance, which is
        an agent for the Banks, prepares combined financial statements of
        the 12 Banks for public distribution. The financial statements are
        not consolidated because there are separate and distinct
        stockholder groups for each Bank with no common management or
        ownership at the system level. The Commission staff believes that
        the correct way to proceed is to have individual Banks register.
        Because of the structure of the System, there is no issuer tied to
        the combined statements to register under the Exchange Act.
        Commission staff believes, however, there are policy reasons for us
        to have an opportunity to review and comment on the combined
        financial statements which are distributed to investors. Under
        Finance Board regulations the Board determines whether the combined
        financials statements comply with their requirements.\11\ Staff
        have proposed that we would have arrangements with the Finance
        Board so that their reviews would give the Commission staff the
        opportunity to review the combined financial statements and provide
        the Finance Board comments, if any. None of the Banks would have
        additional responsibility for the combined financial statements as
        a result of registration under the Exchange Act or the staff's
        proposed arrangements with the Finance Board regarding the combined
        statements.
    ---------------------------------------------------------------------------
        \11\ 12 CFR 985.6(b).
    ---------------------------------------------------------------------------
     The Gramm-Leach-Bliley Act required each of the Banks to
        create a new capital structure. That Act allows each Bank to create
        two classes of stock, one with a redemption period of 6 months and
        the other with a redemption period of 5 years. The Banks are in the
        process of implementing their new capital plans. Because the stock
        will be redeemable, the issue arose as to whether the stock could
        be included as permanent equity on the financial statements of the
        Banks. Because all of the stock of each of the banks is
        ``puttable,'' the Commission staff will not object if it is not
        separated from the equity section of the balance sheet. This would
        be similar to the treatment of the equity for co-ops currently
        registered under the Exchange Act. The face of the financial
        statements would need to indicate the stock is ``puttable'' and the
        notes to the financial statements would include disclosure on how
        the puts work and on how much of the stock is in excess of the
        amount required to be held by member banks which is generally based
        on the member bank's activity. We have indicated to the Banks that
        we will continue to have dialogue with them on the proper
        accounting treatment in the event a stockholder puts the stock to a
        Bank.
     The Commission staff has also had discussions with the Banks
        regarding the appropriate treatment of the joint and several nature
        of the Consolidated Obligations. Staff has indicated to the Banks
        that it would not object to each Bank
        reflecting on the face of its balance sheet as long-term
        indebtedness only the amount of Consolidated Obligations for which
        that Bank has received proceeds and is therefore viewed by the
        Banks as primarily liable. The Banks would also disclose the total
        amount of outstanding obligations. The Commission staff has also
        indicated to the Banks that it would not object to their accounting
        treatment for the contingent liability related to each Bank's
        guarantee of the remainder of the outstanding Consolidated
        Obligations for which it is not primarily liable.
    Conclusion
        The individual and institutional investors who hold debt securities
    of the Banks depend for repayment on the Banks and not a Government
    guarantee. We believe that applying the Commission's disclosure
    requirements and processes is the
    preferred method of helping to ensure that these investors receive the
    materially accurate and complete disclosure they deserve. We believe
    that the Commission's detailed disclosure rules and filing
    requirements, and our staff review and comment process, provide the
    best framework for disclosing that information. We have a long history
    of reviewing the disclosure of companies in many diverse industries and
    we regularly review the complex debt and equity structures of these
    companies. We have not initiated any process to seek voluntary
    registration by the Federal Home Loan Banks of their securities, but we
    do believe that our rules and registration would provide the desired
    result. If registration by the Banks is pursued, we are committed to
    achieving that result with maximum protection for investors and maximum
    efficiency for all registrants consistent with our mission to protect
    investors.
                    PREPARED STATEMENT OF RICHARD S. CARNELL
          Associate Professor of Law, Fordham Univeristy School of Law
                               New York, New York
                               February 10, 2004
        Mr. Chairman, Senator Sarbanes, and Members of the Committee, I am
    pleased to have this opportunity to discuss ways to improve the
    regulation of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank
    System.
        As Government Sponsored Enterprises, these entities are privately
    owned, profit-oriented corporations that have Congressional charters
    and receive an array of Federal benefits not available to businesses
    generally. More importantly, capital market participants believe that
    the Government implicitly backs each GSE--and would not let the GSE's
    creditors go unpaid. This perceived implicit guarantee is the GSEs'
    most important and most distinctive characteristic. It enables the
    three housing GSE's to borrow $2.2 trillion at rates below those
    available to even the most creditworthy fully private borrowers.
        For years the GSE's assured us that they met the highest standards
    of corporate governance, fully complied with generally accepted
    accounting principles, provided disclosure at least as good as what the
    Federal securities laws required, faced tough and effective safety-and-
    soundness regulation, and were so well run that no one had any business
    requiring them to do anything they did not want to do. Recent scandals
    and other developments cast doubt on these claims and on the adequacy
    of GSE regulation. The Administration has proposed major reforms of
    such regulation, including the creation of a new GSE regulatory agency.
    Treasury Secretary Snow has rightly called for ``a strong, credible,
    and well-resourced regulator'' with ``powers . . . comparable in scope
    and force to those of other world-class financial regulators, fully
    sufficient to carry out the agency's mandate, with accountability to
    avoid dominance by the entities it regulates.''
        In my testimony today, I will:

     identify six fundamental questions Congress faces in
        structuring a GSE regulator;
     offer suggested answers to those questions;
     describe the double game by which the GSE's deny that they
        have ``full faith and credit'' Government backing--in ways that
        leave the impression that they have no Government backing at all--
        even as they work to reinforce the market perception of implicit
        Government backing;
     refute the GSEs' attempt to liken FDIC-insured banks to GSE's
        and to argue that we should not concern ourselves with GSE
        subsidies because the Government gives banks greater subsidies; and
     examine ``systemic risk''--particularly the argument that if a
        GSE got into financial trouble, the Government would have no choice
        but to rescue it, lest its failure unacceptably damage the
        financial system.
    Structuring the Regulator
        In designing (or redesigning) a regulatory agency, Congress faces
    six fundamental questions:

     Jurisdiction: Who will the agency regulate?
     Mission: What objectives should the agency seek to achieve?
     Governance: Who will run the agency, and under what ground
        rules?
     Resources: How will the agency pay its expenses?
     Legal Authority: What legal tools will the agency have to do
        its job?
     Incentives: What incentives will the agency's officers and
        employees have?

        I will first briefly analyze OFHEO's structural weaknesses in light
    of these questions. I will then discuss how to structure a new GSE
    regulatory agency, considering the first five questions in turn and (in
    so doing) noting how the answers given to those questions will affect
    the agency's incentives. For the new agency's incentives will be
    crucial to the agency's success or failure.
    OFHEO's Structural Weaknesses
        Congress created OFHEO with significant structural weaknesses.
    Specifically, the Federal Housing Enterprises Financial Safety and
    Soundness Act of 1992 (1992 Act) created a small, hyper-specialized
    agency--with uncertain funding and overly narrow powers--to regulate
    two huge, relatively homogeneous firms with great political clout. The
    Act housed that agency in a department with no institutional commitment
    to safety and soundness, little credibility to spare, and little
    ability to protect OFHEO against pressure from Fannie and Freddie. I
    summarize some of these structural weaknesses and their consequences in
    the table following this page. Building these weaknesses into OFHEO was
    a bit like keeping a watchdog hobbled, muzzled, and underfed.
    Jurisdiction
        The new agency should regulate Fannie, Freddie, and the Federal
    Home Loan Bank System, taking over the functions currently performed by
    OFHEO and the Federal Housing Finance Board.\1\
    ---------------------------------------------------------------------------
        \1\ I will argue below that the new agency should, ideally, also
    become responsible for overseeing Fannie and Freddie's housing mission,
    taking over functions currently performed by HUD.
    ---------------------------------------------------------------------------
        Having a single agency regulate all three housing GSE's would have
    several advantages over the current system. The General Accounting
    Office identified and aptly summarized these advantages in its
    excellent report, Government Sponsored Enterprises: Advantages and
    Disadvantages of Creating a Single Housing GSE Regulator (1997), on
    which I will draw extensively in this part of my testimony.

        First, and most importantly, a single regulator would have more
    independence from the firms it regulates. The Federal Home Loan Bank
    System has a different business model and different interests than
    Fannie and Freddie. These differences should create what the GAO called
    ``a healthy tension in the oversight of the [GSE's] that could help
    prevent the regulator from being `captured' by the GSEs'' (that is,
    from identifying with and primarily serving the GSEs' interests).
        A similar ``healthy tension'' in State thrift regulation yielded
    major benefits during the thrift debacle of the 1980's. The most severe
    losses among State-chartered, Federally insured thrifts occurred in
    States (for example, Texas and California) with hyper-specialized
    regulators that supervised only thrifts. States whose banking
    commissioners also regulated thrifts had a much better record of
    keeping thrifts healthy and avoiding costly failures. This difference
    in outcomes reflected a difference in regulators' incentives. Hyper-
    specialized thrift-only regulators proved overly reluctant to rein in
    risky practices, close insolvent thrifts, and require sick thrifts to
    recapitalize. Such strong measures would have risked alienating thrifts
    (the regulators' main constituency) and putting the regulators out of
    business. By contrast, State officials who regulated both banks and
    thrifts had greater liberty to take tough but necessary action against
    troubled thrifts. State-chartered banks demanded such action. Moreover,
    these officials knew that their agencies could, if necessary, survive
    without a thrift clientele. So regulating both banks and thrifts gave
    these officials more freedom to do their jobs well. Similarly,
    regulating all three housing GSE's would give the new GSE regulator
    more freedom to do its job well than if it regulated only Fannie and
    Freddie or only the Federal Home Loan Banks.
        Second, an agency regulating all three housing GSE's would be
    larger and (in the GAO's phrase) ``more prominent in Government'' than
    OFHEO and the Finance Board. This increased stature ``could help
    attract and retain staff with the special mix of expertise and
    experience needed to examine and monitor these sophisticated GSE's.''
        Third, a single housing GSE regulator could achieve ``some
    economies and efficiencies'' by having staff ``share expertise in such
    areas as examinations, credit and interest rate risk monitoring,
    financial analysis, and economic research'' and by combining
    ``[a]dministrative support functions.''
        Fourth, such an agency could achieve greater consistency in
    regulating the three housing GSE's.
        The main disadvantage of creating a single regulator would be quite
    modest: What the GAO called ``the short-term disruption that would come
    with any type of change.''
    Mission
        OFHEO and HUD currently divide regulation of Fannie and Freddie,
    with OFHEO responsible for safety and soundness and HUD responsible for
    housing mission. The Finance Board, by contrast, has both types of
    responsibility for the Federal Home Loan Bank System.
        Giving the new GSE regulator both safety and soundness and mission
    responsibilities would have three advantages. First, it would promote
    accountability by both the regulator and the GSE's. Divided
    responsibility creates ``the potential for the GSE's to try to pit the
    regulators against each other'' (as the GAO's 1997 report noted) or to
    tell each regulator that a given matter--which may raise both mission
    and safety and soundness issues--falls only within the authority of the
    other regulator. Second, giving a single agency both responsibilities
    would simplify compliance by the GSE's. Third, insofar as GSE policy
    must take account of both mission and safety and soundness, giving one
    agency both responsibilities would promote better-informed
    decisionmaking.
        Accordingly, I would support combining both responsibilities in one
    agency if that can be done under sound governance (discussed below).
    But sound governance is so critical that it should not be compromised
    to obtain the more modest benefits of combining the two
    responsibilities. In any event, the GSE's should have to limit their
    activities to the secondary market and obtain the new agency's approval
    before commencing new activities.
    Governance
    General Approach
        The paramount goal in structuring a new GSE regulatory agency
    should be to assure the agency's independence from the firms it
    regulates. The housing GSE's are powerful, aggressive, and politically
    effective. They are adept at capturing or cowing regulators. But a
    sound governance structure--combined with other reforms (such as having
    one agency, with permanent funding and adequate legal authority,
    regulate all three housing GSE's)--can help the agency avoid such
    capture or intimidation.
        Two possible governance structures offer the best prospects for
    maintaining the agency's integrity, objectivity, and effectiveness.
        The first approach would make the agency an autonomous bureau of
    the Treasury Department.\2\ The Treasury has an institutional
    commitment to safety and soundness, and has the will and the
    institutional credibility to stand up to the GSE's. The GSE's would
    find the Treasury harder to bully than HUD, OFHEO, the Finance Board,
    or a new independent agency. I believe that a Treasury-based GSE
    regulator would also diligently carry out its responsibilities for the
    GSEs' housing mission. The myth of the Treasury as hostile to housing
    and eager to choke off housing finance is just that: A myth,
    popularized decades ago by thrift lobbyists intent on keeping thrift
    regulation a lax, cozy backwater. The Treasury's Office of Thrift
    Supervision (OTS) has performed both safety-and-soundness and housing-
    mission responsibilities for over 14 years, without antihousing bias
    (and with greater competence than the independent agency it replaced).
    ---------------------------------------------------------------------------
        \2\ My confidence in the Treasury may reflect my own association
    with that department from 1993 through 1999. Yet I had concluded years
    before--at the time of the thrift debacle--that the Treasury was the
    best place to house GSE regulation.
    ---------------------------------------------------------------------------
        The second approach would place the new agency under a three- or
    five-member board. The board would include one representative each from
    the Treasury and HUD. It would also include either one or three
    appointed members nominated by the President and confirmed by the
    Senate. An appointed member would serve as chair of the board and
    executive head of the agency. The Treasury, HUD, and the appointed
    member(s) would each bring their own perspectives and expertise to
    bear.
        I view a three-member board \3\ as preferable to a five-member
    board. A larger board would (other things being equal) have more
    difficulty making decisions and be more vulnerable to capture or
    manipulation by the GSE's. Moreover, the two additional appointed
    positions on a five-member board would probably offer too little
    challenge to attract and retain the most talented, energetic people.
    The chair would head the agency, and the Treasury and HUD members would
    have their own responsibilities. But how would the two extra appointed
    members occupy themselves? Would they end up half-idle, hobnobbing with
    the GSE's, intriguing against other board members, or attempting to
    micromanage the agency's staff ? The prospect of such high-level
    underemployment would hinder the recruitment and retention of able,
    independent individuals.
    ---------------------------------------------------------------------------
        \3\ The Pension Benefit Guaranty Corporation provides a precedent
    for a three-member board that draws a majority of its members from
    executive departments. The PBGC board consists of the Secretaries of
    Labor, Treasury, and Commerce. 29 U.S.C. Sec. 1302(d).
    ---------------------------------------------------------------------------
    Regulatory Autonomy
        The Administration has opposed making the new agency a bureau of
    the Treasury unless the agency must clear its regulations and
    Congressional testimony through the Treasury. The Administration gives
    two reasons for requiring such clearance--and thus treating the new
    agency differently than the Treasury's Office of the Comptroller of the
    Currency (OCC) and Office of Thrift Supervision.\4\ First, because the
    new agency would regulate only a few firms, all very large, it would be
    particularly vulnerable to ``capture'' by those firms. This
    vulnerability (in Secretary Snow's words) ``makes the oversight of
    overall policy development by the Treasury Department vital.'' Second,
    ``it is vitally important that the Treasury Department be able to
    monitor the new regulator's policies to ensure that such policies are
    not reinforcing any such market misperception of an implied
    guarantee.''
    ---------------------------------------------------------------------------
        \4\ The Treasury cannot ``delay or prevent the issuance of any rule
    or the promulgation of any regulation'' by the OCC or OTS. No one can
    require clearance of those agencies' Congressional testimony. 12 U.S.C.
    Sec. Sec. 1, 250, 1462a(b)(4).
    ---------------------------------------------------------------------------
        I concur in both arguments: A specialized GSE regulatory agency
    would be acutely vulnerable to capture; and the Treasury should be able
    to monitor a Treasury
    bureau's policies to ensure that they do not reinforce market
    misperception of an implied guarantee. But these arguments do not
    necessarily show that Treasury clearance of regulations and testimony
    is essential--or that autonomy of the general type enjoyed by the OCC
    and OTS would not work. Both the OCC and OTS are (in the words of the
    OTS statute) ``subject to the general oversight of the Secretary of the
    Treasury.'' 12 U.S.C. Sec. Sec. 1, 1462a(b)(1). This oversight offers
    some protection against capture and should help ensure the agency's
    policies do not reinforce the market misperception. Insofar as the
    Treasury remains concerned about the misperception, the Treasury itself
    can speak out any time, which would correct the misperception far more
    effectively than vetting regulations and testimony. Moreover, the GSEs'
    aggressiveness and political clout--and the new agency's consequent
    need for support--would give the agency reason to consult and cooperate
    with the Treasury even if the agency did not need formal Treasury
    clearance of regulations and testimony.
        Requiring Treasury clearance of the new agency's Congressional
    testimony could cause delay, as Treasury officials who might otherwise
    have little interest in the Agency's work scrutinized the testimony to
    make sure it would not embarrass the Treasury Secretary or the
    Administration. One persistently tardy participant in a clearance
    process can make testimony persistently late despite the other
    participants' best efforts. Note, moreover, that if the Secretary
    cannot control the agency's testimony, then it is harder (although not
    impossible) to blame the Secretary for that testimony.
        A stronger case exists for Treasury clearance of the new agency's
    regulations (although I do not regard such clearance as essential).
    Such clearance would help guard against capture. It need not cause
    delay, as regulation-writing takes time and rarely has the short
    deadlines typical in preparing Congressional testimony.
        In any event, Treasury clearance of regulations should not derail
    GSE reform legislation. Congress can develop middle-ground options,
    such as (1) setting a time limit on Treasury review, or (2) permitting
    the new agency to proceed with a proposed regulation unless the
    Treasury expressly disapproves the regulation within a specified time
    period and publishes specific written reasons for its disapproval. Such
    an intermediate option would make Treasury review of the Agency's
    regulations more than merely advisory, while providing safeguards
    against delay or unreasoned disapproval.
    Resources
        Like the OCC and OTS, OFHEO pays its expenses using fees collected
    from the firms it regulates; it receives no general tax money. But
    unlike the OCC and OTS, OFHEO needs an annual appropriation to set and
    collect such fees. Fannie and Freddie have used the appropriations
    process both to pressure OFHEO (just as thrifts used the process to
    pressure the old Federal Home Loan Bank Board) and to limit OFHEO's
    capacity to undertake more rigorous scrutiny of the GSE's. To reinforce
    the new agency's independence from the firms it regulates, Congress
    should end this reliance on appropriations.
    Legal Authority
    Capital, Enforcement, and Prompt Corrective Action
        The Federal Housing Enterprises Financial Safety and Soundness Act
    of 1992 drew on banking law to strengthen the safety and soundness
    regulation of Fannie and Freddie. The 1992 Act required new capital
    standards. It included Prompt Corrective Action provisions to encourage
    the GSE's to correct capital deficiencies. It authorized OFHEO to take
    administrative enforcement action against unsafe practices. But at the
    insistence of Fannie and Freddie, the 1992 Act unwisely tended to deny
    OFHEO authority possessed by bank regulators. As a result, OFHEO has
    (in Tom Stanton's phrase) ``a parody of the authority of the Federal
    bank regulators.'' The limits on OFHEO's authority contrast sharply
    with the goal of creating ``a strong, world-class regulatory agency''
    with powers ``comparable in scope and force to those of other world-
    class financial regulators.''
        Bank regulators have broad authority to prescribe capital
    standards, including authority to impose new standards or toughen
    existing standards. 12 U.S.C. Sec. Sec. 1831o(c)(1), 3907(a). OFHEO, by
    contrast, faces major constraints on the form and content of capital
    standards, including an extraordinarily complex Congressionally
    dictated stress test. Sec. Sec. 4611-4612. The new regulator needs
    authority to raise capital standards in light of experience.
        OFHEO has much weaker enforcement authority (Sec. Sec. 4631-4636)
    than Federal bank regulators (Sec. 1818), as shown in the table
    following this page. For example, bank regulators can issue a cease-
    and-desist order against any ``unsafe and unsound practice.'' OFHEO can
    issue such an order only if the conduct jeopardizes a GSE's capital.
    Bank regulators can bar any officer, director, or employee of an FDIC-
    insured institution from working at that or any other Federally insured
    institution if the individual committed misconduct (for example,
    breaking the law) that (1) enriched the individual or caused loss to
    the institution, and (2) involved personal dishonesty or demonstrated
    willful or continuing disregard for institution's safety and soundness.
    OFHEO has no such authority. Bank regulators can impose civil money
    penalties of up to $25,000 per day for lawbreaking that enriches the
    violator or breaches the violator's fiduciary duties. OFHEO cannot
    impose civil money penalties on these grounds. Bank regulators can
    impose civil money penalties of up to $1 million per day for (1)
    knowingly breaking the law or breaching fiduciary duty, and thereby (2)
    substantially enriching the violator or causing the institution
    substantial loss. OFHEO cannot impose civil money penalties on these
    grounds.

        Fannie and Freddie face Prompt Corrective Action rules
    (Sec. Sec. 4614-4619, 4622) conspicuously weaker than those governing
    FDIC-insured depository institutions (Sec. 1831o). For example, an
    undercapitalized bank cannot increase its total assets unless (1) the
    bank has an acceptable capital restoration plan, (2) the asset growth
    comports with the plan, and (3) the bank's capital ratio increases at a
    rate sufficient to enable the bank to become adequately capitalized
    within a reasonable time. Sec. 1831o(e)(3). Yet no statute bars Fannie
    and Freddie from continuing to grow while undercapitalized, even if
    they have no capital restoration plan or if the growth conflicts with
    such a plan (Sec. 4615). The Prompt Corrective Action statute
    authorizes growth restrictions only against a significantly or
    critically undercapitalized GSE, and makes such sanctions purely
    discretionary. Sec. Sec. 4616(b)(2), 4617(b), (c)(2). Similarly, a bank
    cannot pay dividends if the bank is or would become undercapitalized,
    whereas even an undercapitalized GSE may be able to pay dividends as
    long as the dividends are not so large as to render the GSE
    significantly undercapitalized. Sec. Sec. 1831o(d)(1)(A), 4515(a)(2).
        The GSE enforcement and Prompt Corrective Action rules should be
    strengthened in line with their banking counterparts.
    Receivership
        There are two basic ways to deal with a firm if its liabilities
    exceed its assets and it cannot pay its debts as they become due:
    Liquidation and reorganization. Liquidation involves selling the firm's
    assets and using the proceeds to pay creditors. Reorganization involves
    scaling back the firm's liabilities, such as by turning some of the
    firm's debt into equity.
        Liquidation or reorganization mechanisms exist for most firms. A
    court can liquidate a business corporation under Chapter 7 of the
    Bankruptcy Code or (with enough creditors' approval) reorganize the
    corporation under Chapter 11. The FDIC can liquidate or reorganize an
    insolvent FDIC-insured bank or thrift. The Federal Housing Finance
    Board can liquidate or reorganize a Federal Home Loan Bank.
        But in the case of Fannie and Freddie, no adequate legal mechanism
    exists for dealing with a GSE if its liabilities exceed its assets. The
    Bankruptcy Code does not apply.\5\ Although OFHEO can appoint a
    ``conservator'' to take control of the GSE, the conservator cannot
    require creditors to exchange debt for equity or to accept less than
    full payment of their claims.\6\ Thus if the GSE's assets fall short of
    its liabilities, the conservator has no power to resolve the
    shortfall.\7\ The insolvent GSE would remain adrift in legal
    uncertainty until Congress enacted special legislation.
    ---------------------------------------------------------------------------
        \5\ Specifically, the Bankruptcy Code does not permit Fannie or
    Freddie to become a debtor in a bankruptcy proceeding, whether
    voluntarily or involuntarily. As Federal instrumentalities, Fannie and
    Freddie are ``governmental units'' under Sec. 101(27) of the Bankruptcy
    Code and thus under Sec. 101(41) are not a ``person.'' Under
    Sec. 109(a) only a ``person'' can become a ``debtor'' in a bankruptcy
    proceeding. See 11 U.S.C. Sec. Sec. 101(27), (41), 109(a).
        \6\ Under 12 U.S.C. Sec. 4620(a), a conservator generally ``shall
    have all the powers of the shareholders, directors, and officers of the
    Enterprise under conservatorship and may operate the Enterprise in the
    name of the Enterprise.'' But a firm's shareholders and managers have
    no power to require creditors to exchange debt for equity or to accept
    only partial payment of their claims.
        Nor does Sec. 4620(f) authorize OFHEO to write down creditors'
    claims. Under Sec. 4620(f) OFHEO ``may require a conservator to set
    aside and make available for payment to creditors any amounts that the
    Director determines may safely be used for such purpose.'' Using this
    authority, OFHEO could require a conservator to make larger or earlier
    payments to creditors than the conservator might otherwise make. But
    the statute in no way suggests that by accepting such payments
    creditors would waive their right to eventual payment in full.
        \7\ A conservator might, in theory, attempt to get all of the GSE's
    creditors to agree to scale back their claims. But obtaining the
    creditors' unanimous consent would be impracticable given the large
    number of creditors and the incentive for some creditors to threaten to
    veto the deal unless they received favored treatment.
    ---------------------------------------------------------------------------
        This lack of an orderly ``receivership'' mechanism--that is,
    mechanism for using the insolvent GSE's assets to satisfy the GSE's
    creditors--is a serious gap in current law, with potentially serious
    consequences for financial markets. So long as the gap remains, the GSE
    regulator will not truly have powers ``comparable in scope and force to
    those of other world-class financial supervisors, fully sufficient to
    carry out the agency's mandate.''
        Congress can fill the gap in at least two ways: (1) by authorizing
    the GSE regulator to commence a bankruptcy proceeding against an
    insolvent GSE; or (2) by
    authorizing the regulator to appoint a receiver to deal with the GSE
    under a specialized set of rules such as those applicable to failed
    banks. Either approach can do the job.
        Regulating GSE's but having no receivership mechanism is like
    investing in an elaborate fireprotection system--complete with
    firewalls, smoke detectors, heat sensors, alarm bells, and sprinklers--
    but failing to mount a crucial fire door on its hinges. Like firesafety
    measures, GSE safety and soundness regulation serves dual purposes.
    Firesafety measures protect a building by preventing and extinguishing
    fires there; they also protect other buildings by inhibiting the spread
    of fire. Similarly, GSE regulation seeks not only to keep the GSE's
    themselves safe but also to protect the financial and housing sectors
    from damage that might result from a GSE's failure. Bank regulation
    serves similar purposes and did so even before Federal deposit
    insurance: Seeking both to protect banks' depositors and other
    creditors and to prevent bank failures from causing broader economic
    harm. A receivership mechanism, by providing an orderly means for
    dealing with a failed GSE's obligations, would help limit and contain
    the harm resulting from a GSE's failure.
    The GSEs' Double Game
    In General
        In managing their relationship to the Federal Government, the GSE's
    play an extraordinarily successful double game: They deny that they
    have any formal, legally enforceable Government backing, even as they
    work to reinforce the market perception of implicit Government backing.
    Let us look more closely at the two parts of the double game.
        First, the GSE's emphatically deny that they have any formal,
    legally enforceable Government backing--in itself, a valid point. But
    the GSE's make this point in ways designed to convince the uninitiated
    that the GSE's enjoy no Government backing at all (an implication
    directly conflicting with the second part of the double game). The
    GSE's stress that ``Every one of our debt securities clearly states, in
    plain English, it is not backed by the full faith and credit of the
    Government.'' \8\ They argue that they operate ``with entirely private
    capital'' and that their activities ``are entirely supported by [their]
    revenue . . . and the capital of private investors and are not in any
    way guaranteed by the Federal Government.'' \9\
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        \8\ Franklin D. Raines, Remarks at Conference on Money Markets and
    the News: Press Coverage of the Modern Revolution in Financial
    Services, March 19, 1999.
        \9\ Fannie Mae, FM Watch Observer: Glossary of Terms, www.fmwatch-
    observer.com/glossary.html (emphasis added).
    ---------------------------------------------------------------------------
        Second, the GSE's work to reinforce the perception of implicit
    Government backing. Consider three examples involving Fannie. In the
    first example, Fannie sought legislative history stating that Fannie
    and Freddie ``are implicitly backed by the full faith and credit of the
    U.S. Government.'' \10\ In the second example, Fannie attacked Treasury
    Under Secretary Gensler as ``irresponsible'' and ``unprofessional''
    when he testified before a House Subcommittee on March 22, 2000, that
    ``the Government does not guarantee [GSEs'] securities.'' \11\
    ---------------------------------------------------------------------------
        \10\ When I worked for this Committee on a Glass-Steagall repeal
    bill in 1987-88, Fannie asked that I include such language (emphasis
    added) in a draft section-by-section analysis, which I declined to do.
        \11\ K. Day, Remarks Put Pressure on Fannie, Freddie Bonds,
    Washington Post, Mar. 24, 2000, at E1; J. Kosterlitz, Siblings Fat and
    Sassy, 32 National Journal 1498 (2000).
    ---------------------------------------------------------------------------
        In the third example, Fannie argued in a 1998 letter to the Office
    of the Comptroller of the Currency that ``all GSE issued securities
    merit'' more favorable treatment under the Federal banking agencies'
    risk-based capital standards than all ``AAA-rated [non-GSE] asset-
    backed securities.'' Thus the mere fact that a GSE issues a security
    makes that security more creditworthy than any non-GSE security. An IOU
    issued by a financially troubled GSE (such as the Farm Credit System
    before its 1987 bailout) would, under Fannie's reasoning, still be more
    creditworthy than a top-tier asset-backed security guaranteed by the
    Nation's healthiest fully private corporation. Fannie based this
    argument squarely on what it calls ``the implied Government backing of
    Fannie Mae'':

            GSE issues generically, and Fannie Mae-guaranteed MBS in
            particular, are viewed by the capital markets as near proxies
            for Treasury securities in terms of credit worthiness.

        . . .

            Fannie Mae standard domestic obligations, like Treasuries,
            typically receive no rating on an issue-by-issue basis, because
            investors and the rating agencies view the implied government
            backing of Fannie Mae as a sufficient indication of the
            investment quality of Fannie Mae obligations. . . .\12\
    ---------------------------------------------------------------------------
        \12\ Letter from Anthony F. Marra to OCC, Feb. 3, 1998 (emphasis
    added).

        Thus Fannie contended that in assessing credit quality, investors
    and rating agencies do not (and presumably need not) look beyond ``the
    implied Government backing of Fannie Mae,'' which in Fannie's view
    renders Fannie's securities ``near proxies for Treasuries.'' These
    assertions are all the more remarkable in that Fannie made them in a
    formal comment letter to a bureau of the Treasury. We may reasonably
    infer that when Fannie meets with rating agencies and securities
    analysts--out of earshot of Government officials--it makes arguments at
    least as strong as those quoted above.
        This double game lets the GSE's have it both ways. In effect, the
    GSE's tell Congress and the news media, ``Don't worry, the Government
    is not on the hook''--and then turn around and tell Wall Street,
    ``Don't worry, the Government really is on the hook.'' The GSE's play
    this game unchallenged, year after year.
        Fannie's CEO, Franklin D. Raines, recently seemed to question the
    ``theory . . . that there is an `implied guarantee' that the Government
    would repay our creditors if we failed.'' In a February 6 speech at the
    American Enterprise Institute, Mr. Raines declared:

            [S]ome assert that we have an ``implied guarantee'' that the
            market relies on. Yet it is not clear what an implied guarantee
            means. We do not know who is making the implication or exactly
            what is being guaranteed. Indeed, Treasury Secretary Snow has
            testified that there is no implied guarantee.

            I believe that the true value of our charter does not rest on a
            Government guarantee of our obligations--implied or otherwise.

            Instead, our charter signifies that the Government places such
            a high value on our mission of expanding homeownership and
            affordable housing, that it goes to extraordinary lengths to
            ensure that the private management of our operations is closely
            supervised, and that our private capital is matched to our
            risks, even under extraordinary circumstances--all to ensure
            our continued success.

            This is the pact that the Federal Government has with
            investors. It does not cost taxpayers anything. And so far, it
            has worked very well. This pact ensures that it is private
            capital that is at risk, not the taxpayer. [Emphasis added.]

        I urge the Committee to follow up on this statement by having
    Fannie and Freddie answer three simple questions:

     Do capital market participants err in perceiving the Federal
        Government as implicitly backing Fannie and Freddie?
     Do you believe that the Government in any way implicitly backs
        Fannie and Freddie?
     If Fannie and Freddie were to default on their obligations,
        would the Government have any moral obligation to assure that
        Fannie and Freddie's creditors got paid?

    Ineffective Statutory Disclaimers
        In seeking to limit the taxpayers' exposure to the GSE's, Congress
    has enacted three disclaimers of liability. But the phrasing of these
    disclaimers, far from hindering the GSEs' double game, fits it neatly.
        First, the Federal Housing Enterprises Financial Safety and
    Soundness Act of 1992 declares ``neither the Enterprises [that is,
    Fannie and Freddie] . . . nor any securities or obligations issued by
    the Enterprises . . . are backed by the full faith and credit of the
    United States.'' 12 U.S.C. Sec. 4501(4). But this disclaimer merely
    restates the obvious: That the Government has no formal, legally
    enforceable liability for the GSEs' securities. It does not disclaim
    implicit backing, nor does it signal that market participants err in
    perceiving such backing. It thus avoids the real issue.
        Second, a statutory section entitled ``Protection of taxpayers
    against liability'' declares that the 1992 Act ``may not be construed
    as obligating the Federal Government, either directly or indirectly, to
    provide any funds'' to Fannie or Freddie ``or to honor, reimburse, or
    otherwise guarantee any obligation or liability'' of Fannie or Freddie.
    Sec. 4503. This disclaimer also avoids the real issue. No one argues
    that the 1992 Act created implicit backing where it did not already
    exist. Market participants had long believed such backing to exist
    under the GSEs' charters. Congress did not act to correct that
    perception.\13\
    ---------------------------------------------------------------------------
        \13\ The second disclaimer also replicates the weakness of the
    first disclaimer in declaring that the 1992 Act ``may not be construed
    as implying that any such enterprise . . ., or any obligations or
    securities of such an enterprise . . . are backed by the full faith and
    credit of the United States.'' Sec. 4503.
    ---------------------------------------------------------------------------
        Third, each firm's securities must include ``appropriate language .
    . . clearly indicating'' that the securities ``are not guaranteed by
    the United States and do not constitute a debt or obligation of the
    United States or of any agency or instrumentality thereof'' other than
    the GSE in question. Sec. Sec. 1455(h)(1), 1719(b), (d)-(e). This
    requirement repeats the fundamental weakness of the first disclaimer:
    It disclaims formal, legally enforceable liability, even as it fails to
    disclaim implicit backing. ``Indeed, the disclaimer itself hints at a
    special Federal relationship; completely private firms do not need to
    disclaim Federal backing because no one believes such backing exists.''
    \14\
    ---------------------------------------------------------------------------
        \14\ Ronald C. Moe and Thomas H. Stanton, Government Sponsored
    Enterprises as Federal Instrumentalities: Reconciling Private
    Management with Public Accountability, 49 Pub. Admin. Rev. 321, 323
    (1989).
    ---------------------------------------------------------------------------
        No one argues that the Government has any formal, legally
    enforceable liability for the GSEs' securities. Thus the disclaimers
    ignore the real issue: Whether the Government, although not legally
    bound to rescue the GSE's, would nonetheless do so (for example,
    because it felt a moral obligation for their debts or feared that a GSE
    default might damage the Nation's financial system).
    Subsidy Denial
        The GSEs' double game helps the GSE's argue that they get little or
    no Government subsidy. Yet no one can honestly dispute that Fannie and
    Freddie receive
    valuable benefits not available to businesses generally. These benefits
    include exemption from most State and local taxes and exemption from
    the registration and reporting requirements of the securities laws. The
    benefits also include a conditional line of credit at the U.S. Treasury
    and special rules relating to the GSEs' securities--for example, rules
    that: Equate those securities with U.S. Treasury securities for some
    purposes; permit issuance and transfer of those securities over the
    system used for issuing and transferring U.S. Treasury securities; and
    fail to limit FDIC-insured banks' investments in those securities. This
    special treatment strongly abets the market perception of implicit
    Federal backing. The Congressional Budget Office's reports and
    testimony demonstrate the great value of these special benefits.
        Yet Fannie, in particular, insists that it receives no subsidy.
    Relying on a narrow dictionary definition to the effect that a
    ``subsidy'' is ``monetary assistance granted by a Government to a
    person or private commercial enterprise,'' Fannie asserts: ``Fannie Mae
    does not receive a penny of public funds. To the contrary, last year
    our Federal tax liability was $1.6 billion. True subsidies also are
    tangible. Fannie Mae's Government benefits are not.'' \15\ Fannie's
    reasoning--that a subsidy involves only a tangible payment of money by
    the Government--produces absurd results. If Congress were to exempt
    Fannie from ever again having to pay any corporate income tax, that
    would supposedly not be a subsidy because it involves no cash
    payment to Fannie. Similarly, if a foreign government gave an energy-
    intensive, capital-intensive export industry unlimited access to free
    electricity and no-interest loans, that would supposedly not be a
    subsidy, either. These examples highlight the unreality of Fannie's
    arguments.
    ---------------------------------------------------------------------------
        \15\ Timothy Howard, Fannie Mae's Benefits to Home Buyers: The
    Business Perspective, 37 Fed. Reserve Bank Chi. Ann. Conf. Bank
    Structure & Competition 68, 69 (2001).
    ---------------------------------------------------------------------------
    Curbing the Double Game
        I suggest that any GSE legislation:

        (1) correct the faulty statutory disclaimers of Federal liability
    for Fannie and Freddie (discussed above);
        (2) correct sloppy language in the Secondary Mortgage Market
    Enhancement Act of 1984 stating that for some purposes Fannie and
    Freddie securities ``shall be considered to be obligations issued by
    the United States,'' 15 U.S.C. Sec. 77r-1(a)(1)-(2);
        (3) prohibit any GSE from representing that the U.S. Government
    directly or indirectly backs the GSE (except in discussing formal,
    legally enforceable obligations of the Government) with the intent to
    induce anyone to rely on that representation in connection with the
    purchase or sale of any security; and
        (4) prohibit any Government agency or official from characterizing
    GSE securities as Government securities.
    Properly Comparing Banks and GSE's
        Fannie and Freddie often argue that the Federal Government gives
    FDIC-insured banks \16\ benefits comparable to, or even greater than,
    those it gives Fannie and Freddie; that concern about subsidies to
    Fannie and Freddie is accordingly unwarranted and even hypocritical;
    and that any greater financial success shown by Fannie and Freddie
    simply reflects their greater efficiency.
    ---------------------------------------------------------------------------
        \16\ For simplicity I use ``banks'' to refer to all FDIC-insured
    depository institutions, including thrift institutions.
    ---------------------------------------------------------------------------
        Let us start with the issue of efficiency. Fannie and Freddie have
    lower overhead than banks because they do a different business than
    banks. Most banks do a predominantly retail business. To deal directly
    with large numbers of small customers, they have more offices and
    larger staffs than they otherwise would. By contrast, Fannie and
    Freddie do a wholesale business, which enables them to have lower
    overhead.
        Now let us turn to the issue of relative subsidy. FDIC insurance
    has a different set of costs and benefits than the Government's
    sponsorship of Fannie and Freddie. You might expect FDIC insurance to
    provide a greater net subsidy.\17\ After all, FDIC insurance is
    established by law and carries the Government's full faith and credit.
    Yet the Government's perceived implicit backing of Fannie and Freddie
    actually tends to provide a greater net subsidy than FDIC insurance,
    for six structural reasons.\18\
    ---------------------------------------------------------------------------
        \17\ The gross subsidy represents the total value of the special
    benefits provided by the Federal Government--benefits not available to
    businesses generally or even financial institutions generally. The net
    subsidy represents the difference between the gross subsidy and the
    offsetting costs that the entity must incur as a bank or GSE--costs not
    imposed on financial institutions generally.
        \18\ I have set forth these arguments more fully in The Structure
    of Subsidy: Federal Deposit Insurance Versus Federal Sponsorship of
    Fannie Mae and Freddie Mac, in Serving Two Masters, Yet Out of Control:
    Fannie Mae and Freddie Mac 56-83 (2001).
        Most of these structural reasons hold true for the Federal Home
    Loan Banks, which also enjoy exemption from the Federal income tax. But
    the Federal Home Loan Banks do face the possibility of receivership,
    and must pay 10 percent of their net income to an affordable housing
    program and another 20 percent toward interest payments on debt
    securities issued to help finance the thrift clean-up. 12 U.S.C.
    Sec. Sec. 1430(j), 1433, 1441b(f)(2)(C), 1446.
    ---------------------------------------------------------------------------
        1. Unlimited Coverage. Federal deposit insurance applies only to
    deposits and then only up to a $100,000 limit. The FDIC can protect a
    failed bank's uninsured deposits and nondeposit creditors (such as
    bondholders) only under very narrow circumstances. By contrast, the
    Government's perceived implicit backing of GSE's has no limits: It
    applies to all of a GSE's obligations, with no dollar ceiling.
        2. No Receivership Mechanism. When an FDIC-insured bank fails, the
    FDIC becomes receiver for the bank: It takes control of the bank,
    gathers the bank's assets, and pays the bank's creditors in a specified
    order of priority. The bank's depositors must get paid in full before
    the bank's other creditors can get paid at all. If the bank's
    liabilities exceed its assets, its shareholders lose their ownership
    interest, its nondeposit creditors normally incur a partial or total
    loss, and its uninsured depositors often incur some loss. Similarly,
    when an ordinary nonfinancial company fails, it is liquidated under
    Chapter 7 of the Bankruptcy Code. The bankruptcy court appoints a
    trustee, who takes control of the company, gathers its assets, and pays
    creditors in a specified order of priority. The lack of any
    receivership mechanism for Fannie and Freddie reinforces the market
    perception that the Government would assure full payment of each firm's
    creditors.
        3. No Cross-Guarantees to Protect Taxpayers. Federal deposit
    insurance involves strong safeguards designed to ensure that banks--
    rather than the taxpayers--bear any losses incurred in protecting
    insured depositors. Banks must normally pay premiums large enough to
    ensure that the FDIC's insurance funds have at least $1.25 in reserves
    for each $100 of insured deposits. This obligation to pay premiums
    gives each insurance fund a claim on the capital and earnings of all
    banks insured by that fund--and in effect creates a network of indirect
    cross-guarantees among FDIC-insured banks. Thus each member of the Bank
    Insurance Fund is liable for ensuring that the FDIC can protect insured
    depositors at every other BIF member bank. As long as the fund can
    replenish its reserves, its existence precludes any loss to the
    taxpayers.
        No similar cross-guarantees reduce the Government's risk-exposure
    to Fannie and Freddie. The two GSE's pay no insurance premiums and have
    no insurance fund. The two GSE's do not even cross-guarantee each
    other. If one GSE failed, the survivor would have no responsibility to
    pay the failed GSE's creditors.
        4. Special Deals Instead of General Rules. To a much larger degree
    than banks, Fannie and Freddie reap the benefits of special, company-
    specific laws and avoid the discipline of generic law. Instead of
    operating under laws applicable to thousands of businesses, the two
    GSE's often get to operate under statutes designed for them alone.
        5. Protection from Effective Competition Subsidizes GSE
    Shareholders. Federal and State regulators routinely issue bank
    charters to qualified applicants. Once chartered, a bank can typically
    engage in a wide range of activities statewide and even nationwide. No
    longer does each bank charter require special legislation. No longer do
    regulators grant charters sparingly so as to limit competition with
    existing banks. Entry into banking is relatively easy, and banking law
    affords banks little protection against competition. Thus, if banks
    receive a net Federal subsidy, they should generally face enough
    competition to force them to pass the subsidy through to their
    customers.
        Fannie and Freddie, by contrast, enjoy significant protection
    against competition. Their Government sponsorship reduces their
    borrowing costs and increases the value of their guarantees to such an
    extent that no fully private firm can compete against them effectively.
    And only Congress can charter a competing GSE. By impeding competition
    with Fannie and Freddie, these constraints on entry increase the
    potential for the two GSEs' Government benefits to end up in the hands
    of their shareholders rather than their customers.
        6. Free Ride. Banks must normally pay for deposit insurance. They
    must also comply with an array of restrictions and requirements not
    applicable to businesses generally. But Fannie and Freddie pay no fee
    for their Government sponsorship. They make no payments to an insurance
    fund or affordable housing fund. They need not provide public benefits
    that impose significant costs on their shareholders. HUD's affordable
    housing goals are so weak that Fannie and Freddie can meet them without
    doing more for affordable housing than banks do. I believe that the two
    GSE's would have a profit motive to do their affordable housing
    business in any event, even without a Government subsidy.
        Considering the great value of the benefits Fannie and Freddie
    receive from the Government, they should be doing far more to increase
    homeownership at the margin (for example, by the lower-middle class,
    the working poor, and members of certain historically disadvantaged
    minority groups).
    Systemic Risk
        GSE's are often characterized as ``too big to fail''--meaning that
    if they neared default on their debts, the Government would have to
    rescue them lest their failure unleash ``systemic risk'' that would
    gravely damage the Nation's financial system and economy.
        Discussions of systemic risk (whether in the GSE or the bank
    context) often have a tone of inevitability. But systemic risk is not a
    force of nature like earthquakes, hurricanes, and tornados. It results
    from human decisions: For example, decisions by market participants and
    Government officials about how to structure the financial system, what
    risks to take, and how to respond to problems. If investors expect the
    Government to protect them from the full pain of downside scenarios,
    they will tend to take greater risks than they otherwise would have
    taken. Thus ``too big to fail'' and ``systemic risk'' are to a large
    extent circular: They have their roots in prevailing expectations, and
    they easily become self-fulfilling prophecies. Insofar as investors
    expect the Government to rescue troubled GSE's, market discipline on
    GSE's will weaken, which will tend to increase the risk that the GSE's
    ultimately will get into financial trouble.
        If a GSE's troubles coincide with a broader financial crisis,
    Government officials will face additional pressures to rescue the GSE.
    For if during the crisis those officials seriously upset established
    expectations, they may create contagious uncertainty about the
    Government's willingness to meet other expectations. A crisis is thus a
    particularly inopportune time for attempting to reeducate market
    participants about the scope of the Government's undertakings. So if
    the Government
    tacitly accepts ``too big to fail'' expectations during good times, it
    may find itself constrained during a crisis to rescue a GSE against its
    better judgment.
        But the circularity of systemic risk also has a positive side: If
    the Government acts in a timely way, it can correct ``too big to fail''
    expectations. Congress did just that in the FDIC Improvement Act of
    1991 (FDICIA) by curtailing the practice of treating FDIC-insured banks
    as ``too big to fail.'' \19\ FDICIA's ``least-cost resolution'' rule
    allows the FDIC to protect a failed bank's uninsured depositors and
    nondeposit creditors only if doing so is the ``least costly to the
    deposit insurance fund of all possible methods'' for meeting the FDIC's
    obligation to insured depositors. 12 U.S.C. Sec. 1823(c)(4). The rule
    has a narrow systemic-risk exception, which has never been used.\20\
    Before FDICIA, the FDIC was spending extra money from the deposit
    insurance fund to protect uninsured depositors at banks as small as
    $500 million in total assets. But less than 1 year later, when an $8.8
    billion bank group in a swing State failed just a few days before the
    1992 Presidential election, the FDIC did not protect uninsured
    depositors and financial markets took that action in stride. By giving
    clear and timely notice of the new policy, Congress had succeeded in
    changing market participants' expectations. Proper and timely
    Government action can thus reduce the potential for systemic risk.\21\
    ---------------------------------------------------------------------------
        \19\ In context of a failed FDIC-insured bank, ``too big to fail''
    treatment involves spending extra money from the deposit insurance fund
    to protect deposits above the $100,000 limit on deposit insurance
    coverage. It may also involve extra spending to protect nondeposit
    creditors.
        \20\ The systemic-risk exception becomes an option only if
    recommended to the Secretary of the Treasury by two-thirds majorities
    of both the Federal Reserve Board and the FDIC's Board of Directors.
    The Secretary can make the exception only if the Secretary determines,
    ``in consultation with the President,'' that least-cost resolution of a
    given institution ``would have serious
    adverse effects on economic conditions or financial stability.'' The
    Secretary must document the determination. The General Accounting
    Office must review and report on the exception, including the potential
    for it to diminish market discipline and encourage unsound risk-taking.
    To recoup the additional cost of deviating from least-cost resolution,
    the FDIC must levy a special assessment on insured depository
    institutions. Sec. 1823(c)(4)(G). Congress designed these rules to
    promote accountability and make the process sufficiently unpleasant
    that systemic-risk exceptions would be made rarely (if at all) and
    never lightly.
        \21\ By engineering a bailout of Long Term Capital Management in
    1998, the Federal Reserve Bank of New York squandered some of FDICIA's
    hard-won gains. Yet the dramatic change in how the FDIC dealt with
    failed banks during the early 1990's shows that progress can be made in
    curtailing too big to fail treatment.
    ---------------------------------------------------------------------------
        Effective safety and soundness regulation of the GSE's can further
    reduce that risk. Yet we should beware of relying excessively on
    regulation. Regulation did not prevent the U.S. banking system from
    collapsing in 1933. Regulation did not prevent the 1980's thrift
    debacle, with its $125 billion cost to the taxpayers. Regulation did
    not prevent the bank failures of the 1980's and early 1990's, which
    depleted the FDIC's Bank Insurance Fund. Nor, more recently, did OFHEO
    detect Fannie and Freddie's accounting problems, even though it had
    examiners scrutinizing each GSE year-round. The failings of regulation
    underscore the need to maintain market discipline on the GSE's and
    other large financial institutions.
    Miscellaneous
    Ending the Government's Role in Appointing GSE Directors
        Under current law, Federal officials appoint some members of each
    housing GSE's board of directors. For both Fannie and Freddie, the
    President appoints 5 of each GSE's 18 directors. 12 U.S.C.
    Sec. Sec. 1452(a)(2)(A), 1723(b). The Federal Housing Finance Board
    appoints 6 of each Federal Home Loan Bank's 14 directors. Sec. 1427(a).
        The Administration rightly proposes to end governmental appointment
    of GSE directors (and, as an initial step in that direction, has
    indicated that it will no longer appoint directors of Freddie).
    Government-appointed directors face a conflict of interest. They
    presumably have some duty to serve the public. Yet under corporate law
    they presumably also have fiduciary duties to their corporation's
    shareholders. These duties conflict whenever the shareholders'
    interests run counter to some broader public interest: For example,
    when the shareholders' interest in maximizing profits conflicts with
    the public interest in protecting the taxpayers or promoting affordable
    housing. In 1988, Freddie's directors concluded that their fiduciary
    duties compelled them to side with the shareholders against the
    taxpayers.\22\ In any event, government appointments to GSEs' boards of
    directors have served more as political plums than as vehicles for
    upholding the public interest.
    ---------------------------------------------------------------------------
        \22\ The three members of the old Federal Home Loan Bank Board--
    appointed by the President and confirmed by the Senate--served ex
    officio as Freddie's board of directors. Freddie's preferred share
    price had more than doubled in response to a proposal to allow anyone
    to own Freddie shares. (By severing Freddie's historic link to the
    thrift industry, the proposal would free Freddie to increase its
    profits by amassing a large portfolio of mortgage-backed securities.)
    Senate Banking Committee Chairman William Proxmire developed a plan to
    grant the relief desired upon payment of a fee to reduce the taxpayers'
    bill for the thrift clean-up. But Freddie's management convinced
    Freddie's directors that their fiduciary duties compelled them to
    oppose the Proxmire plan.
    ---------------------------------------------------------------------------
        Ending such appointments--so that GSE shareholders would elect all
    GSE directors--would remove the conflict of interest. By strengthening
    shareholders' control over each GSE, ending such appointments could
    also help shareholders hold management more accountable and thus
    promote better corporate governance.
    Complying with Securities Laws
        The GSEs' statutory exemption from the registration and reporting
    requirements of the Federal securities laws is an anachronism and
    deserves to be repealed. The exemption sends the wrong signal: That
    GSE's are so ``special,'' so close to the Government, that investors in
    their securities have no need for the protections afforded by those
    requirements.
    Opportunities for Immediate Administrative Action
        Regulators can and should act now to improve the regulation of
    Fannie and Freddie.
        First, to help avoid unhealthy concentrations of credit risk among
    FDIC-insured banks, the Federal banking agencies should prescribe
    guidelines for banks' credit exposure to individual GSE's and to GSE's
    generally.\23\
    ---------------------------------------------------------------------------
        \23\ Regulators could, for example, prescribe rules or guidelines
    under Section 305(b)(1)(A)(ii) of FDICIA, which requires risk-based
    capital standards to ``take adequate account of . . . concentration of
    credit risk.'' Regulators could also issue more specific examination
    standards.
    ---------------------------------------------------------------------------
        Second, the Securities and Exchange Commission should prohibit
    mutual funds whose portfolios consist largely of GSE securities from
    mislabeling themselves as ``Government'' or ``U.S. Government''
    funds.\24\
    ---------------------------------------------------------------------------
        \24\ The SEC prohibits a mutual fund from having ``name suggesting
    that the Fund . . . [is] guaranteed . . . by the United States
    Government.'' 17 CFR Sec. 270.35d-1. But many mutual funds that invest
    predominantly in GSE securities nonetheless call themselves ``U.S.
    Government Securities Funds.'' To take what is probably an extreme
    example, the Pacific Capital U.S. Government Securities Cash Assets
    Trust had 98.8 percent of its assets in GSE securities as of September
    30, 2003; it evidently held no U.S. Government securities at all. See
    http://www.aquilafunds.com/ourcompany/moneyfunds.htm (semi-annual
    report), at 9.
    ---------------------------------------------------------------------------
        Third, the Federal Reserve Board should proceed with its proposal
    to curtail so-called ``daylight overdrafts'' by GSE's.
        Fourth, HUD should tighten its scrutiny of the GSEs' mission, using
    its authority to review activity-expansion, prescribe affordable-
    housing goals, and interpret relevant statutes.
    Conclusion
        The GSE's argue as though the present is always the wrong time to
    enact any reform that they do not want, such as reform that benefits
    taxpayers or homebuyers rather than the GSEs' managers and
    shareholders. In the GSEs' view, either (1) there is no acute problem
    warranting reform, or (2) reform now would crimp housing markets and
    risk destabilizing the financial system. But now is the right time to
    act--to correct the deficiencies in GSE regulation before a crisis hits
    or another scandal breaks.
                                   ----------
                     PREPARED STATEMENT OF JAMES R. RAYBURN
                President, National Association of Home Builders
                               February 10, 2004
    Introduction
        The 215,000 members of the National Association of Home Builders
    (NAHB) appreciate the opportunity to present their views to the Senate
    Committee on Banking, Housing, and Urban Affairs on the regulatory
    framework for Fannie Mae, Freddie Mac, and the Federal Home Loan Bank
    (FHLBank) System, including safety and soundness oversight, new program
    approval, and the establishment and enforcement of affordable housing
    goals. These housing-related Government sponsored Enterprises (GSE's)
    are critical components of the Nation's housing finance system and are
    largely responsible for the efficiency and resiliency of that system,
    as reflected in the tremendous advances recorded in the availability
    and affordability of mortgage products for homebuyers and providers of
    rental housing. The success and value of our housing finance system has
    been clearly evident in recent years, as the housing sector sustained
    economic performance while other areas of the economy faltered.
        Considering the complexity of the housing finance marketplace and
    the risks at stake, the task of restructuring the regulatory framework
    of the housing-related GSE's is a daunting one. However, NAHB believes
    that two governing principles should guide the debate. First, the
    regulatory framework for the GSE's must be credible and effective to
    ensure these organizations fulfill their mission in a safe and sound
    manner. Second, the public/private partnership of the housing finance
    system is sacrosanct; any other changes to the current system should
    not disrupt the efficient operation of the mortgage markets and the
    impediments to the development of effective programs to address the
    Nation's housing needs. With these concepts as a foundation, NAHB
    offers the following recommendations.
        NAHB maintains its previously asserted position that the Department
    of Housing and Urban Development (HUD) is the appropriate agency to
    regulate the mission of Fannie Mae and Freddie Mac, including approving
    new programs and establishing and enforcing affordable housing goals.
    However, if Congress chooses to
    explore the option of creating an independent regulator with oversight
    for all the housing-related GSE's, we implore Congress to ensure that
    the regulator has a thorough understanding of and extensive involvement
    in housing-related issues. We do not believe that the Department of the
    Treasury, which is well-suited as a safety and soundness regulator, has
    sufficient expertise and involvement in housing issues to serve as a
    housing-related GSE program regulator.
    Background
    Housing and the Economy
        The housing market has been an engine of growth in recent years,
    sustaining the economy during a difficult stretch. That performance
    continued in 2003, with new home sales reaching a record performance of
    more than a million closings. Single-family home construction has been
    robust and totaled 1.5 million units in 2003. Multifamily activity has
    been more subdued, but still posted a respectable showing, pushing
    total housing starts above the lofty 1.8 million units threshold.
        While low interest rates and favorable demographics have spurred
    demand, these results would not have been possible without the support
    of the finance system for housing. The bedrock of that system is a
    liquid and vibrant secondary market that is the product of the
    activities of Fannie Mae, Freddie Mac, and the FHLBank System. These
    enterprises have not only contributed to the affordability of housing
    credit, but also have taken the lead in expanding the menu of
    affordable housing programs and products.
    GSE's and Housing Finance
        The housing-related GSE's are American success stories. As
    mentioned above, they have brought enormous benefits to homebuyers,
    renters, and the housing finance system. These include:

            Reduction of mortgage interest rates--The impact of the
            housing-related GSE's on mortgage borrowing costs is well
            documented. Homebuyers with conforming loans--mortgages
            eligible for purchase by Fannie Mae and Freddie Mac, those up
            to $333,700 for one-unit properties--pay mortgage rates that
            are approximately 25 to 50 basis points lower than rates paid
            by other conventional mortgage borrowers. The FHLBanks have
            done their share by passing through their advantageous
            borrowing rates for use in member loan programs. Further rate
            reductions are provided through the subsidies of the FHLBank
            System's Affordable Housing Program (AHP) and the Community
            Investment Program (CIP).
            Reliable and stable flow of mortgage credit--The linkage that
            the GSE's provide to the national and international capital
            markets sustains the flow of capital to housing, even under
            changing economic conditions. While the economy has undergone
            major shocks over the past decade, homebuyers have experienced
            no interruption in the availability of mortgage credit.
            Elimination of regional disparities in interest rates--The
            GSE's provide a nationwide market for mortgage funds, a key
            factor in the elimination of regional disparities in the
            availability and cost of mortgage credit, which occurred
            regularly before the housing-related GSE's came on the scene.
            Today, interest rates in mortgage markets around the country
            vary by no more than 10 basis points.
            Cushion against local economic downturns--When regional
            economies begin to slow, some participants in the mortgage
            industry have restricted credit or abandoned markets in search
            of opportunities elsewhere. This is not the practice of the
            GSE's. They maintain a presence in all markets under all
            economic conditions, cushioning the impact of local or regional
            declines in economic activity.
            Market standardization and innovation--The GSE's have brought
            innovation to the mortgage markets to address a broad range of
            borrower and
            investor preferences. For example, Fannie Mae and Freddie Mac
            have established reduced downpayment programs to help cash-
            strapped first-time homebuyers. Recently developed mortgage
            products to assist borrowers with tarnished credit histories
            further exemplify the extent to which Fannie Mae and Freddie
            Mac employ novel approaches to respond to consumer credit
            needs. The FHLBanks also stand out in this area by virtue of
            the programs that are stimulated and supported by the AHP and
            the CIP.
            Expansion of homeownership and rental housing opportunities--
            The housing GSE's have made very significant strides in
            expanding homeownership opportunities and increasing the supply
            of affordable rental housing in underserved areas. The housing
            goals enacted by the 1992 GSE Act have successfully encouraged
            both Fannie Mae and Freddie Mac to significantly
            increase their service to the market sectors targeted by the
            housing goals. The supply of affordable housing is further
            augmented by the 12 FHLBanks; each contributes at least 10
            percent of its annual net earnings to its statutorily
            prescribed Affordable Housing Program to subsidize the cost of
            housing for very low-income and low- or moderate-income
            households.
    Context for GSE Oversight Evaluation
        NAHB believes that debate and discussion on the future of GSE
    regulation should begin by reflecting on how and why these entities
    came to exist. The genesis of all three housing-related GSE's can be
    traced to Congress' recognition of the strong public policy benefits of
    housing and homeownership opportunities. Fannie Mae, Freddie Mac, and
    the FHLBank System were chartered to provide liquidity and stability
    for the Nation's housing finance system. The decision by Congress to
    confer the sponsorship of the U.S. Government on these entities was not
    a superficial one. Undoubtedly, Congress realized that no private
    corporation would assume the risks or expend the resources to undertake
    an objective of this magnitude. Moreover, it would be unlikely that any
    particular entity would have the credibility to attract the appropriate
    blend of borrowers and investors. Rather, Congress was keenly aware
    that in order for an enterprise to overcome such obstacles it would
    need the imprimatur of the U.S. Government. It is this well-forged
    public/private alliance that makes this Nation's housing finance system
    the model, if not the envy, of the world.
        As mentioned above, housing is a significant financial element in
    today's economy, not just in a macroeconomic sense, but also in terms
    of every homeowner's portfolio. The remarkable growth of Fannie Mae,
    Freddie Mac, and the FHLBank System has been raised by others as a
    point of discussion and concern. NAHB suggests that the performance of
    these entities should be evaluated within the context of the growth of
    the housing finance sector and its impact on consumers, investors, and
    the economy at large. From this perspective their growth can be viewed
    in a positive light.
        NAHB believes it would be a tremendous mistake to turn discussion
    on GSE regulation into a referendum of our highly successful housing
    finance system. Attempts to alter the Government's sponsorship of
    Fannie Mae, Freddie Mac, or the FHLBanks arguably contradicts Congress'
    intent, and most definitely would destroy the foundation upon which the
    system rests.
        The key to the GSEs' success is their steadfast focus on their
    mission. They are in one business, housing finance--a relatively low-
    risk endeavor. This narrow focus should be recognized in the discussion
    of any future regulatory framework. The GSE's are not banks operating
    in far-flung and highly risky product lines and markets and should not
    be regulated as such.
        Even the staunchest advocates of GSE regulatory reform would agree
    that there is no imminent crisis in the GSE system. Therefore, NAHB
    urges a careful and thoughtful approach on GSE regulation. NAHB is
    certain that such a course will produce tremendous rewards to those
    with most at stake in the process--America's homeowners and renters.
    Guiding Principles for GSE Oversight
        Since the GSE regulatory reform debate began in earnest last year,
    there has been no shortage of recommendations on a wide range of
    elements that many policymakers believe would enhance the stature of
    the regulatory system for Fannie Mae, Freddie Mac, and the FHLBank
    System. NAHB notes that most of the recommendations focus primarily on
    enhancing the power of the regulator to impose restrictions on the
    GSE's. Such proposals often make no reference to the responsibility of
    the regulator to ensure that the GSE's fulfill their Congressionally
    mandated purpose. Furthermore, others have recommended simply
    transferring the oversight from one agency to another without
    establishing a logical nexus between the expertise of the regulator and
    the mission of the entities to be regulated. NAHB urges this Committee
    to take a more rational approach by first establishing a foundation of
    core principles on which to build a solid regulatory framework. As
    direct participants in the production of housing and related
    activities, NAHB offers the committee the following set of core
    principles:

            1. The GSE status of these institutions must be maintained.
            Efforts to privatize, withdraw any of the Federal privileges
            and legal exemptions, or otherwise diminish the ability of the
            GSE's to provide housing financing at the lowest possible cost
            should be opposed.
            2. The GSE's should fulfill their public mission by conducting
            activities authorized by their charters in a safe and sound
            manner and by promoting access to mortgage credit to address
            the needs of affordable housing throughout the Nation.
            3. The regulatory framework of the GSE's should be strong and
            credible, possess adequate authority and resources and reflect
            the differences inherent in the charters and operating
            structures of the GSE's. Further, the regulatory framework
            should foster competition among the GSE's to develop and
            implement innovative, low-cost funding and other programs to
            meet the nation's housing credit needs.
            4. The mission oversight of Fannie Mae and Freddie Mac
            (including approval of new programs and enforcement of
            affordable housing goals) should be conducted by the Department
            of Housing and Urban Development or another entity with a
            thorough understanding of and extensive involvement in housing-
            related issues.
            5. The safety and soundness oversight of Fannie Mae and Freddie
            Mac should be conducted by an independent regulatory agency
            through rigorous examinations, enforcement of regulations
            (including capital standards) and transparency, without
            unnecessarily impairing the ability of these GSE's to
            accomplish their mission.
            6. The recently implemented risk-based capital standards for
            Fannie Mae and Freddie Mac should be allowed to remain in place
            for a period of time sufficient to evaluate the effectiveness
            of the new standards.
            7. The regulation of the mission and safety and soundness of
            the Federal Home Loan Bank System should reflect the uniqueness
            of the System's mission, cooperative operating structure,
            charter type, and other characteristics. This is best
            accomplished by having a regulator dedicated solely to FHLBank
            System oversight or by having a separate FHLBank System
            oversight division if a single agency regulates all of the
            housing GSE's.
    Current GSE Regulatory Framework
    Fannie Mae and Freddie Mac
        The 1992 GSE Act established a dual regulatory oversight structure
    for Fannie Mae and Freddie Mac. HUD is the programmatic (or mission)
    regulator and the Office of Federal Housing Enterprise Oversight
    (OFHEO) is the safety and soundness regulator.
        The 1992 GSE Act requires Fannie Mae and Freddie Mac to obtain
    prior approval by HUD of any new mortgage programs. The Act defines new
    programs as any programs that are significantly different from programs
    previously approved or engaged in prior to 1992. HUD is required to
    review new programs to ensure that they are consistent with the GSEs'
    charters and are in the public interest. In addition, Fannie Mae and
    Freddie Mac are required by law to meet annual housing goals
    established by HUD.
        Finally, the 1992 GSE Act established OFHEO as an independent
    office within HUD to oversee the safety and soundness of Fannie Mae and
    Freddie Mac. OFHEO's primary responsibilities are to establish and
    enforce capital standards for Fannie Mae and Freddie Mac and to conduct
    annual on-site examinations of the firms to ensure that they are
    operating in a safe and sound manner. Fannie Mae and Freddie Mac are
    required to meet two capital standards, a minimum leverage ratio and a
    risk-based capital (RBC) standard.
    Federal Home Loan Bank System
        The FHLBank System was created by Congress in 1932 by the Federal
    Home Loan Bank Act. The Federal Housing Finance Board (Finance Board)
    is the FHLBank System's regulator. An independent agency, the Finance
    Board regulates both mission and financial safety and soundness. The
    FHLBanks are required to comply with both a leverage and a RBC capital
    requirement. The FHLBanks are also required by law to contribute a
    percentage of their net earnings each year to fund affordable housing
    programs.
    Administration's Proposal
        The Bush Administration proposes to create a new Federal agency
    within the Department of the Treasury (Treasury) to regulate and
    supervise the financial activities of Fannie Mae, Freddie Mac, and the
    FHLBank System. The new agency would have general regulatory,
    supervisory, and enforcement powers for GSE oversight, including the
    authority to establish, enforce, and revise capital standards.
    Oversight of Fannie Mae's and Freddie Mac's existing activities and
    approval of new activities would be shifted from HUD to the new
    Treasury agency. HUD would be left with minimal regulatory authority,
    limited to oversight of the annual affordable housing goals and a
    consultative role in program oversight. The Administration's proposal
    makes no specific recommendations for how the new regulatory agency
    would accommodate the inherent differences between Fannie Mae, Freddie
    Mac, and the FHLBank System. The Secretary of the Treasury would
    enforce policy accountability through review of the new agency's
    regulations, budget, and policy statements to the Congress.
    Importantly, the Administration does not recommend any changes in the
    GSEs' agency status.
    NAHB Position on Key Elements
        Several elements of the Administration's proposal are antithetical
    to the core principles of GSE oversight. At the very least, the
    Administration's proposal would raise the costs of housing and stifle
    innovation. At worst, the proposal has the potential to undermine the
    entire housing finance system.
        Much of the debate surrounding the GSE regulatory restructuring has
    focused on the treatment of Fannie Mae and Freddie Mac. Indeed, most of
    the key elements of the Administration's proposal relate exclusively to
    these two GSE's. Other reform proposals have proposed including the
    Federal Home Loan Banks under the new GSE regulatory framework, either
    within the Treasury safety and soundness regulator or through the
    establishment of an independent regulator for all the housing GSE's.
    NAHB's comments and recommendations on key elements of these various
    proposals are discussed below.
    Proposed Fannie Mae and Freddie Mac Regulatory Framework
    Location of Program Oversight
        Under the Administration's proposal, Treasury would assume not only
    safety and soundness duties but also most mission-related oversight
    duties. For example, HUD's current authority to approve new programs
    would be transferred to Treasury under the premise that new program
    approval is a safety and soundness issue rather than a mission-
    oversight issue. HUD would have a consulting role.
        NAHB maintains that the program approval activities that are
    currently conducted by HUD should not be transferred to the Treasury
    Department. HUD is the preeminent regulatory authority on housing-
    related issues. Treasury has virtually no experience or expertise in
    evaluating the effectiveness and appropriateness of housing policies,
    especially those pertaining to housing for working families. Treasury
    presently has oversight for two important housing tax programs, low-
    income housing tax credits and mortgage revenue bonds. Operation of
    these programs is left to the States and HUD to set program specifics.
    Outside of these tax programs, Treasury has little experience or
    expertise in evaluating the effectiveness and appropriateness of
    housing policies.
        The ability of Fannie Mae and Freddie Mac to spur innovative
    solutions and to develop new products that increase homeownership and
    rental housing opportunities will be jeopardized if the mission of
    these corporations is regulated by Treasury. This stifling of
    innovation would reduce the capacity of Fannie Mae and Freddie Mac to
    provide the liquidity and stability needed to keep mortgage credit
    available at the lowest possible cost to homeowners and rental housing
    providers.
        NAHB believes that Fannie Mae's and Freddie Mac's ability to spur
    innovative solutions and to develop new products that increase
    homeownership will continue only if the mission of these corporations
    is regulated by an agency which also has a housing mission, that would,
    as a consequence, contain a thorough understanding of and extensive
    involvement in housing-related issues. The only Federal agency in
    existence now with sufficient housing mission orientation, experience,
    knowledge and focus is the Department of Housing and Urban Development.
    For this reason, NAHB recommends that HUD should retain its current
    status as the mission regulator for Fannie Mae and Freddie Mac,
    including approving new programs and establishing annual affordable
    housing goals.
        The legislative history of program oversight provisions clearly
    indicates that the objective and focus of program oversight is not
    safety and soundness, it is mission compliance. The 1968 Fannie Mae
    Charter Act, which reconstituted Fannie Mae as a Government sponsored
    private corporation, granted HUD general regulatory power to ensure
    Fannie Mae's compliance with its housing mission as specified in the
    charter. In 1970, HUD was vested with prior approval of all new Fannie
    Mae programs through the Emergency Home Finance Act, which also created
    Freddie Mac. HUD was granted regulatory oversight of Freddie Mac in
    1989 through the Financial Institutions Reform, Recovery, and
    Enforcement Act (FIRREA), which transferred this authority to HUD from
    the Federal Home Loan Bank Board. Finally, the Federal Housing
    Enterprises Financial Safety and Soundness Act of 1992 (the GSE Act)
    reaffirmed HUD as the program regulator of Fannie Mae and Freddie Mac
    and gave HUD the authority to establish, monitor and enforce affordable
    housing goals.
        The legislative history reflects the recognition by Congress that
    program oversight is a function of mission regulation that must be
    conducted by an agency with a thorough understanding of and extensive
    involvement in housing-related issues. Indeed, during consideration of
    the 1992 GSE Act, Senate Banking Committee Chairman Riegle stated that
    ``in order to properly coordinate national housing policy . . .
    regulations relating to the housing missions of Fannie Mae and Freddie
    Mac should be issued only with the review of the HUD Secretary.''
        HUD has proven itself to possess the capacity to adequately
    evaluate the potential benefits to housing from the GSEs' innovation
    and advancement in products and to ensure that the GSE's do not stray
    from their statutory mission. However, NAHB believes that HUD's program
    oversight could be strengthened through the establishment of an
    independently funded office within HUD. Having an office within HUD
    dedicated to mission oversight of Fannie and Freddie would be
    preferable to the current situation where GSE oversight is conducted
    through the Office of Housing with few dedicated staff and staff from
    other HUD offices are detailed on an ad hoc basis for GSE oversight
    duties. NAHB would support assessing Fannie Mae and Freddie Mac to fund
    the new HUD office.
    Process of Program Approval
        Under current law, Fannie Mae and Freddie Mac must submit a new
    program approval request to HUD if the initiative is ``significantly
    different'' from a program previously approved; is an activity in which
    the GSE had not engaged prior to passage of the 1992 GSE Act; or,
    represents an expansion in terms of dollar volume, number of mortgages
    or securities involved above limits expressly contained in any prior
    program approval. Further, if HUD believes an activity should be
    subject to prior approval, HUD may also request additional information
    or require a GSE to submit a program request. (Prior to 1 year after
    the effective date of the risk-based capital regulations, the GSE's
    were required to simultaneously submit new program requests to the
    Director of OFHEO. With the implementation of the RBC rule in September
    2002, OFHEO now has a consulting role, at HUD's discretion, in the
    evaluation of new programs.) HUD is required to approve any new program
    request unless it is not authorized by the GSEs' Charter Acts or is not
    in the public interest.
        The Administration proposes to significantly expand what would have
    to be
    approved, to include any activity or product that differs significantly
    from current activities. Fannie Mae and Freddie Mac introduce a myriad
    of new activities and products each year. Submitting each of these to
    the approval process envisioned by the Administration would severely
    inhibit or delay the development and implementation of valuable new
    mortgage products and technological innovations. The housing-related
    GSE's require a program approval process that provides adequate
    flexibility to respond promptly to market needs, while empowering their
    regulator to ensure ongoing charter compliance and to assess safety and
    soundness.
        The existing program approval requirements and process have served
    the housing market well by ensuring effective regulatory oversight and
    encouraging product innovation to fulfill the GSEs' housing mission.
    This is particularly true in the affordable housing area where both
    GSE's have introduced products and services to
    expand homeownership opportunities for low- and moderate- (low/mod)
    income borrowers, renters and residents of areas underserved by the
    broader housing finance system. Technological innovations by the GSE's,
    such as their automated underwriting systems (AUS), also have
    contributed to their efforts to expand homeownership opportunities. In
    the affordable multifamily market, both GSE's have established forward
    commitment programs that support much-needed production of new units.
    Further, each has developed partnerships and alliances at the national
    and local levels to expand affordable housing opportunities.
        While NAHB strongly supports the current process, we believe that
    the process could be improved in three areas: (1) the scope of review;
    (2) safety and soundness considerations, and (3) the mechanics of the
    review process.
        Scope of review should facilitate innovation. A delicate balance is
    required between a careful examination of whether a new GSE program
    serves its important public mission and the need to not over-burden
    these organizations' innovative efforts to provide new lending
    opportunities in the most difficult to serve communities. There may be
    a need to improve the current approval process, NAHB urges Congress to
    proceed cautiously, and resist efforts to over-encumber this process.
        The current process rightfully limits prior approval to new
    programs, which are defined as very broad undertakings unlike what is
    currently being done. The Administration proposes to significantly
    broaden what would have to be approved to include any new business
    activities. Submitting each new activity to the approval process
    envisioned by the Administration would result in such micromanagement
    of the GSEs' innovations that they would be unable to respond to
    changing market conditions in a timely fashion. The result would be to
    stifle or severely inhibit development and implementation of valuable
    new mortgage products and technological innovations that have helped to
    dramatically expand homeownership in the country.
        The Administration asserts that their proposed new activity review
    would be the same model under which banks operate. A review of activity
    approval for banks and their financial subsidiaries indicates that this
    is not the case. Banks are not subject to an activity by activity
    review as envisioned by the Administration. They have wide latitude to
    engage in any activity enumerated in the National Bank Act. Banks also
    are permitted to conduct activities that are incidental to those
    enumerated.
        There are no specific statutory or regulatory requirements for
    national banks to notify or seek OCC approval prior to engaging in a
    new business activity. However, banks often seek preliminary
    determinations from the OCC if an activity does not have a readily
    apparent nexus to an activity listed in the National Bank Act. Issues
    relating to new and ongoing activities are also addressed during the
    bank examination process.
        Similarly, financial subsidiaries of national banks also have
    expansive latitude to engage in a wide range of statutorily enumerated
    activities without prior approval. Under the Gramm-Leach-Bliley (GLB)
    Act financial subsidiaries may engage in activities that are
    ``financial in nature''. The act provides a preliminary list of such
    activities and authorizes the list to be expanded by the Treasury
    Department in coordination with the Federal Reserve. If a bank wishes
    to engage in one of the enumerated new activities through a financial
    subsidiary, it must provide a notice to the OCC within 5 days before
    engaging in a new activity. The only prior approval notice added in the
    GLB Act is for activities not listed in the statute when the company is
    seeking the Treasury and Fed to authorize such activities.
        Safety and soundness considerations should accompany, not dominate
    program approval decisions. The present program approval structure
    strikes an appropriate balance between mission and safety and soundness
    oversight. Safety and soundness are not criteria for new program
    approval. Indeed, the Treasury Department reached the same conclusion
    in its 1990 study on the GSE's. Treasury stated,

            ``the regulatory authority which monitors a GSE's fulfillment
            of its Congressional mandate should be different from the
            entity implementing financial safety and soundness standards.
            Separating these two regulatory functions will remove risks to
            the taxpayers by removing a perceived conflict of interest
            [emphasis added]. . . . The Treasury recommends that the
            current program regulator continue to be responsible for
            ensuring that the GSE meets its Congressional mandate by
            effectively serving its intended beneficiaries.'' Report of the
            Secretary of the Treasury on Government Sponsored Enterprises,
            May 31, 1990.

        It is interesting that the Administration now views program
    approval as a function of safety and soundness oversight to be overseen
    by the Treasury. As discussed above, NAHB believes Treasury is the
    wrong place to put program approval. Treasury lacks experience in and
    knowledge of housing.
        This is not to say that safety and soundness should not be a
    consideration in new program review. NAHB believes that safety and
    soundness is one of the many elements that should be evaluated during
    the new program approval process, but maintains it should not be the
    paramount consideration as the administration has proposed.
        Reviewing new programs solely on the basis of safety and soundness
    would severely retard the development of programs needed by Fannie Mae
    and Freddie Mac to fulfill their housing mission. It will stifle
    innovation necessary to provide liquidity to the housing credit
    markets, particularly in areas that otherwise would not be adequately
    served. Such activities, by definition, involve higher risk and would
    be greatly constrained if program approval is solely a component and
    function of safety and soundness regulation.
        The safety and soundness regulator should have a consultative role
    in program review, not the final decision. Some criteria that the
    safety and soundness regulator should consider are:

     Risk assessment: Does the new program pose undue risks to the
        Enterprise or the housing finance system generally?
     Risk management: Does the Enterprise have the expertise,
        resources, and programs in place to effectively manage the interest
        rate, credit, or other risks associated with the new program?
     Capital adequacy: Does the Enterprise have present or
        reasonably anticipated reserves to compensate for the risks
        involved?

        Further, we note that the risks of new activities are accounted for
    in the risk-based capital model, which ensures that the GSE's have
    adequate reserves to cover the risks of new programs.
        Program review process should be clarified with specific criteria.
    Presently, HUD has 45 days to review a new program request, with one 15
    day extension. As noted, HUD is required to approve a new program
    request unless it is not in compliance with the GSEs' Charter Acts or
    is not in the public interest. The present process is vague on the
    content of the application request and the criteria for approval. NAHB
    supports retention of the current timeframes for approval of new
    program requests and offers the following suggestions for application
    content and review criteria.
        New Program Request Application Content:

     Citation to the statutory, regulatory, or other legal
        authority;
     Estimate of the anticipated dollar volume of the program
        (short- and long-term);
     Full description of proposed program, including: Purpose and
        operation; target market; delivery system; and effect of the
        activity on the housing market, broadly, and/or ability to meet
        affordable housing goals; and,
     Assessment of the risks associated with the activity, and a
        demonstration of the Enterprise's ability to manage those risks.

        Review Criteria:

     Charter compliance: Is the program consistent with the
        Enterprise's charter and other relevant statutory and regulatory
        authority, and does the new program support the mission of the
        Enterprise?
     Public interest: Is the new program in the public interest?
        Does it support or help to fulfill an important housing-related
        objective?
     Innovation: Does the new program foster innovation in the
        availability or delivery of housing-related financial services?
     Risk Assessment: Must consult with and consider risk
        assessment by safety and soundness regulator.

    Extent and Control of Fannie Mae and Freddie Mac Affordable Housing
            Goals
        The current statute contains three specific goals that are intended
    to push Fannie Mae and Freddie Mac further into housing finance
    products and markets than they may otherwise go. HUD sets the specific
    levels of business they must achieve. HUD has steadily increased the
    levels and the GSE's have achieved them.
        NAHB has always been a strong supporter of the affordable housing
    goals for Fannie Mae and Freddie Mac since HUD was granted this
    authority by the 1992 GSE Act. The housing goals establish percent of
    business purchase goals for three categories: Low- and moderate-income,
    underserved areas, and special affordable. The first set of goals was
    established by regulation in 1995, and was updated in 2000 to cover the
    years 2001-2003. Current goals levels, as a percent of annual
    purchases, are: 50 percent for low-mod; 31 percent for underserved
    areas; and, 20 percent for special affordable.
        Both GSE's have consistently exceeded all of the housing goals
    since the initial goals were established in 1995. The goals have
    encouraged Fannie Mae and Freddie Mac to reach deeper into the
    affordable housing market with tangible benefits. The GSE's financing
    of housing for low- and moderate-income families has increased from
    under 30 percent of their purchases in 1992 (prior to passage of the
    GSE Act) to over 51 percent in 2002.
        The Administration is proposing to strengthen HUD's housing goals
    authority over Fannie Mae and Freddie Mac. As the HUD Secretary
    outlined in his October 16, 2003 testimony before this Committee, this
    will include the creation of a new GSE office within HUD, independently
    funded by the GSE's, to establish, maintain, and enforce housing goals.
    HUD would be granted new administrative authority to enforce housing
    goals, enhanced civil penalties for failure to meet the goals, and
    expanded authority to set housing goals and sub-goals beyond the three
    currently established. The President's proposed budget for fiscal year
    2005 also calls for adding a new goal to promote affordable housing
    homeownership.
        For the same reason that NAHB supports HUD as Fannie Mae's and
    Freddie Mac's mission regulator, NAHB supports HUD as the regulator for
    the GSEs' housing goals. We agree with the HUD Secretary that ``HUD is
    the appropriate agency to develop and enforce housing goals.
    Institutionally, [HUD's] mission is devoted to furthering the goal of
    affordable housing and homeownership and HUD has the most expertise in
    this area.'' Indeed, NAHB believes housing goals authority is one of
    HUD's key functions as mission regulator for Fannie Mae and Freddie
    Mac.
        NAHB also agrees that more needs to be done to encourage the GSE's
    to increase their activities in some market segments. However, we do
    not believe that adding additional goals or sub-goals, as the
    Administration has proposed, is the best way this could be
    accomplished. Fannie Mae and Freddie Mac were created to serve a broad
    range of housing needs and we would not want overly stringent or
    complex goals to impede that mission. Continual increases in the
    percentage targets will have diminishing returns and run the risk of
    adversely impacting other housing programs, such as FHA's single family
    program.
        NAHB believes that a better way to encourage increased GSE activity
    in underserved markets is through bonus point incentives within the
    existing goals system. HUD's 2000 goals rule, which established goals
    for 2001-2003, also provided for bonus points during this period for
    units financed for GSE mortgage purchases in small (5-50 unit)
    multifamily properties and for units in 2- to 4-unit owner-occupied
    units. These units are key sources of affordable housing for large
    numbers of low- and moderate-income households, first-time homebuyers,
    and minorities. One-third of the rented homes are in buildings with 5
    to 50 units and minority renters are more likely to be the occupant
    than are white residents. The bonus point system ended on December 31,
    2003, when HUD chose not to extend it beyond the effective termination
    date.
        NAHB is a strong supporter of the bonus points system as a flexible
    means to provide incentives for the GSE's to increase activity in
    targeted markets and we adamantly oppose HUD's decision to terminate
    the bonus points. The bonus points were an integral component of the
    current goals structure and they served their intended purpose as both
    Fannie Mae and Freddie Mac increased their purchases of bonus-related
    mortgages. For example, Fannie Mae's purchases of small multifamily (5-
    50) properties as a percentage of their total multifamily purchases
    more than doubled from 1.7 percent in 1997 to 4 percent in 2002.
    Similarly, Freddie Mac's purchases increased from 3 percent in 1997 to
    6.5 percent in 2002.
        NAHB is concerned that the elimination of the bonus points
    incentive will disrupt the progress that has been made in these markets
    as the GSE's focus on larger multifamily properties which are more
    ``goals-rich'' in order to meet their overall housing goals. More work
    remains to be done in the small multifamily market, especially in rural
    areas and urban infill locations that are part of community
    revitalization efforts.
        As we have stated above, NAHB believes bonus points are a very
    effective tool for focusing GSE affordable housing efforts on areas of
    greatest need. NAHB urges this Committee to instruct HUD to reinstate
    the bonus points for small multifamily properties. We also recommend
    that bonus points for loans on small multifamily projects, rural homes
    and newly built homes be included in statutory provisions for
    affordable housing goals under any new GSE regulatory regime.
        Finally, NAHB suggests that consideration should be given to the
    statutory factors HUD must consider in setting the housing goals. The
    1992 GSE Act requires HUD to consider the following six factors in
    establishing the goals:

     national housing needs;
     economic, housing, and demographic conditions;
     performance and effort of the GSE's toward achieving the goal
        in previous years;
     size of the conventional mortgage market serving the targeted
        population or areas, relative to the size of the overall
        conventional market;
     ability of the GSE's to lead the industry in making mortgage
        credit available for the targeted population or areas; and,
     the need to maintain the sound financial condition of the
        GSE's.

        Of particular concern, is the requirement that the GSE's ``lead the
    market'' in reaching underserved populations. In evaluating this
    criterion, HUD includes markets in which the GSE's are unable to fully
    participate, such as manufactured housing loans and subprime loans.
    While NAHB does not dispute that the GSE's should be held accountable
    for their performance in these areas, NAHB believes that some
    allowances should be made for the fact that these markets are not
    readily available to them.
    Safety and Soundness Regulator
        NAHB supports strong and credible safety and soundness oversight
    for Fannie Mae and Freddie Mac. The purpose of safety and soundness
    regulation is to ensure that Fannie Mae and Freddie Mac are adequately
    capitalized for the mission-related programs they are operating, and
    appropriate governance structures and procedures are in place to
    operate those programs in a safe and sound manner. The safety and
    soundness of Fannie Mae and Freddie Mac should be ensured through
    rigorous examination, enforcement of capital standards and
    transparency, without unnecessarily impairing the ability of the GSE's
    to perform their housing mission. It is
    imperative that the safety and soundness functions be separate from
    mission regulation, specifically program oversight and housing goals.
    Safety and soundness regulation should not be a vehicle for
    disapproving programs so the enterprises undertake little or no risk.
        As stated earlier, NAHB strongly disagrees with the position that
    the GSE safety and soundness regulator must have the primary role in
    approving new programs in order to adequately perform safety and
    soundness oversight. This argument is based on the assumption that the
    mission regulator would increase the riskiness of Fannie Mae's and
    Freddie Mac's operations by allowing them to expand into activities
    beyond the scope of their charters. As outlined above, charter
    compliance is a prerequisite for new program approval. NAHB supports a
    requirement that the mission regulator consult with the safety and
    soundness regulator during new program reviews. We also feel that the
    safety and soundness regulator should be empowered to prevent the GSE's
    from undertaking any new activity representing a threat to their
    ongoing viable operation. However, the focus of safety and soundness
    regulation and supervision should be on ensuring that Fannie Mae and
    Freddie Mac hold adequate capital in relation to the risk of the
    activities they are undertaking and that these enterprises have the
    appropriate staff, systems, and management controls in place to operate
    the programs in a safe and sound manner.
        Safety and soundness oversight of Fannie Mae and Freddie Mac
    presently resides with OFHEO, an independent office within HUD. Recent
    events with respect to Freddie Mac's and Fannie Mae's accounting
    practices have led a number of observers to raise serious questions
    about OFHEO's ability to perform these regulatory functions. In light
    of these concerns, NAHB would support the transfer of safety and
    soundness oversight of Fannie Mae and Freddie Mac from OFHEO to another
    entity with greater capacity and resources, such as the Treasury
    Department. We recognize Treasury as the premier financial institution
    regulator because of its expertise and experience with financial
    issues. However, as explained above, the authority of the office must
    be limited primarily to safety and soundness functions only because
    Treasury is not equipped to handle mission oversight of the GSE's.
    Capital
        NAHB has consistently supported the establishment and enforcement
    of appropriate capital standards for Fannie Mae and Freddie Mac.
    Pursuant to the 1992 GSE Act, Fannie Mae and Freddie Mac are required
    to meet two capital standards, a minimum leverage ratio and a risk-
    based capital (RBC) standard. The minimum leverage ratio is 2.5 percent
    of assets plus 0.45 percent of adjusted off-balance sheet obligations.
    By law, the RBC standard, is based on a stress test which calculates
    the amount of capital that Fannie Mae and Freddie Mac must hold to
    maintain positive capital over a 10-year period of adverse credit and
    interest rate conditions, plus an additional 30 percent of this capital
    level to cover management and operations risk. The firms must meet both
    the RBC and minimum capital standards to be classified as adequately
    capitalized. Failure to meet the capital standards would trigger
    enforcement actions ranging from limits on growth and activities to
    conservatorship.
        Fannie Mae and Freddie Mac have consistently met their capital
    standards and thus have been classified as adequately capitalized.
    Prior to the implementation of the RBC standard, the firms were
    required to meet the minimum leverage ratio. The RBC standard became
    enforceable on September 13, 2002, after nearly 10 years of
    development. The RBC test is the first regulatory capital standard to
    be based on a stress test and has been hailed as the most dynamic and
    stringent capital standard for any financial institution.
        The Administration proposes to provide the Treasury regulator
    greater flexibility in establishing the leverage and RBC requirements.
    However, in testimony before this Committee last year, Treasury
    Secretary Snow mentioned the need for stability in capital standards
    and suggested that capital standards should not be subject to frequent
    change. NAHB agrees with this perspective and applauds Secretary Snow's
    decision not to recommend any changes in the statute dictating the
    GSEs' minimum and RBC requirements. Given that the current RBC
    standards took 10 years to develop and have been in effect for only 1
    year, we are pleased that the Treasury is willing to give the
    requirements a chance to work. NAHB recommends against any immediate
    changes in the GSEs' minimum capital standard as well. Longer-term,
    NAHB agrees the safety and soundness regulator should have the
    flexibility to adjust capital standards as necessary. However, NAHB
    cautions against significant changes in the GSE's RBC standard or any
    significant increase in the GSE's minimum capital standard.
    Overcapitalization of the GSE's, beyond the level of risk, is not
    economically efficient and could have unintended consequences for the
    housing markets, by reducing the level of capital for housing and
    increasing mortgage rates.
        NAHB would also oppose the imposition of bank-like capital
    standards for the GSE's as some have proposed. Congress rejected this
    notion and intentionally drafted a separate capital regime for Fannie
    Mae and Freddie Mac under the 1992 GSE Act. The present capital
    framework takes into account the unique nature of the GSE's business,
    that there are only two firms (as compared to thousands of banks) and
    they engage in a monoline business, focused on low-risk residential
    mortgages (unlike banks which engage in a wide range of activities).
    During the lengthy development process of the current RBC standard,
    OFHEO took great pains to ensure that the standard appropriately ties
    capital to risk. Bank regulators have recognized that bank capital
    standards do not tie capital to risk and are now engaged in a process
    to revise bank capital standards through the Basel II Accord.
    Independence of Regulator
        OFHEO currently operates independently of the cabinet agency where
    it resides (HUD). Other banking regulators within Treasury also operate
    with independence. For example, regulations, agency guidance and
    testimony emanating from the Office of Thrift Supervision (OTS) or the
    Office of the Comptroller of the Currency (OCC) are not subject to a
    mandatory approval requirement by Treasury. The Federal Housing Finance
    Board is an independent, stand-alone regulatory agency.
        The Administration proposal requires Treasury approval of testimony
    and regulations from the regulator within Treasury. NAHB strongly
    believes that safety and soundness regulators should be objective,
    nonpartisan, and protected from political interference. This is
    especially critical at times when regulators must make difficult and
    sometimes politically unpopular decisions. The primary responsibility
    of the regulator is to implement policy made by the Congress, and to do
    so in a safe and sound manner. NAHB strongly believes that a regulator
    lacking true independence may eventually find itself pursuing other
    agendas, not the will of Congress, nor what is demanded to assure
    safety and soundness.
        Independent regulation also protects Congress' ability to receive
    the regulator's best judgment on regulatory matters unfiltered and
    without delay. With billions of dollars of potential taxpayer liability
    at stake, it is in everyone's interest that this important safeguard
    not be weakened. Therefore, NAHB believes if a new agency is created
    within Treasury, it should have autonomy in the following key areas:

     Testimony. Congress should be able to count on receiving the
        agency's unadulterated views on all issues it faces.
     Rulemaking. The agency's policy justification for issuing
        regulations should be devoid of interference from politically
        appointed officials.
     Supervision and Examination. True safety and soundness cannot
        be attained without a strict separation between political
        appointees and supervisory and examination staff.
     Enforcement. The agency's enforcement actions must be
        unblemished by any extraneous influence.
    Inclusion of the FHLBank System
        The Administration has called for placing Fannie Mae, Freddie Mac,
    and the FHLBanks under a single regulator. In fact, the President's
    proposed budget for fiscal year 2005 includes provisions for
    transferring oversight of the Federal Home Loan Banks from the Federal
    Housing Finance Board to the same new office at Treasury that would
    regulate Fannie Mae and Freddie Mac. NAHB believes that it is Congress'
    responsibility to scrutinize the regulatory oversight of the housing
    GSE's, and to ensure that they provide the Nation's network of
    community-based financial institutions with the safest, soundest source
    of residential mortgage and community development credit possible.
    While all three GSE's have much in common, NAHB believes it is
    important to both recognize and preserve the unique nature of the
    FHLBanks. For example, unlike Fannie Mae and Freddie Mac, the FHLBank
    System is a cooperative owned by its member institutions. The FHLBanks'
    stock is not publicly traded and does not fluctuate in value. In
    addition, each of the FHLBanks is jointly and severally liable to all
    the others.
        Each of the three GSE business models has their strengths. Any
    revised regulatory system should continue to respect those differences,
    while advancing the common goal--to maintain their financial safety and
    soundness.
    Funding of Regulator
        President Bush's fiscal year 2005 budget proposes to increase the
    amount of resources allocated to regulating the housing-related GSE's.
    The proposed budget
    earmarks $83 million to establish a new office within Treasury. The
    budget also anticipates that HUD will incur approximately $6.25 million
    in the establishment and enforcement of affordable housing goals,
    ensuring GSE compliance with fair housing laws, and providing
    consultation to the safety and soundness regulator on new activities.
    The activities of the safety and soundness regulator would be funded
    through mandatory assessments on all of the GSE's; the mission
    oversight costs at HUD would be assessed on Fannie Mae and Freddie Mac.
        NAHB believes that those who supervise and regulate the GSE's
    should possess adequate authority and resources. The housing-related
    GSE's are engaged in a myriad of complex financial transactions. It is
    crucial for the regulator to possess a high degree of experience,
    knowledge, and familiarity with current accounting, risk-management and
    housing-related issues so that they are credible, confident, and
    capable. Furthermore, NAHB believes that it is entirely reasonable for
    the GSE's to fund the responsibilities of their regulator.
    Independent Regulatory Body
        The idea of a stand-alone independent regulator has been floated as
    a compromise to break the current impasse among policymakers on the key
    issues of program oversight and political independence of the
    regulator. It is argued that a stand-alone agency would resolve
    concerns about independence of the regulator from Treasury, as well as
    Treasury's oversight of new programs. It might also ease concerns about
    including the FHLBanks in the new system since a merged agency would
    avoid a perception that any of these Government Sponsored Enterprises
    are subject to more effective regulation than any of the others.
        While not our first preference, NAHB would be open to exploring the
    concept of a new independent regulator for all three housing GSE's
    outside the Treasury Department, depending on how key details are
    implemented. NAHB's primary concern in either regulatory scenario is
    that the mission regulator must have a housing focus and expertise and
    the safety and soundness regulator must have sufficient respect and
    authority to satisfy Congress and the capital markets.
        In addition to the funding and political independence issues
    addressed in other sections of this testimony, NAHB notes that other
    preliminary characteristics to consider are the corporate structure of
    the agency, and how its managers will be selected. Given the diversity
    and complexity of supervisory issues the agency will address, NAHB
    initially recommends the agency be structured as a board of directors
    rather than a single agency head. In this scenario, NAHB suggests that
    a HUD representative should serve on the board in order to ensure that
    it possesses a housing-oriented focus and experience. NAHB also
    suggests that the board comprise stakeholders from various industry
    sectors. As mentioned above, it is imperative to recognize the
    differences between Fannie Mae, Freddie Mac, and the FHLBanks. This
    could be effectuated by establishing two divisions and maintaining
    separate funding for the costs of regulation.
    Conclusion
        NAHB appreciates the opportunity to share our views on the
    regulatory framework for Fannie Mae, Freddie Mac, and the Federal Home
    Loan Bank System. The critical supports provided by these housing
    Government Sponsored Enterprises (GSE's) were an essential component to
    the recent success of the housing market in sustaining the Nation's
    economy. NAHB appreciates the Committee's efforts to assess and seek
    improvements to the regulatory framework of these GSE's. We look
    forward to working with the Committee as you progress toward fashioning
    a narrow regulatory solution to the oversight of these important
    housing institutions.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                          FROM ALAN L. BELLER

        At our October 23, 2003 hearing, Federal House Finance
    Board (FHFB) Chairman Korsmo testified that he recommended to
    Congress that all 12 Federal Home Loan Banks (FHLB's) comply
    with the Securities Exchange Act of 1934. However, some of the
    12 FHLB's have argued that, due to the unique nature of the
    System, disclosure registrations as required under the
    Securities Exchange Act of 1934 are difficult to implement, and
    would prevent the FHLB's from efficiently offering securities
    to the market. Only the Cincinnati FHLB has voted to implement
    the disclosure registrations of the Securities Exchange Act of
    1934.
    Q.1.a. What is your reaction to that argument? Do you foresee
    any major impediments to Securities Exchange Act of 1934
    compliance for the FHLB's? Why or why not?

    A.1.a. We do not foresee any major impediments. We have met
    with representatives of many of the Banks and with staff of the
    Federal Housing Finance Board to discuss a number of aspects of
    the requirements and timing of registration under the
    Securities Exchange Act of 1934. In particular, we have
    addressed what have been identified as four threshold
    accounting issues. As noted in my testimony, we have resolved
    those issues.
        In addition, Commission staff members have worked with
    representatives of a number of the Banks to discuss
    accommodations the staff will make to address concerns the
    Banks have raised. The Commission staff has clearly indicated
    that it will provide ``no-action,'' interpretive or other
    relief, to accommodate each Bank's preference to register a
    class of its capital stock rather than a class of debt. We
    believe that the investors in the publicly issued debt of the
    Banks are entitled to the same level of information as that
    provided to investors in debt securities of other public
    companies. However, if the Banks register a class of their
    capital stock with the SEC, they would be subject to certain
    disclosure and other requirements beyond those to which
    companies that have registered only their debt securities with
    us, and not their common stock or other equity securities, are
    subject. In our discussions with the representatives of the
    Banks and the Finance Board, the Commission staff has agreed to
    provide relief from provisions of the securities laws that
    would make the requirements to which they are subject
    consistent with those of companies who have registered only
    their debt securities with us.
        The Federal Home Loan Banks, although federally chartered
    entities, have many of the same disclosure issues faced by any
    financial institutions whose securities are issued to, and held
    by, the public. The Federal Home Loan Bank System is one of the
    largest issuers of debt securities in the world. The debt of
    the Banks does not carry the full faith and credit backing of
    the United States and investors in the Banks' debt must,
    therefore, look only to the Banks for repayment of the debt.
    Therefore, disclosures by the Banks should give the holders of
    their debt a materially complete and accurate picture of the
    Banks' financial and operational situation to provide investors
    in their debt with sufficient information on which to evaluate
    an investment. As noted above, we believe that the holders of
    debt issued by the Office of Finance, for which the 12 Banks
    are jointly and severally liable, are entitled to the same type
    of information that is provided to investors in other public
    debt securities. We believe that the Commission's detailed
    disclosure rules and filing requirements and the staff review
    and comment process provide the best framework for disclosing
    information to which investors are entitled. In addition, we
    have a long history of reviewing complex entities that comply
    with the disclosure requirements of the Exchange Act and other
    Federal securities laws.

    Q.1.b. Would registration prevent the FHLB's from efficiently
    offering securities to the market?

    A.1.b. No. Under the Securities Exchange Act of 1934, publicly
    reporting companies are required to file periodic and current
    reports. Registration under the Securities Exchange Act of 1934
    is not tied to the timing of offerings as it is under the
    Securities Act of 1933. There would, therefore, be no impact on
    a Bank's timing or other aspects of offering securities as a
    result of Exchange Act registration. Some Banks have expressed
    concern that staff review of a Bank's Exchange Act reports
    might require a Bank to cease selling its securities. However,
    the staff does not advise or instruct a publicly reporting
    company to stop selling securities based on its comments on the
    company's Exchange Act filings. As is the case now, if a Bank
    uncovers a disclosure issue the Bank itself must determine
    whether or not it should continue to sell securities in the
    public markets. While registration under the Exchange Act may
    cause the Commission staff to raise a comment which could alert
    a Bank to a particular issue, it would, as now, be up to the
    Bank to determine whether the issue was significant enough to
    temporarily curtail securities offerings until the appropriate
    disclosure was
    provided to the public. This would be the case whether the
    issue was identified by the Bank itself or by the Commission
    staff in a comment letter.

        Fannie and Freddie have argued that due to the nature of
    the mortgage-backed securities market structure, the fees
    associated with the Securities Act of 1933 disclosure would be
    onerous, seriously slowing the offering of mortgage-backed
    securities to the ``To Be Announced'' (TBA) market, as well as
    being unfairly costly. They also claim the volume of the
    securities they offer also makes such registrations difficult
    for the SEC to handle expeditiously.
    Q.2.a. What is your reaction to that argument? In your opinion,
    can the SEC handle such registrations? Would it be too
    difficult to implement or too costly?

    A.2.a. We have a long history of overseeing the disclosure and
    offerings of companies in many diverse industries including
    financial companies that perpetually offer securities to the
    market. The current registration fee is $126.70 for each
    $1,000,000 of securities offered. Since Fannie and Freddie
    issue a large volume of securities, the fees they would pay for
    registering the offer and sale of securities under the
    Securities Act of 1933 could be large. We have no reason to
    believe that subjecting Fannie and Freddie to the same fees,
    disclosure, and review as other companies that offer mortgage-
    backed securities to the market would be unfairly costly to
    Fannie or Freddie or present any difficulties for the SEC.
    However, as noted below, we do not know whether or how
    requiring registration of the mortgage-backed securities would
    impact the mortgage market, and we have consistently stated
    that an evaluation of this
    impact should be part of any consideration of whether their
    mortgage-backed securities should be registered under the Act.

    Q.2.b. What would be the effect of implementing SEC
    registration on the liquidity of the Nation's housing finance
    system and on the end mortgage interest rates available to the
    homebuyer?

    A.2.b. It has been our priority that investors who purchase and
    sell stock or ``straight'' debt (that is, non-mortgage-backed
    debt) of the GSE's are entitled to the corporate information
    publicly registered companies must disclosure under the
    Securities Exchange Act of 1934. Fannie Mae has registered its
    common stock under the Exchange Act and is now fully subject to
    the Commission's disclosure rules and the requirements of the
    Sarbanes-Oxley Act. Freddie Mac has not yet completed the
    process of registering under the Exchange Act but has stated it
    intends to complete the registration process when it completes
    its restatement and audit of its financial statements. Both of
    the GSE's continue to be exempt from the requirements to
    register the offer and sale of securities under the Securities
    Act of 1933 and as such the timing of their offerings and
    therefore, as noted above, their liquidity will not be impacted
    by Exchange Act registration.
        Registration of offerings of the GSE's mortgage-backed and
    related securities under the Securities Act may raise issues
    regarding the impact on the mortgage market, especially the TBA
    market. A decision to require registration under the Securities
    Act of offers and sale of mortgage-backed securities should
    properly take into account consideration of whether, and if so,
    how such registration might impact the mortgage market and the
    operation of the TBA market. The staff of the Commission does
    not have expertise to determine whether or how this might
    impact the mortgage market. As noted above, we have
    consistently stated that an evaluation of this impact should be
    part of any consideration of whether Fannie's and Freddie's
    mortgage-backed securities should be registered under the
    Securities Act.

    Q.3. It is my understanding that Freddie's compliance with the
    1934 Act is being delayed due to its ongoing revisions of its
    financial statements. Freddie is expected to release its
    revised earnings sometime this month. Has Freddie communicated
    with the SEC regarding when they expect to come into compliance
    with the 1934 Act? When specifically do you believe they will
    be able to do so?

    A.3. Freddie Mac has indicated it intends to complete the
    Exchange Act registration process when it completes its
    restatement and audit of its financial statements and is
    current in its financial statements. Most recently, Freddie Mac
    has indicated it believes it will complete registration under
    the Exchange Act by mid-2005.

                           PROPOSALS FOR IMPROVING
                           THE REGULATION OF HOUSING
                        GOVERNMENT SPONSORED ENTERPRISES

                                  ----------

                           TUESDAY, FEBRUARY 24, 2004

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:01 a.m., in room SD-538, Dirksen
    Senate Office Building, Senator Richard C. Shelby (Chairman of
    the Committee) presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The Committee will come to order.
        Today, the Committee continues its consideration of needed
    reforms to the regulatory regime for the housing GSE's. This is
    the fourth hearing on this matter. The time and the resources
    that the Committee have dedicated to this matter underscore its
    importance.
        Fannie Mae, Freddie Mac, and the Federal Home Loan Bank
    System provide liquidity to a vital sector of our national
    economy--the housing markets. Because of their crucial roles in
    our economy, the financial condition, and safe and sound
    operations of these institutions must be diligently monitored.
        Given their size, and their sophisticated risk management
    strategies, this monitoring is no simple task. It is one of my
    top priorities to report legislation from this Committee that
    will create a new housing GSE regulator that will have the
    stature, sophistication, and necessary regulatory tools to
    ensure that these institutions continue to carry out their
    public policy mission in a safe and sound manner.
        Today, the Committee will hear from Alan Greenspan, the
    Chairman of the Board of Governors of the Federal Reserve
    System. Chairman Greenspan will share his insights with this
    Committee on the role that the housing GSE's play in the
    housing sector, the impact of their operations on our financial
    markets, and the need to establish a strong, credible
    regulator.
        Senator Allard, do you have an opening statement?

                   STATEMENT OF SENATOR WAYNE ALLARD

        Senator Allard. Mr. Chairman, I do have just a very brief
    statement.
        First of all, I would like to thank you for your diligence
    in following this issue. It is very important, I think, and I
    would also like to thank Chairman Greenspan for taking time
    from his busy schedule to show up before this Committee to
    testify. I have always valued his testimony before this
    Committee. And as Chairman of the Housing Subcommittee,
    reforming the GSE's is a topic in which I am keenly interested.
        The housing market is no doubt a critical aspect of the
    U.S. economy. We have seen the housing market sustain itself
    during this last economic downturn that we had. It was actually
    a persistent bright spot that we had in our economy when
    everything else was not doing well. The financing of mortgages
    I think in recent years has helped to power the economy through
    the recent recession.
        Now, the GSE's have been an active part of helping the
    American Dream come true for millions of families. The GSE's,
    though, are large, complex financial institutions that merit
    the highest levels of scrutiny. I believe alternative
    regulatory proposals to ensure the protection of the U.S.
    housing markets are necessary. This regulatory authority needs
    to rest on a strong, financially sound foundation, and I look
    forward to discussing the necessary elements a regulator must
    have to do its job effectively.
        Though many items still need to be worked out as part of a
    new regulatory regime, I believe we are making progress, and I
    hope that we can all agree that we must have a strong
    regulator. We owe nothing less to the taxpayers and homeowners
    of the Nation.
        I look forward to hearing from Chairman Greenspan and his
    thoughts on how we can reform and improve the regulatory
    structure for GSE's.
        Chairman Shelby. Senator Dole.

                  STATEMENT OF SENATOR ELIZABETH DOLE

        Senator Dole. Thank you, Mr. Chairman. I would like to
    express my appreciation for your continued leadership on this
    very important issue.
        Last summer, Senators Hagel, Sununu, and I introduced S.
    1508, the Federal Enterprise Regulatory Reform Act. I think my
    colleagues would agree that approximately 95 percent of this
    bill enjoys broad, bipartisan support. As for that remaining 5
    percent, I am confident you will find agreement, Chairman
    Shelby, as you are working this issue.
        The question of the proper powers and resources available
    to a regulator of the Government Sponsored Enterprises has
    proven to be a vexing issue. Chairman Shelby, you have been
    carefully crafting solutions to some of the more controversial
    proposals contained in the GSE reform package, and this
    Committee is very close, I believe, to achieving a consensus.
    After so much work, it is my hope that the consensus will earn
    all of our support.
        I understand, Chairman Greenspan, that you have devoted a
    considerable amount of your time, in addition to that of your
    staff, on the risks and benefits of our GSE bill. I appreciate
    your willingness to weigh in on these important issues.
        One issue of particular importance is the need to ensure
    that the regulator has the ability to control nonmortgage
    investments of the GSE's. In his testimony 2 weeks ago, the
    Comptroller General stated, ``We again recommend that Congress
    legislate nonmortgage investment criteria for HUD or any new
    GSE regulator that may be established through legislation.''
    The General Accounting Office has warned us that the incentives
    to use the benefits of Government sponsorship to increase
    shareholder value could, over time, erode the public mission. I
    believe every Member of this Committee is committed to ensuring
    that the mission to create greater opportunities for
    homeownership, especially for minority populations, is the
    number one priority for the GSE's. We must make sure that our
    effort gives this mission the focus and attention it deserves
    by all GSE's, and that there is no chance of erosion over time.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Carper.

                 STATEMENT OF SENATOR THOMAS R. CARPER

        Senator Carper. Thanks, Mr. Chairman.
        Chairman Greenspan, welcome. It seems like you were just
    here. In fact, I think you were. Welcome back.
        I read in some of the briefing material for today's hearing
    an explanation--I think it showed up in the American Banker--
    about different kinds of capital from minimum to risk-based
    accords, or a whole lot of others. And so the question that I
    am going to be asking you, just to telegraph my pitch, is to
    explain all those capital standards in ways that even former
    Governors can understand. And if you could do that today, you
    will get an A-plus from me, and maybe make those relevant to
    our discussion.
        When I was Governor of Delaware, we used to have a slogan
    in our administration. You have all heard probably somewhere in
    your life the axiom, somebody who did a job, did not do it
    necessarily very well, you say, ``That is good enough for
    Government work.'' I never liked that.
        Later on, I used to hear people say often, ``If it ain't
    broke, do not fix it.'' And that applies, I guess, to things
    inside as well outside of Government. And I have never been
    real crazy about that one either.
        The slogan that we adopted for 8 years was, ``If it is not
    perfect, make it better.'' And I think when we look at the way
    that we regulate our GSE's, it is not perfect. We can make it
    better. But as we approach the job of doing that, I think it is
    important for us to keep in mind that today in this country,
    almost 70 percent of the people live in a home that they own.
    And it is a remarkable success story.
        In my little State, our homeownership rate is actually
    approaching 75 percent. And as we try to make what is not
    perfect more perfect, I think it is important that we do so in
    a way that does not undermine the remarkable success that we
    have had in fostering homeownership.
        Welcome back. We look forward to your testimony.
        Chairman Shelby. Senator Bunning.

                    STATEMENT OF SENATOR JIM BUNNING

        Senator Bunning. Thank you, Mr. Chairman.
        Just less than 2 weeks ago, Chairman Greenspan, you
    testified before this Committee about monetary policy, and at
    the time I criticized you for allowing yourself and the Fed to
    be drawn into things that have nothing to do with monetary
    policy. I do not think that studies on home interest rates and
    whether GSE's help or hurt homeownership have much to do with
    monetary policy. However, your monetary policy decisions,
    comments, and studies can have a great influence on home
    interest rates and whether or not someone can purchase a home.
        I was very surprised to hear about the recent Fed GSE
    study. I was surprised it stated that Fannie and Freddie are
    responsible for an average of 7-basis-point decrease on home
    mortgages.
        I have two Kentucky papers in front of me. Both have
    mortgage surveys. Both of them show a 25- to 50-basis-point
    difference between 30-year fixed-rate mortgages that GSE's can
    buy and 30-year jumbo mortgages which GSE's cannot buy. I would
    like to know your opinion on why there is such a difference
    between the rates of the jumbo and the fixed-rate loans and if
    these differences are consistent with the recent Fed study.
        I was also struck by a comment in your speech yesterday to
    the credit unions. You stated, ``Recent research within the
    Federal Reserve suggests that many homeowners might have saved
    tens of thousands of dollars had they held adjustable rate
    mortgages rather than fixed-rate mortgages during the past
    decade, though this would not have been the case, of course,
    had interest rates trended sharply upward.''
        Of course, if homeowners knew that rates would be lower,
    they would have used adjustable rate mortgages. But most
    homeowners do not know what rates are going to be for the next
    30 years. That is why they buy fixed-rate mortgages. Not very
    many homeowners have the resources that the Fed has in being
    able to predict long-term interest rates. So they buy fixed-
    rates despite the fact that they are more expensive to hedge
    against risk.
        For the average American, losing your home is not worth the
    risk of possibly saving some money on a 30-year adjustable
    mortgage. Rates were low in the last decade, historically low.
    But most of us here remember the 1970's and early 1980's and
    how high rates were then. If rates started to rise to Carter-
    level rates, I am fairly certain that no one would want an
    adjustable rate mortgage.
        You are always warning economic institutions, public and
    private, that they must hedge against risk. I agree with you
    and think it is very prudent advice. But I also think the
    average American should hedge against risk for their most
    important investment--their home.
        Once again, thank you for coming today. I look forward to
    your testimony.
        Chairman Shelby. Senator Reed.

                     STATEMENT OF SENATOR JACK REED

        Senator Reed. Thank you very much, Mr. Chairman, for
    scheduling these hearings on this very important topic of
    Government Sponsored Enterprises, and thank you, Chairman
    Greenspan, for attending.
        There are a host of technical issues that we have to
    consider, things such as the merger of the various regulatory
    agencies, whether or not there should be a statutory standard
    for capital, the potential impact on all of these things. But
    what most concerns me is how we can harness these
    organizations, both Fannie Mae and Freddie Mac and the Federal
    Home Loan Banks, to provide affordable housing opportunities
    for our citizens. Because as I go about this country, that is
    one of the great sources of concern and difficulty for families
    all across this country. Housing prices are soaring. The
    housing markets are doing extremely well. As a result, rental
    markets are appreciating dramatically. It is impossible for
    anyone making a minimum wage job to afford even a decent rental
    unit in most places, probably every place in the country.
        We have to do something. And, to date, we have been unable
    to harness in a proactive way the Federal policy for a housing
    trust fund or anything that will stimulate production and try
    to generate more opportunities. And if not by design, then by
    default, we have to rely upon some of these private entities.
        I frankly think we have to challenge all of these entities
    to do more, not just rhetorically but practically, to provide
    opportunity for affordable housing, not simply to provide
    mortgage support for people who can afford to buy expensive
    homes or even mid-priced homes, but to look out and make sure
    that we have a place so that all of our families can find a
    place. I hope in the context of these discussions that you can
    give us your advice on that point also.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Crapo.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you very much, Mr. Chairman.
        Mr. Greenspan, again, we thank you for sharing your wisdom
    and being with us here today.
        I think my focus today is going to be, as I think is
    indicated by Senator Carper, on the capital standards issue.
    Obviously, there are a lot of issues that we need to deal with
    as we address the relationship in the home mortgage industry
    between Fannie and Freddie, the Federal Home Loan Banks, and
    the private sector lending institutions.
        To me, one of the questions that is clearly in the
    forefront is the question of capital standards, the questions
    like: Should the statute, if we pass one, set a floor? Or
    should the statute establish any type of capital standard as
    opposed to letting it be set regulatorily by any new regulator
    that might be established? Questions like: Should the capital
    requirements be different for different types of institutions
    depending on the nature of risk which they incur? Should
    capital standards be imposed that extend beyond the level of
    risk? And is establishment of a capital standard that exceeds
    risk economically inefficient?
        It is questions like this which I believe we must address
    as we address the question of establishing a new regulator and
    setting the parameters and the scope of authority of such a new
    regulator.
        I know that you have looked at this very closely, and I
    look forward to your testimony today. And, Mr. Chairman, I also
    look forward to working with you as we put this together. Thank
    you.
        Chairman Shelby. Absolutely.
        Senator Enzi.

                  STATEMENT OF SENATOR MICHAEL B. ENZI

        Senator Enzi. Thank you, Mr. Chairman. I appreciate your
    holding this hearing. I would ask that my full statement be a
    part of the record.
        Chairman Shelby. Without objection, it is so ordered.
        Senator Enzi. I would mention something a little more basic
    on getting homes, and that is having jobs. I passed the
    Workforce Investment Act, and I am going to be pressing both
    sides to come up with conferees for that so that people can
    upgrade their skills, make a little bit more money, and be able
    to afford houses.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Sarbanes.

                 STATEMENT OF SENATOR PAUL S. SARBANES

        Senator Sarbanes. Mr. Chairman, first of all, I want to
    express my appreciation to you once again for continuing the
    Committee's thorough and careful examination of the issue of
    the regulation of the housing GSE's. This is an important
    series of hearings, and obviously, I hope at the end of it we
    will be able to develop a consensus with respect to a world-
    class regulator for Fannie Mae, Freddie Mac, and the Federal
    Home Loan Banks.
        I think it is always important, of course, to remind
    ourselves that the primary purpose of Fannie Mae and Freddie
    Mac is to maintain a strong, liquid, stable secondary market
    for residential mortgages, including multifamily mortgages. I
    think most people feel they have done this well over the years
    and it is reflected in the rates of homeownership that exist in
    this country when compared with what exists elsewhere in the
    world.
        The other primary purpose of these Enterprises is to expand
    access to affordable housing for low-income families and for
    those who live in underserved areas. We have sought to
    accomplish this by setting certain affordable housing goals,
    and while those targets have been met, there is some
    considerable sentiment that more could be done to expand
    housing opportunities.
        Housing has a special place in American society. A home of
    one's own is part of the American Dream. Both the current and
    previous Administrations have made expanded homeownership,
    particularly for minorities, an important goal. And, indeed, I
    think it should be. Homeownership is associated with a whole
    set of social and civic virtues, from better school performance
    to lower levels of juvenile delinquency, to higher levels of
    voting and civic participation. And I think we need to keep
    that in mind as we consider the framework within which these
    institutions will operate.
        The considerable question has been raised as to the
    adequacy of existing regulations, with considerable concern
    about the Federal Housing Finance Board, whose examination and
    supervisory capacity is being far short of what is required.
    OFHEO, which has been working quite hard recently to catch up
    on its responsibilities, seems not to have been aware of the
    depth of the problems at Freddie Mac. And because the housing
    GSE's are so important to our economy and our financial system,
    obviously we have an important responsibility to ensure that
    they are properly supervised and regulated.
        Mr. Chairman, I am pleased that we have Chairman Greenspan
    here with us today. I understand, I think, that tomorrow
    afternoon we will be hearing from the representatives of the--
    --
        Chairman Shelby. That is right, the GSE's.
        Senator Sarbanes. The three GSE's, and I look forward to
    that hearing as well.
        Thank you very much.
        Chairman Shelby. Chairman Greenspan, welcome again to the
    Committee. You spend a lot of time with us, but we think that
    is quality time. You proceed as you wish.
        Senator Sarbanes. They tell us you look forward to it with
    unanticipated joy. Is that correct?
        [Laughter.]
        Chairman Greenspan. It is always a joy, Senator.
        Senator Sarbanes. Thank you.
        Chairman Shelby. The Chairman can handle his own, I am
    sure.

                 STATEMENT OF ALAN GREENSPAN, CHAIRMAN

            BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

        Chairman Greenspan. Mr. Chairman, Senator Sarbanes, and
    Members of the Committee, thank you very much for inviting me
    to discuss the role of the housing-related Government Sponsored
    Enterprises in our economy this morning.
        As you know, Fannie Mae, Freddie Mac, and the Federal Home
    Loan Banks collectively dominate the financing of residential
    housing in the United States. Indeed, these entities have grown
    to be among the largest financial institutions in the United
    States.
        During the 1980's and 1990's, Fannie and Freddie
    contributed importantly to the development of the secondary
    mortgage markets for home loans and to the diversification of
    funding sources for depository institutions and other mortgage
    originators, as I explain in somewhat greater detail in my
    written remarks.
        Yet given their history of innovation in mortgage-based
    securities, why do Fannie and Freddie now generate such
    substantial concern? The unease relates mainly to the scale and
    growth of the mortgage-related asset portfolios held on their
    balance sheets. That growth has been facilitated, at least in
    part, by a perceived special advantage of these institutions
    that keeps normal market restraints from being fully effective.
        The GSEs' special advantage arises because, despite the
    explicit statement on the prospectus of GSE debentures that
    they are not backed by the full faith and credit of the U.S.
    Government, most investors have apparently concluded that
    during a crisis the Federal Government will prevent the GSE's
    from defaulting on their debt. An implicit guarantee is thus
    created not by the Congress but by the willingness of investors
    to accept a lower rate of interest on GSE debt than they would
    otherwise require in the absence of Federal sponsorship.
        Because Fannie and Freddie can borrow at a subsidized rate,
    they have been able to pay higher prices to originators for
    their mortgages than can potential competitors and to gradually
    but inexorably take over the market for conforming mortgages.
    This process has provided Fannie and Freddie with a powerful
    vehicle and incentive for achieving extremely rapid growth of
    their balance sheets. The resultant scale gives Fannie and
    Freddie additional advantages that potential private sector
    competitors cannot overcome. Importantly, the scale itself has
    reinforced investors' perceptions that, in the event of a
    crisis involving Fannie and Freddie, policymakers would have
    little alternative than to have the taxpayers explicitly stand
    behind GSE debt. This view is widespread in the marketplace
    despite the privatization of Fannie and Freddie and their
    control by private shareholders, because these institutions
    continue to have Government missions, a line of credit with the
    Treasury, and other Government benefits, which confer upon them
    a special status in the eyes of many investors.
        A recent study by a Federal Reserve economist, Wayne
    Passmore, attempts to quantify the value of that implicit
    subsidy to the private shareholders of Fannie and Freddie. His
    research indicates that it may account for more than half of
    the stock market capitalization of these institutions.
        Passmore's analysis suggests that Fannie and Freddie likely
    lower mortgage rates less than 16 basis points, with a best
    estimate centering on about 7 basis points. If the estimate of
    7 basis points is correct, the associated present value of
    homeowner savings is only about one-half the after-tax subsidy
    that shareholders of these GSE's are estimated to receive.
    Congressional Budget Office and other estimates differ, but
    they come to essentially the same conclusion. A substantial
    portion of these GSEs' implicit subsidy accrues to GSE
    shareholders in the form of increased dividends and stock
    market values.
        As noted by the General Accounting Office, the task of
    assessing the costs and benefits associated with the GSE's is
    difficult. One possible way to advance the technical discussion
    would be for the Congress to request disinterested parties to
    convene groups of technical experts in an effort to better
    understand and measure these costs and benefits.
        The Federal Reserve is concerned about the growth and the
    scale of the GSEs' mortgage-related portfolios, which
    concentrate interest rate and prepayment risks at these two
    institutions. Unlike many well-capitalized savings and loans
    and commercial banks, Fannie and Freddie have chosen not to
    manage that risk by holding greater capital. Instead, they have
    chosen heightened leverage, which raises interest rate risk but
    enables them to multiply the profitability of subsidized debt
    in direct proportion to their degree of leverage. Without the
    expectation of Government support in a crisis, such leverage
    would not be possible without a significantly higher cost of
    debt.
        In general, interest rate risk is readily handled by
    adjusting maturities of assets and liabilities. But hedging
    prepayment risk is more complex. To manage this risk with
    little capital requires a conceptually sophisticated hedging
    framework. In essence, the current system depends on the risk
    managers at Fannie and Freddie, as good as they are, to do
    everything just right, rather than depending on a market-based
    system supported by the risk assessments and management
    capabilities of many participants with
    different views and different strategies for hedging risks. Our
    financial system would be more robust if we relied on a market-
    based system that spreads interest rate risks, rather than on
    the current system, which concentrates such risk with these two
    GSE's.
        As always, concerns about systemic risk are appropriately
    focused on large, highly leveraged financial institutions such
    as the GSE's that play substantial roles in the functioning of
    financial markets. I should emphasize that Fannie and Freddie,
    to date, appear to have managed these risks well and that we
    see nothing on the immediate horizon that is likely to create a
    systemic problem. But to fend off possible future system
    difficulties, which we assess as likely if GSE expansion
    continues unabated, preventive actions are required sooner
    rather than later.
        As a general matter, we rely in a market economy upon
    market discipline to constrain the leverage of firms, including
    financial institutions. However, the existence, or even the
    perception, of Government backing undermines the effectiveness
    of market discipline. A market system relies on the vigilance
    of lenders and investors in market transactions to assure
    themselves of their counterparties' strength. Many
    counterparties in GSE transactions, when assessing their risk,
    clearly rely instead on the GSEs' perceived special
    relationship to the Government. Thus, with housing-related
    GSE's, regulators cannot rely significantly on market
    discipline.
        Determining the suitable amount of capital for Fannie and
    Freddie is both a difficult and technical process, and in the
    Federal Reserve's judgment, a regulator should have a free hand
    in determining the minimum and risk-based capital standards for
    these institutions.
        The size of Fannie and Freddie and the complexity of their
    financial operations and the general indifference of many
    investors to the financial condition of the GSE's because of
    their perceived special relationship to the Government suggest
    that the GSE regulator must have authority similar to that of
    the banking regulators. In addressing the role of a new GSE
    regulator, the Congress needs to clarify the circumstances
    under which a GSE can become insolvent and, in particular, the
    resultant position--both during and after insolvency--of the
    investors that hold GSE debt. This process must be clear before
    it is needed; otherwise, should these institutions experience
    significant financial difficulty, the hands of any regulator,
    and of public authorities generally, would be constrained by
    uncertainties about the process. Left unresolved, such
    uncertainties would only heighten the prospect that a crisis
    would result in an explicit guaranteeing of GSE debt.
        World-class regulation, by itself, may not be sufficient
    and, indeed, as suggested by Treasury Secretary Snow, may even
    worsen the situation if market participants infer from such
    regulation that the Government is all the more likely to back
    GSE debt. This is the heart of a dilemma in designing
    regulation for the GSE's. On the one hand, if the regulation of
    the GSE's is strengthened, the market may view them even more
    as extensions of the Government and view their debt as
    Government debt. The result, short of a marked increase in
    capital, would be to expand the implicit subsidy and allow the
    GSE's to play an even larger unconstrained role in the
    financial markets. On the other hand, if we fail to strengthen
    GSE regulation, the possibility of an actual crisis or
    insolvency is increased.
        Most of the concerns associated with systemic risks flow
    from the size of the balance sheets that these GSE's maintain.
    One way the Congress could constrain the size of these balance
    sheets is to alter the composition of Fannie's and Freddie's
    mortgage financing by limiting the dollar amount of their debt
    relative to the dollar amount of mortgages securitized and held
    by other investors. Although it is difficult to know how best
    to set such a rule, this
    approach would continue to expand the depth and liquidity of
    mortgage markets through mortgage securitization but would
    remove most of the potential systemic risks associated with
    these GSE's. Ideally, such a ratio would focus the business
    operations of Fannie and Freddie on the enhancement of
    secondary markets and not on the capture of the implicit
    subsidy.
        Limiting the debt of Fannie and Freddie and expanding their
    role in mortgage securitization would be consistent with the
    original Congressional intent that these institutions provide
    stability in the market for residential mortgages and provide
    liquidity for mortgage investors. Deep and liquid markets for
    mortgages are made possible using mortgage-based securities
    that are held by non-GSE private investors. Fannie's and
    Freddie's purchases of their own or each other's securities
    with their debt do not appear needed to supply mortgage market
    liquidity or to enhance capital markets in the United States.
        The expansion of homeownership is a widely supported goal
    in this country. A sense of ownership and commitment to our
    communities imparts a degree of stability that is particularly
    valuable to society, as Senator Sarbanes pointed out. But there
    are many ways to enhance the attractiveness of homeownership at
    significantly less potential cost to taxpayers than through the
    opaque and circuitous GSE paradigm currently in place.
        In sum, Mr. Chairman, the Congress needs to create a GSE
    regulator with authority on a par with that of banking
    regulators, with a free hand to set appropriate capital
    standards, and with a clear process sanctioned by the Congress
    for placing a GSE into receivership. However, if the Congress
    takes only these actions, it runs the risk of solidifying
    investors' perceptions that the GSE's are instruments of the
    Government and that their debt is equivalent to Government
    debt. The GSE's will have increased incentives to continue to
    grow faster than the overall home mortgage market. Because they
    already purchase most conforming mortgages, they, like all
    effective profit-maximizing organizations, will be seeking new
    avenues to expand the scope of their operations, assisted by a
    subsidy that their existing or potential competitors do not
    enjoy.
        Thus, GSE's need to be limited in the issuance of GSE debt
    and in the purchase of assets, both mortgages and nonmortgages,
    that they hold. Fannie and Freddie should be encouraged to
    continue to expand mortgage securitization, keeping mortgage
    markets deep and liquid while limiting the size of their
    portfolios. This action will allow the mortgage markets to
    support homeownership and homebuilding in a manner consistent
    with preserving the safe and sound financial markets of the
    United States.
        Thank you very much, Mr. Chairman, and I would appreciate
    it if my complete remarks are included for the record, and I
    look forward to your questions.
        Chairman Shelby. Without objection, your written statement
    will be made a part of the record in its entirety.
        Mr. Chairman, to go back over this again, you state that
    possible future systemic difficulties are likely if GSE
    expansion continues unabated. Why do you feel that such
    systemic problems are likely--your word--and what can be done
    to prevent such problems? I think this is important here.
        Chairman Greenspan. Senator, this is the most crucial
    issue. As I have stated in my written remarks, Fannie Mae and
    Freddie Mac are extraordinarily effective institutions, and
    they have done a great deal for this country in developing the
    secondary mortgage market, which has been a very important
    issue in the whole structure of the developed asset-backed
    securities markets in which they originally took the lead.
        The problem that exists is that because of the fact that
    they have a subsidy, granted, as I indicated before, not by the
    Congress, but by the expectation that Government will bail them
    out in the event of a crisis, they have been able to take a
    highly competitive position and, indeed, essentially are
    elbowing out a number of competitors who did not have such a
    subsidy, and as a result, they have been growing at an
    exceptionally rapid rate, increasing their share of the market.
    And if you project into the future, you effectively get a
    system in which they will be increasingly pressing to move
    beyond the mortgage markets because they need a continuous
    growth rate in their profitability to maintain the level of
    their stock price.
        Chairman Shelby. What do you mean ``move beyond the
    mortgage''--into other products?
        Chairman Greenspan. Yes, into other products and into
    nonmortgage areas. And to the extent that they are a profit-
    making organization, they are very properly concerned about the
    value of their stock, and the value of their stock has been
    largely a function of the extraordinarily stable gain in
    earnings, although I must admit that has come into question
    with respect to the accounting at Freddie Mac, but nonetheless
    they have been very effective increasing balance sheets,
    increasing earnings, and increasing stock prices.
        I must say to you these are very effectively run
    organizations, and I wish they would be running without their
    subsidy because I think they would still be doing very well.
        Chairman Shelby. Mr. Chairman, you stated that the GSE's
    receive a funding advantage from the market's perception that
    they are too big to fail. What about large banking institutions
    like Citigroup or Bank of America, does the market perceive
    them too big to fail in perhaps a different vein? Do they
    receive a similar funding advantage?
        Chairman Greenspan. I think they receive some, Senator.
        Chairman Shelby. Have you ever quantified that? Has anybody
    at the Federal Reserve?
        Chairman Greenspan. Yes, it is very substantially less than
    the types of numbers we are looking at. Remember that there are
    significant differences. Remember that these large banking
    organizations are fairly well-capitalized, far better, of
    course, than Fannie or Freddie, and they are supervised with
    respect to all of their actions and activities in a way which
    we are hopeful that the Congress will move on shortly on the
    GSE's.
        So the answer is, yes, there are similarities here, but the
    degree of difference is very large. And I would say one of the
    reasons why the issue of Fannie and Freddie did not arise
    earlier is they were not large enough, and they did not create
    a potential significant problem for the overall financial
    system--not that they do today, as I point out, but they will
    almost surely do in years ahead unless some changes are made in
    the structure of how these organizations function.
        Chairman Shelby. If these huge banking institutions,
    Citigroup, Bank of America and so forth, if they are perceived
    as too big to fail, do we need--
        Chairman Greenspan. Let me just say that I did not mean to
    imply that. I think there are some who do believe that. I do
    not think that is the general market.
        Chairman Shelby. There is a perception by some people that
    some of the largest banks are too big to fail.
        Chairman Greenspan. Yes, the reason I say ``not quite'' is
    that if you look at the prices of their securities in the
    marketplace, it is fairly evident that there is very
    considerable question as to whether in the event of failure
    they will in fact be bailed out. That is far less the case on
    the part of the securities of Fannie and Freddie, which very
    significantly indicate a generalized expectation of support by
    the Government in the event of crisis.
        Chairman Shelby. In that context, do we need to give the
    new proposed GSE regulator the same type of systemic risk
    powers that FDIC has?
        Chairman Greenspan. I would certainly think so, sir.
        Chairman Shelby. Senator Sarbanes.
        Senator Sarbanes. Thank you very much, Mr. Chairman.
        Chairman Greenspan, do you favor, as a goal, privatizing
    the GSE's?
        Chairman Greenspan. As a goal, I would, and, in fact, I
    have stated so on many occasions--but the main problem is to
    reduce the subsidy and to make these particular institutions
    far more balanced in the way they function in the market. I
    think privatizing them would do that, but I think, short of
    that, the types of recommendations that I have made will also
    do that.
        And since I fully recognize that my view about
    privatization is a highly minority point of view, I think it is
    sometimes important to go to the really important issue, which
    is eliminating the subsidy, and that could be substantially
    done and taken out of the marketplace as a crucial disturbing
    factor without privatization.
        Senator Sarbanes. Why do you think your view on
    privatization is a highly minority view?
        Chairman Greenspan. Because I have taken surveys amongst a
    lot of people.
        [Laughter.]
        Senator Sarbanes. Well, that explains the quantity of it,
    but it does not explain the quality of it. What is the
    rationale that prevents it or that keeps it as a highly
    minority point of view?
        Chairman Greenspan. I suspect it is an issue of experience
    and education. I believe my concern is that we do not get
    educated in a way which will make us all recognize that
    privatization is a potential goal.
        I do think that if Fannie and Freddie were to function
    mainly by securitizing mortgage-backed securities, which is a
    profitable business, I think that the extent of the subsidy
    which is involved in that is really quite small. And
    considering the advantages that would carry with it, I think it
    could be well within the realm of the types of subsidies which
    the Congress has created over the years, and certainly would
    not, in any way, from my point of view, induce concerns about
    systemic risk.
        The systemic risk issue is wholly related to the question
    of issuing debentures and investing the proceeds of those
    debentures in other assets, whether they be mortgages,
    mortgage-backed securities or, as a significant part of the
    portfolio of the GSE's indicate, nonmortgage assets.
        Senator Sarbanes. In a letter to Representative Baker back
    in 2000, you said that ``lower mortgage costs that may result
    from the implicit subsidy would result in housing expanding
    relative to nonhousing investment, including private-sector
    initiatives such as investment in productivity-enhancing plant
    and equipment.''
        Do you think, as a society, we channel too much capital
    into housing?
        Chairman Greenspan. I do not. I think that, from an
    economic point of view, there is no question that doing that,
    in a technical sense, is less efficient than moving capital
    into productivity-enhancing assets.
        I made a speech on Friday in which I indicated how
    important the issue of the sense of property rights and
    ownership is to the basis of a free market capitalist system in
    this country. And while I certainly recognize the
    inefficiencies that might technically be
    involved with respect to moving capital from so-called
    productivity-producing assets to homeownership, I think the
    value that homeownership has is far superior as an important
    value in maintaining our economic and social system than the
    question of efficiency.
        There is no doubt that it is, from a technical point of
    view, less efficient in the creation of wealth. But from the
    overall view of what is important for a market capitalist
    system, to have broad acceptance of property rights and a broad
    ownership of property in this country far exceeds, in my
    judgment, the values of the efficiency questions which I
    raised.
        Senator Sarbanes. Let me address this Passmore study. There
    are two CBO studies which find a greater reduction in mortgage
    rates for borrowers than the Fed study. You found a reduction
    of 7 basis points in the mortgage rates. The two CBO studies
    found 25 basis points in one, 35 basis points in the other.
        Now, in your testimony, you seem to dismiss this difference
    by saying that the Fed and CBO come essentially to the same
    conclusions, that shareholders were paying a portion of the
    subsidy. But the degree might be quite significant from a
    policy point of view. The CBO studies indicate the benefit to
    the public of the GSE's is considerably greater than one would
    conclude from the Fed study.
        Chairman Greenspan. But they are both very small in the
    sense that all of the analysis that we have done, and others,
    have indicated that 25 or 35 or 45 basis points has very little
    effect on the rate of homeownership or on housing starts. We
    have examined, over the years, the sensitivity of home
    construction and homeownership to interest rates.
        Senator Sarbanes. Let me be clear on this point. So you are
    shifting your argument now away from how much of the benefit
    goes to the borrower to the argument that even if all of the
    benefit went to the borrower, it would still not affect the
    rate of homeownership; is that correct?
        Chairman Greenspan. No. ``All of the benefits'' is a very
    large number.
        Senator Sarbanes. The CBO study has about two-thirds of the
    benefits going to the borrower.
        Chairman Greenspan. Let me put it this way, very
    specifically. There are two questions here. One is there is a
    gross subsidy and how much of it passes through directly to the
    homeowner, that number is a fraction of the total by everyone's
    calculation. And the question essentially is, is this an
    efficient way of creating homeownership, when we know,
    statistically, that the major contributors to homeownership are
    issues of downpayment and income? I am not saying that interest
    rates do not have an effect. What I am largely saying is that
    where the numbers are concentrated with respect to estimates,
    the notion that significantly enhances homeownership is
    something we find statistically difficult to sustain.
        One of the reasons why I am suggesting that this issue be
    examined in far greater detail is that we are dealing with a
    very major public policy question, and how one concludes on
    this issue and how one decides what to do I think requires the
    best analysis.
        Obviously, Wayne Passmore and his staff had full access to
    the previous studies, and I think it is a question of people
    sitting down who are technically expert in this field and
    making judgments of which sets of data are accurate. I will
    just say this: One, all of the estimates imply that a very
    significant amount of the subsidy goes to the profits of these
    institutions and, two, the major estimates indicate levels
    which do not historically suggest to us that they have a major
    impact on homeownership. I would suggest, finally, that issues
    of downpayment be looked at far more carefully. FHA, for
    example, does it quite efficiently in that regard.
        Senator Sarbanes. Mr. Chairman, I am still not getting an
    answer. If all of the benefits pass through, I take it, it
    would still be your position against because you do not think
    it affects homeownership rates; is that right?
        Chairman Greenspan. First of all, let us remember this is
    not a legal subsidy. This is a subsidy granted by the private
    sector. If all of the subsidies went through, and it was
    sanctioned by the Congress, I would say that was an appropriate
    procedure by which the Congress endeavored to lower mortgage
    interest rates, which have value.
        I am not saying it has no value. I am just saying its
    impact on homeownership and on housing starts is not great, but
    it is obviously a very important financial advantage to a
    homeowner to get a lower interest rate, and if the whole
    subsidy were passed through to homeowners, it would make a
    significant difference. I am saying that it is not a
    substantial proportion and that, in my judgment, is not the way
    a subsidy should function.
        Senator Sarbanes. Thank you, Mr. Chairman.
        Chairman Shelby. Senator Allard.
        Senator Allard. Thank you, Mr. Chairman.
        I am going to base my question on what you think the impact
    of the debt that both of the GSE's have on our economy
    potentially. I have been looking at some of the figures too.
    The figures I have is on the CBO. I think they said about 50
    percent of the value of the subsidy goes to homeowners and
    about 50 percent goes to administration, which is mainly
    executive salaries and then also the shareholder profits.
        And then I also look at the total debt that you have in the
    GSE's. It is around $2.2 trillion I think in 2002, and the
    public debt for the Federal Government was at $3.2 trillion,
    and the trend, as expressed by Dr. Gregory Mankiw, who is
    Chairman of the President's Council of Economic Advisers, said
    if that trend continues, it could exceed the privately held
    debt of the Federal Government.
        So my question to you, Mr. Chairman, and I would appreciate
    hearing your thoughts on the future of the GSE's, as it relates
    to debt and systemic risk, and do you believe that this debt
    poses any threat to the U.S. economy?
        Chairman Greenspan. I believe the process, in the long-run,
    would, in the sense that we have now in place a very ambiguous
    structure which I do not think should be allowed to continue.
    Either the Congress should agree that, in the event of default,
    it will guarantee GSE debt or not. If the former is the case,
    then it should be stipulated explicitly, and the Congress
    obviously can do that, and that would clarify a good deal of
    the issue.
        The problem is that, unless that is done, we are confronted
    with a situation in which, on the one hand, there is a general
    belief in the marketplace that these securities are backed by
    the full faith and credit of the U.S. Government, even though
    they are explicitly not so stated, and the law says they are
    not, and the question is, the larger that debt becomes, the
    more this is an issue.
        What we have is an ambiguity which, in the event of a
    crisis migth require explicit guaranteeing of the debt, and a
    crisis could occur not because Fannie and Freddie are doing
    anything wrong, and indeed, as I said in my opening remarks,
    they are very skillful operators. I think they do risk
    management exceptionally well, and I think they are very well-
    run organizations in general.
        The problem is that it is not in their control to really
    comprehend all of the type of crises that can arise, and
    because they have concentrated interest risk, what that
    basically means is that their ability to hedge that risk is
    limited; that is, it is theoretically possible to fully hedge
    interest rate risk. As a practical matter, it is extremely
    costly and never quite fully the case, for reasons I could get
    into, but I do not think it is really necessary at this point.
        My major concern is that if you just project this debt into
    the future without resolving either the subsidy question that
    is implicit there or what will happen in the event of a crisis,
    it may be many years hence before you can address the issue
    again. I find that an issue which can be addressed now or in
    the immediate future in a manner which would fend off that
    concern which I think will grow as the years go on.
        Senator Allard. Mr. Chairman, I even worry about the
    Federal Government. If the Federal Government guarantees this
    debt of $2.2 trillion, that would add into the public debt.
    That is going to have an impact, would it not?
        Chairman Greenspan. It becomes equivalent to public debt,
    certainly.
        Senator Allard. Yes, and then all of a sudden your public
    debt has really a marked increase, and I wonder what that would
    do, as far as instilling confidence in the economy when that
    figure would come out? It seems to me that even that would have
    an adverse impact on the economy.
        Chairman Greenspan. Well, I think the main issue here is to
    get this issue resolved sooner rather than later. I am not sure
    exactly what the impact would be now, but I would certainly
    agree with you if the issue were left to fester for a number of
    years, and we tried to address it at a later time.
        Senator Sarbanes. Is the Senator referring the U.S.
    Government debt?
        Senator Allard. Yes, I am referring to the debt that we
    have with the GSE's. He is assuming, in his response to me, he
    said, well, one way that we could assure that the debt would
    not be a problem, as far as the economy is concerned, is if
    there was a guarantee from the Federal Government.
        My point is, if there is a guarantee from the Federal
    Government, then that $2.2 trillion gets added into the $3.2
    trillion, and if people all of a sudden see that jump to $5.4
    trillion, that could have an impact on people's thinking, and
    consequently an impact on the economy.
        Senator Sarbanes. Oh, I see.
        Is the $3.2 trillion, that is the Government debt?
        Senator Allard. That is the public debt.
        Senator Sarbanes. And is that what we were told 3 years ago
    we were paying down too quickly?
        [Laughter.]
        Chairman Greenspan. I just want to point one thing out;
    that when the Government guarantees debt, it is handled in a
    somewhat different way. But from an economic point of view,
    there is no question that what you are stating is correct,
    Senator.
        Senator Allard. Mr. Chairman, may I proceed with a second
    question?
        Chairman Shelby. Go ahead. One more question.
        Senator Allard. I am interested in OFHEO. It has a lot of
    regulatory responsibilities, and the question I have is do you
    believe that funding for the regulator should be guaranteed in
    the President's budget or should it be subjected to the annual
    appropriations process? And also do you believe that the need
    for resources would differ greatly if the regulator resided
    independently rather than within the Treasury?
        Chairman Greenspan. With respect to the latter question, I
    am not sure, and I am not sure it should be an issue one way or
    the other.
        I do think that you want the funding of the resources of
    the new regulator to be outside the appropriations process, if
    that is at all feasible.
        Senator Allard. Mr. Chairman, my time has expired, and I
    appreciate your generosity on that.
        Thank you.
        Chairman Shelby. Senator Carper.
        Senator Carper. Thanks.
        Chairman Greenspan, I have a couple of questions I am going
    to ask, and I am going to ask you just to limit your responses.
    So just be as direct with me as you can, and I know you will.
        Let us just back up just for a moment, and just share, at
    least with me, and maybe with some of my colleagues, what is
    the wrong that we are trying to right here? What is the
    potential harm that we are trying to avert?
        Chairman Greenspan. I believe that is a very good question,
    Senator.
        What we are trying to avert is we have, in our financial
    system right now, two very large and growing financial
    institutions which are very effective and are essentially
    capable of gaining market shares in a very major market, to a
    large extent as a consequence of a subsidy that prevents the
    markets from adjusting appropriately. It prevents competition
    and the normal adjustment processes that we see on a day-by-day
    basis from functioning in a way that creates stability.
        It is basically creating an abnormality which the system
    cannot close around, and the potential of that is a systemic
    risk sometime in the future if they continue to increase at the
    rate at which they are.
        Senator Carper. You spoke of your own minority view as to
    the course that we should take with respect to privatizing the
    GSE's. You also shared with us a different approach, and I
    believe that it dealt with limiting GSE issuance of debt. Would
    you go back to that and just explain that again for us, please.
        Chairman Greenspan. Yes, Senator. There are two businesses
    here in the GSE's. First of all, the GSE's purchase mortgages
    from mortgage originators: Commercial banks, savings and loans,
    mortgage bankers, and the like.
        Part of their business is to securitize those mortgages,
    guarantee them, charge a fee for servicing and the guarantee
    and then selling the mortgage-backed security on to other
    investors like pension funds, commercial banks or a number of
    other institutions. That is a profitable business, and that is
    indeed the secondary mortgage market.
        There is another business which relates to the issue of
    taking part of the mortgages which are purchased and holding
    them on the balance sheets of the GSE's. These mortgages are
    selling at market interest rates. But if you have a subsidy in
    issuing debt, the GSE's are picking up an abnormal profit,
    which is the normal profit in the spreads plus the size of the
    subsidies, so that there is the incentive to put assets on the
    balance sheet, whether or not they are mortgages, corporate
    bonds, or other things which are on the GSE balance sheets,
    that, in effect, harvests the subsidy, which, remember, because
    it is not restricted by the Congress, can be expanded at will
    by the GSE's.
        And so what we have is a structure in which a very rapidly
    growing organization, holding assets and financing them by
    subsidized debt, is growing in a manner which really does not,
    in and of itself, contribute to either homeownership or
    necessarily liquidity or other aspects of the financial
    markets.
        There are disputes, I must tell you, and there are some
    people who do believe that has some effect on securities
    markets. I think the evidence here is very murky and clearly,
    in any event, more of a secondary issue than anything else.
        The crucial question there is these are two businesses.
    They are both subsidized. They both have a high rate of return
    on equity. Indeed, the rate of return on equity on the part of
    the GSE's is significantly above that of, say, large commercial
    banks, which is an indication that they have a special
    advantage. And I am saying that there is one part of this
    business which we should be endeavoring to get them to expand
    because that is the base in which the secondary mortgage market
    functions.
        The ownership of assets on the balance sheet is a very
    seriously lesser force. My own judgment is it has very little
    to do with either homeownership, home construction, or even
    having a very significant impact at all on interest rates. The
    real issue is the securitization, which is what Fannie and
    Freddie originated. They do an exceptionally good job of that
    technically.
        And my own view--and why I think privatization would be the
    thing for them to want to do--is I basically believe that if
    they were to fully privatize, they would be smaller
    organizations, their profit levels would be somewhat less,
    their price earnings ratios would be much higher, and in all
    likelihood they may even have greater market value largely
    because they do things so well.
        Senator Carper. My time has expired.
        Mr. Chairman, I had indicated earlier that I wanted to
    raise some questions relating to capital and different kinds of
    capital, but I am going to yield to Senator Crapo over there
    because my suspicion is he or Senator Enzi will probably get
    into that.
        Thank you.
        Chairman Shelby. Thank you.
        Senator Dole.
        Senator Dole. Chairman Greenspan, 2 weeks ago, the
    Comptroller General testified before this Committee and
    recommended that the legislation we consider contain clear
    criteria for nonmortgage investments.
        Your testimony clearly states that you support a limitation
    of nonmortgage investments. Would you elaborate on why this
    limitation is so important?
        Chairman Greenspan. Well, Senator, from the point of view
    of profitability of the GSE's, whether you hold mortgage
    assets, corporate bonds, or any form of securities not related
    to housing at all--indeed, any asset at all--will create a
    profit, because remember, since the issuance of debt, which has
    this implicit guarantee on it, is unrestrained--in fact, the
    initiation is wholly up to the GSE itself--it means that if you
    can find assets in which to invest the proceeds that are at
    market values, you will automatically generate a profit and in
    effect pick up an additional above-market profit to the extent
    that there is a lowered cost of your borrowed funds.
        I find very little in the way of this process which helps
    homebuilding--or, I should say, homeownership--and if the
    purpose of the structure of the GSE's is to enhance the
    secondary mortgage market, which was its original purpose, it
    is not clear to me that that does anything whatever except
    increase the profitability of the GSE's.
        Senator Dole. I appreciate how clear you are in your
    prepared testimony when you state that ``In the Federal
    Reserve's judgment, a regulator should have a free hand in
    determining the minimum and risk-based capital standards.''
        Should we have the regulator consider any factors other
    than safety and soundness when deciding what the proper level
    of minimal capital should be?
        Chairman Greenspan. Senator, I think it is very difficult
    to have mixed goals. It is tough enough as it is to have safety
    and soundness as your purpose in regulating an institution. And
    I would hope that to the extent that there are changes,
    enlargement, or anything with respect to the GSEs' mission that
    those things be kept separate from the issue of how capital is
    determined, because the purpose of capital in this particular
    context is to insulate the problems of a GSE from creating
    overall financial problems for the system as a whole.
        I would hope that the new regulator of the GSE's would have
    very much the same sorts of authority that the Federal Reserve,
    the Office of the Comptroller, and the FDIC have in order to
    manage the risks that we all are exposed to. To constrain that,
    I think, creates overall risks to the financial system which I
    do not think are desirable.
        Senator Dole. Now, it is my understanding that the GSE's
    consider families with incomes at or below 80 percent of area
    median income to be low income, while the Community
    Reinvestment Act defines families with incomes at or below 50
    percent of area median income to be low income.
        Chairman Greenspan, do you believe that we should create a
    uniform standard for what should be considered a low-income
    loan toward affordable housing goals?
        Chairman Greenspan. I think that is a determination for
    those who are directly related to housing policy in this
    country, because as I indicated before, homeownership is
    something which is strongly supported by this Nation and, as I
    said before, for good reason, and how one gets there is not
    necessarily through secondary mortgage market, which I
    certainly acknowledge does help, but there are lots of other
    things which relate to this policy, and I think that the
    integration of the homeownership goal and housing goal
    generally of the GSE's has to be consistent with the other
    goals of our policies in this area. But I could not give you
    any judgment as to how that should be reconciled.
        Senator Dole. When Fannie and Freddie established their
    automated underwriting standards, they established a standard
    in which no lender can compare its underwriting standards to
    those established by the GSE's. A loan is either accepted or
    rejected by the GSE's, with no idea as to how risk factors are
    weighted or why the borrower failed to qualify.
        How can this black-box underwriting be considered to
    support liquidity? Doesn't a liquid market need a significant
    degree of transparency?
        Chairman Greenspan. Senator, there is a problem here in the
    fact that these are private organizations, and that is private
    property, and they have developed it in a manner which they
    perceive to be of value, and I think one has to argue that it
    is clearly a significant value for these institutions.
        I think the issue that comes up is with respect to the
    question of transparency, largely because of this very
    ambiguous relationship with the GSE's, but in my judgment, so
    long as it is private property, it belongs to the GSE's and
    should not be made available except under extraordinary
    circumstances, and I think that is one of the issues which I
    think is on the table.
        Senator Dole. Thank you, Mr. Chairman. I think my time has
    expired.
        Chairman Shelby. Thank you, Senator Dole.
        Senator Reed.
        Senator Reed. Thank you very much.
        Thank you, Chairman Greenspan. Mr. Chairman, is there
    anything that we should do to make it clearer that the full
    faith and credit of the United States is not behind the
    operations of these GSE's, because much of our discussion this
    morning rests upon this subsidy of some kind, and yet--and I
    hope you can enlighten me--it appears that we have taken steps,
    at least legally, to try to make it clear that these agencies
    will not be supported by us. I mean, there is always the
    hypothetical, but what more can we do I guess is the question.
        Chairman Greenspan. I think that there are innumerable ways
    to do that. A basic problem that we all have is that when
    somebody--a Government official or even groups of people in the
    Congress--may stipulate that that will not happen, they do not
    believe you, because they believe that in the event of a
    crisis, in effect, the Federal Government will not allow the
    institution to go into receivership.
        I presume there are ways in which the Congress can pass a
    law that prohibits it or does something, but you have to be a
    little careful because what you do not want to do is inhibit
    any forms of activity which are required in the event of a
    crisis.
        For example, we are the lender of last resort. In the event
    of a crisis of a major institution which we think were it to
    liquidate very quickly could create systemic instability, we
    will endeavor to find a way to liquidate it gradually, unwind
    the whole operation, obviously eliminate all shareholders value
    and perhaps even create some haircuts to the debt itself. But
    that process is necessary in order to prevent a shock to the
    system and a destabilization.
        So it is not an easy issue to resolve, but I do think that
    in the wisdom of the Congress, you will find a way, if that is
    your desire, to make that clear and in effect, perhaps, in the
    way in which the receivership issue gets handled in the new
    regulator, convey that implicit in that are potential haircuts
    to debt.
        Senator Reed. As an aside, perhaps, but is your policy that
    you have just announced with respect to institutions that you
    govern reflected in their equity prices and their ability to go
    to the market and receive the more preferential rates?
        Chairman Greenspan. Do you mean is our general policy--
        Senator Reed. For a large money center bank, do you think
    it is reflect there as you suggest it is reflected in the
    ability of Freddie and Fannie to go to the equity markets and
    the debt markets?
        Chairman Greenspan. For Fannie and Freddie, it is very
    clear that it is reflected. If you look at the prices of debt
    of some major commercial banks, you see some of it, but far
    less. In other words, senior debt on the part of the major
    banks has higher yields than senior debt on the part of Fannie
    and Freddie. And the reason for that is largely there is a
    different view. While there is a Federal safety net for our
    depository institutions, the market does not view that debt as
    risk-free, essentially, and as a consequence requires a higher
    yield than the market requires of Fannie and Freddie.
        Senator Reed. Let me turn to a question that I raised in my
    opening statement. This goes to how we can support policies for
    better, more affordable housing--not just homeownership but
    multifamily housing that provides for citizens who cannot yet
    afford a house.
        What I think you have been saying is that there is an
    implicit subsidy because the market reads what we do or thinks
    that we will step in at the last minute. This implicit subsidy
    is not fully passed through to achieve the goals that we have
    outlined--homeownership, expansion of those opportunities. Do
    you think as a matter of policy it would be appropriate for us
    to somehow recapture some of that undistributed benefit for
    housing programs?
        Chairman Greenspan. I think that is an issue for Congress
    to make a judgment on. In other words, I am not against private
    institutions making a profit. I feel uncomfortable when their
    profit is made by subsidies. And I am not in a position to make
    a judgment as to where the Congress draws the line, but in this
    case, I will say, and I have said many times in the past, I do
    not think it is wise for this very odd situation to continue
    indefinitely, namely, that the markets believe that the
    Government will do one thing, the Government says it will not,
    and down the road eventually from that point of view is a very
    serious financial problem.
        So clarification of this question I think is very
    important. If the Congress decides that it is perfectly all
    right for a significant part of the subsidy to go to
    shareholders, that is a judgment for the Congress to make.
        Senator Reed. And on the contrary, some of that subsidy
    should be returned in some way into the marketplace for
    homeownership--is that a legitimate judgment also?
        Chairman Greenspan. Sure.
        Senator Reed. Thank you.
        Chairman Shelby. Senator Crapo.
        Senator Crapo. Thank you very much, Mr. Chairman.
        Chairman Greenspan, I have a number of issues I want to try
    to get into, so I will try to move as quickly as I can through
    them. But first, before I get into the capital requirement
    issue, I noted in your testimony that you have stated that the
    Federal Home Loan Banks are not the focus of your testimony
    today but that much of what you have to say today applies to
    them as well. In fact, you say that because the Federal Home
    Loan Banks can design their advances to encompass almost any
    type of risk, they are even more complex to analyze than the
    GSE's.
        As you know, we are looking at establishing a new
    regulator. If such a new regulator were established, do you
    believe that the Federal Home Loan Banks as well as the GSE's
    should all be under the same regulator?
        Chairman Greenspan. I do, Senator.
        Senator Crapo. With regard to the capital standards, in
    your testimony you state that ``Determining the suitable amount
    of capital for Fannie and Freddie is a difficult and technical
    process, and in the Federal Reserve's judgment, a regulator
    should have a free hand in determining the minimum and risk-
    based capital standards for these institutions.''
        Do you believe that in any legislation we establish, we
    should stay away from establishing a capital standard but
    instead set the risk-based factors or at least get some kind of
    policy analysis so that the regulator is involved in setting
    both the minimum and the other risk-based capital requirements?
        Chairman Greenspan. Senator, I think that the way it is
    handled for depository institutions is the model that I think
    should be followed, which is there is a generic authority given
    to the regulator. For example, we have as you know under FIDICA
    a set of catgories which the Congress put in legislation not in
    numbers but in the nature of where we should be putting various
    different sorts of numbers. I believe the 2 percent is
    statutory. But there is very considerable discretion on the
    part of regulators as to where we then essentially translate
    the notions expressed by the Congress in legislation into
    numbers, and those numbers will change from time to time, as
    indeed they should.
        So, I would say you could do worse than just take a look at
    the statutes which you enable us to function under.
        Senator Crapo. Thank you.
        With regard to your testimony, you also indicated that the
    leverage which Fannie and Freddie now are able to utilize would
    not be possible without the expectation of a Federal guarantee.
    Do you believe that the current capital standards that Fannie
    and Freddie operate under are too low given the risk that is
    being incurred?
        Chairman Greenspan. Senator, it is difficult to make a
    judgment, and let me express why. There is a tradeoff in
    interest rate risk or management. It is, as I indicated before,
    theoretically possible to so create a hedge structure that you
    fully eliminate all interest rate risk, and then, all you are
    dealing with is credit risk. And there is no question that
    mortgages per se are fairly safe instruments.
        My own suspicion is that there is likely to be some
    increase in capital requirements if you have a regulator,
    largely because it is very difficult to get what we call
    ``convexity hedging'' as the result of a tendency in a big
    refinance boom for problems to arise.
        The general issue is that you can create a very significant
    hedge but not without very significant cost. So that there is a
    tradeoff here between the cost that the GSE's are willing to
    expend, effectively, to get zero duration gap, and appropriate
    convexity hedging, and the issue of capital. There are
    tradeoffs.
        So it is conceivable to me that Fannie and Freddie could
    set up a set of hedges which would require very little capital
    to be supported. But remember, crucial here is the fundamental
    question which comes first--is the Federal Government going to
    stand behind those instruments?
        If indeed the Federal Government is going to guarantee the
    debentures of Fannie and Freddie, the required capital is
    called ``zero''--you do not need any capital under those
    conditions.
        Senator Crapo. Thank you. That leads to the last question I
    wanted to ask. I would like to into a lot more on the capital,
    but I just have one last question to ask, and that is, assuming
    that it would be the policy of the Congress to make it clear
    that the Federal Government was not providing a guarantee and
    that we were to do something in any legislation to try to
    clarify that, I am struggling with exactly how we would
    effectively do so.
        For example, we could put language in the statute that said
    the Federal Government will not guarantee the insolvency of
    Fannie and Freddie, but there would still, it seems to me, be a
    perception----
        Chairman Greenspan. They will not believe you.
        Senator Crapo. Yes. That is the point. I mean, we can say
    it in the statute, and we could even put ``and we really mean
    it,'' but the question is how do we actually make it clear that
    this Congress will not back?
        Chairman Greenspan. I think the only way to do it--and I am
    not necessarily recommending this, because I think it is a very
    sensitive issue in the marketplace would be if you were to
    clarify how one would actually create a receivership and what
    would happen to the various holders of debt and equity and
    various other instruments, how they would be handled in
    advance, it might actually create a greater reality than I
    think merely a firm stipulation that you will not do anything
    would carry.
        Senator Crapo. Thank you. I look forward to working that
    out in a little more detail with your thoughts on that, and
    perhaps we might even find some procedural mechanisms to put
    into place that would require a super-majority vote in
    Congress. But I am not even sure we could pull that off. So, I
    thank you for those thoughts.
        Chairman Shelby. Senator Stabenow.

                  STATEMENT OF SENATOR DEBBIE STABENOW

        Senator Stabenow. Thank you, Mr. Chairman, and welcome,
    Chairman Greenspan.
        First, I would just indicate to you, Mr. Chairman, that
    given the comments about the importance of downpayments in
    terms of helping in homeownership, I would just point out that
    Senator Gordon Smith and I have for some time introduced a
    first-time homebuyers' tax credit that we believe is
    substantial and would help homebuyers, and we would welcome the
    opportunity to bring it up before the Committee and have the
    opportunity to debate and pass that legislation.
        Before questions, I do have an observation, though, Mr.
    Chairman. I have watched as a member of the Budget Committee
    and had the honor of hearing you on a number of occasions on
    the Budget Committee as well as before this Committee debating
    the importance of paying down debt and the relationship to
    interest rates and the fact that we know, even during difficult
    economic times that it has been the housing market that has in
    large part sustained us because of low interest rates.
        So, I find it interesting and surprising that now we would
    be saying today that interest rates do not matter that much for
    people, when I truly believe that in the situation that we have
    been in, and the challenging times economically, in fact the
    actions of your agency and the low interest rates and the
    housing market, the refinancing, the purchasing of new homes,
    has been a substantial part of driving the economy and helping
    people into homeownership.
        I am surprised to hear you say somehow that interest rates
    do not matter, or that somehow the ability for Freddie Mac and
    Fannie Mae to make a difference on interest rates would not
    make a difference. Certainly it makes a difference in the
    monthly payment I know that I make, and I look very closely, as
    my constituents do, at the interest rate and how it relates to
    the payments that they have to make in order to buy a home.
        Chairman Greenspan. I think you are raising an important
    issue which probably should have been discussed earlier.
        All the evidence that we have suggests that the types of
    interest rate changes that really matter are not basis points
    but percentage points. In other words, you really need 1 or 2
    percentage points' change to really change the overall outlook.
        There is no question, though, that any small change in
    interest rates does affect the monthly payment that people make
    on their mortgages. But I want to point out that to the extent
    that that decline is the result of a contingent liability that
    might be arising because of a subsidy, the homeowner as
    taxpayer is actually taking on a commitment which is probably
    as large in some cases and under certain assumptions larger
    than the benefits that they would get from the lowered monthly
    payments.
        There is no question that lowering interest rates--for
    example, all the refinancing that we went through--had a very
    important impact on consumer purchasing and on the basic
    economic well-being of the average American household. But all
    of our analysis--and we have done this for years, and so has
    everybody else--suggests that you really need far greater
    decreases in interest rates than 25 basis points, for example,
    to have a significant impact on either homeownership or on home
    construction.
        Senator Stabenow. I appreciate you clarifying that, because
    I do believe that in fact what you are saying is true in terms
    of interest rates and the importance of interest rates.
        I do have a question regarding the Passmore analysis in
    looking at this more closely and the really startling assertion
    that the GSE's do not contribute a significant rate difference
    between conforming and jumbo mortgages.
        I notice that in the study--which admittedly is very
    complicated, as you have said; it is a complex economic
    exercise--Mr. Passmore's study concedes, though, that ``These
    data are not up to the tax of measuring the GSEs' effect on
    mortgage rates precisely.''
        My question is given the fact that he is admitting the
    complexity and that they have not been up to the task of
    measuring the effect precisely, this would suggest that the
    information is possibly incomplete or possibly inaccurate.
        The question I would have is why would we assume, then,
    that his conclusions are absolutely accurate and complete.
        Chairman Greenspan. The answer, Senator, is we do not. And
    we do something different. You are dealing in this particular
    area with very complex sets of relationships, and we have a
    number of very sophisticated statistical techniques which
    enabled us to get a model of how these markets function and, if
    we have data that is appropriate and accurate,
    interrelationships amongst various variables.
        By the very nature of the way we do it, we cannot precisely
    estimate anything, but we get ranges. I mean, for example, one
    of the criticisms on this came from Dr. Greene at NYU the other
    day, and I read his piece, and it is a very interesting piece.
    It demonstrates that certain of the relationships create errors
    in the way the calculations are made. And I could add four or
    five myself as to what assumptions are made.
        But what we do know is that in the very broadest sense,
    that even with all the errors, of which there are many, we can
    get a judgment of what is accurate.
        For example, when everybody says about the Passmore study
    that, oh, it is incorrect here or incorrect there, or it does
    not do this or it does not do that, I am waiting for somebody
    to come up with an alternate model. It is one thing to say,
    well, this is not necessarily the case--and I would say,
    absolutely. But I would argue, for example, there is this very
    serious question as to what proportion of the subsidy flows
    through to the homeowner. And the argument is--is it, say, 7
    basis points, 10 basis points, 12--the point at issue is what
    is the probability that all of the subsidy goes through to the
    homeowner. And I will tell you that approaches zero.
        In other words, we do not know exactly what the pass-
    through is--or, as Dr. Greene focuses on in his paper, the so-
    called ``omega parameter'' in Passmore's study--but we know
    with a high degree of probability that it is within a
    reasonable range, and that range essentially says that the
    proportion of the subsidy that flows through to the homeowner
    is far less than I suspect is conventional wisdom as to what
    happens in the world.
        So while it is certainly the case that all of these models
    are weak, in one form or another, they are very robust with
    respect to answering the question, in what range do these
    numbers tend to fall, as distinct from what the specific number
    is.
        I would suggest--and indeed, we are very thankful that
    people are trying to address this issue; I find that I am quite
    pleased that everybody is trying to help us--I ask, in addition
    to them helping us, instead of just saying this could be wrong,
    this could be wrong, this is likely to be in error, to come up
    with a system which is an alternative way of looking at the
    same problem and demonstrating that the conclusion, the generic
    conclusion that is made in the Passmore piece, is wrong.
        And I will tell you if they do that, we will be the first
    to say, ``Congratulations. That is a remarkable piece of
    analytical work.'' I am waiting.
        Senator Stabenow. Mr. Chairman, if I might just quickly ask
    one other issue, because I think there is another important
    piece of all that. That is, as we are talking about the
    benefits of the GSE's, we also give them responsibility, we
    also give them affordable housing goals, we also set up certain
    criteria for them--and, as you are suggesting privatizing on
    the one side, of course, then the question is will in fact
    those goals be able to be met on the other side, and wouldn't
    eliminating the Government sponsorship and eliminating the
    affordable housing goals redirect capital in the second market
    toward loans that are easier to make. Often, these are
    difficult goals to achieve, and there are public purposes for
    it, which is why we have the GSE's in the first place, and I
    would have a real concern about whether or not capital would be
    redirected in the secondary market without this relationship.
        Chairman Greenspan. I understand your concern, but we have
    the Federal Housing Administration, they come directly at the
    issue of homeownership by effectively getting downpayments
    down. I am not sure that there are not a whole series of
    alternate means to enhance homeownership.
        I think that the GSE's, whether private or not private, are
    exceptionally well-structured to maintain a viable secondary
    mortgage market, which is an extraordinarily valuable asset in
    this country.
        The issue of the impact on homeownership is far more
    directly done by other means. If, for example, these
    institutions were privatized, I think that you are quite right,
    they would not and should have as a private organization any
    requirement of homeownership responsibility. But I do believe
    there are innumerable other vehicles to do that. They are not
    the only ones to do it, and actually, I am not sure that that
    is an efficient way of doing it.
        What they do is a very efficient way of maintaining a
    viable, deep, and liquid mortgage market which has great
    importance beyond housing. But I would never consider that that
    particular economic structure is well-suited or best-suited for
    the purpose of enhancing homeownership.
        Senator Stabenow. Thank you.
        Chairman Shelby. Senator Sununu.

                  STATEMENT OF SENATOR JOHN E. SUNUNU

        Senator Sununu. Thank you, Mr. Chairman.
        Mr. Greenspan, oftentimes going last means we get a choice
    to either ask you strange questions that have not yet been
    asked or just to make you repeat the good stuff, so bear with
    me here as I try to add something to this discussion. And I
    know that you want to talk more about ``convexity'' and
    ``omega,'' but I do not understand any of that.
        I do understand a little bit about risk, though, and you
    spent some time talking about an ideal world where these GSE's
    could hedge all of their interest rate risk. It would be
    expensive, but they could do it.
        Now, even if that were accomplished, is it still the case,
    however, that they would maintain credit risk, and they would
    maintain prepayment risk and therefore need to have some
    minimum capital that is regulated by the regulator that we have
    been talking about?
        Chairman Greenspan. Well, they can with difficulty hedge
    prepayment risk. It is expensive, and it is a little tricky,
    because it sometimes requires that you get in what is called
    ``delta hedging'' and complex types of hedging instruments, and
    they do not always work, as indeed we have found out in the
    last year. A number of organizations tried to hedge their
    interest rate risk and largely failed.
        But it is possible to take out numbers of different types
    of hedges. There are difficulties in the event of a crisis
    where you could get both Fannie and Freddie trying to get the
    same type of hedge in the same market, and it may be difficult
    to do. But that is a technical question.
        All I was trying to stipulate was that capital is not the
    sole criterion to essentially cover interest rate risk and that
    credit risk as such is indeed rather small in the holding of
    mortgage assets, and the amount of capital required for that is
    clearly lower than C&I loans or credit card debt or something
    of that nature.
        I was merely raising the issue of these without talking
    about what degree of hedging you have succeeded in doing, the
    determination of what is the appropriate amount of capital for
    interest rate risk is not determinative.
        Senator Sununu. It is my understanding that roughly 60
    percent of the country's banking institutions hold at least
    half of their equity capital in GSE debt. Is that a number that
    you agree with, and to what extent does that contribute to some
    of the concerns of systemic risk that you discussed in your
    testimony?
        Chairman Greenspan. It is a large number. I do not know
    whether it is the explicit number. My concerns are not related
    to that per se. In other words, my concerns are that if we
    stabilize the system and create an overall model which can go
    forward over the longer-term, there is no reason to believe
    that those particular instruments are in any way open to
    question.
        But I think the major issue is to focus on where the
    current relationships will lead us if we do not change
    direction.
        Senator Sununu. Doesn't the degree to which our financial
    institutions depend on these securities as a part of their
    equity capital make getting this regulatory structure more
    important?
        Chairman Greenspan. I think that here is where supervision
    really matters. That is, every one of the banks are scrutinized
    with respect to what they have and where their concentrations
    are, and I think there are lots of discussions that go on
    between bank supervisors and the officers of the commercial
    banks. My judgment is that there is a considerable amount of
    effort on the part, I know, of our supervisors to be fairly
    vocal on the question of concentration of risk within
    particular institutions. And I suspect, but I do not know in
    detail, that that issue is up front, discussed, and evaluated
    and the risks understood, I believe, by both the regulators and
    the banks.
        Senator Sununu. You described a second business, two
    businesses, that the GSE's are engaged in. The second business
    you described as one where the GSE's hold mortgages or
    mortgage-backed securities on their books that are paid
    interest at market rates, and they finance the purchase of that
    portfolio with their own debt, which is discounted because of
    the implied subsidy that we have been talking about. That is a
    good business. What would you call that business? Is it fair to
    call that a form of arbitrage?
        Chairman Greenspan. It is a perfectly sound business, and a
    lot of organizations engage in it. My only concern is that
    there is a subsidy in the liability side of the balance sheet.
        Senator Sununu. Is it fair to describe that business as
    arbitrating their implied subsidy?
        Chairman Greenspan. No.
        Senator Sununu. Or, their implied guarantee.
        Chairman Greenspan. Well, I do not know if the word
    ``arbitrage'' is the right term there. What they are doing is
    very simple. They are borrowing money, and they are investing
    it, and that is a financial intermediation activity. Arbitrage
    is usually related to differences between prices, but here, it
    is just a big, fat gap which they can use.
        Senator Sununu. There is a subtlety there that escaped me,
    but I think the point was made.
        You suggested that that business, that second business,
    does not contribute to homeownership rates. Is that a fair
    characterization?
        Chairman Greenspan. I would be surprised if anybody could
    demonstrate that it had a significant impact on homeownership.
    I am waiting to see the evidence. I have seen none.
        Senator Sununu. Would you recommend by extension any
    absolute limits, limitations, on the size of the portfolio that
    the GSE's could then hold?
        Chairman Greenspan. At this stage, I have not given very
    much thought to that. All I know is where I believe the problem
    is is right here, and the question is that first a judgment has
    to be made as to whether in fact the regulator or the Congress
    or people who are going to be making these judgments believe
    that that is indeed the case. If that is the conclusion, then,
    that is a secondary question as to where the appropriate
    numbers would be.
        My own judgment is that the extent of the subsidy
    increasing should not be at anywhere near the pace that it has
    been in recent years.
        Senator Sununu. There is a resolution introduced by Senator
    Schumer--I am sorry he is not here today--and I think it is
    cosponsored by half a dozen or so Members of this Committee,
    and in part the language of the resolution states: ``Whereas,
    Chairman Greenspan has provided a steadying hand on policy
    during periods of great financial risk for America; and
    whereas, Chairman Greenspan has carefully upheld the
    responsibility of the Federal Reserve to be unbalanced and
    impartial in its decisionmaking; and whereas, Chairman
    Greenspan possesses wisdom and experience and competence in the
    public''--now, I am sorry to say that I am not a cosponsor of
    the resolution, but it would seem to me that someone who was to
    unbiased and impartial and has these great qualities would be
    an excellent nominee to sit on the advisory board that has been
    contemplated and discussed in previous hearings for overseeing
    a new regulator.
        Wouldn't those be good qualities to have as a board member
    exercising fiduciary responsibility and oversight of such an
    important part of our financial system?
        Chairman Greenspan. Senator, it would if it were not for
    the fact that we have a potential large conflict of interest.
    On the one hand, we are involved in being the lender of last
    resort and the institution which has been required by the
    Congress to try to maintain systemic stability. If we were
    involved, I am fearful that we would have on the one hand the
    desire to make sure that the GSE's were whole the way all
    regulators do and we do for commercial banks, but we would
    clearly be concerned if we thought there were systemic risks
    involved in the process.
        So, I would say we would probably be uncomfortable in that
    particular role and hope that we are not asked to do so.
        Senator Sununu. Thank you, Mr. Chairman.
        Chairman Shelby. Thank you.
        Chairman Greenspan, you have touched on a number of things
    here today, and I might go over a few that you have already
    talked about a little bit.
        We do have that ambiguous relationship--that is, the
    Federal Government--with the GSE's. How do we actually get rid
    of that ambiguity is a complicated, tricky thing. I do not know
    how we do it. You have alluded to it a little bit, but how do
    we define the relationship is important, is it not?
        Chairman Greenspan. Yes. Of all the issues that have been
    discussed today, I think that is the most difficult one,
    because you cannot have in a rational government or a rational
    society two fundamentally different views as to what will
    happen under a certain event, because that invites crisis and
    it invites instability, and invites a conclusion that the
    Congress will not be able to control unless it moves in advance
    and defines exactly how this issue will be resolved.
        One possibility--and as I said, it is difficult to know
    exactly how to construct this--is to define what would happen
    in the event of some form of crisis where you can define the
    nature of a receivership and who gets what under certain
    conditions. That would be a difficult thing to do. It would
    clarify the issue and perhaps clarify enough to remove the
    ambiguity going forward.
        Chairman Shelby. But there is a heck of a lot of difference
    between a conservatorship and a receivership. The banking
    system that we deal with up here every day, they are subject,
    at least technically, to a receivership. Is that correct?
        Chairman Greenspan. Correct.
        Chairman Shelby. Now, if we were to create some type of
    receivership in legislation, you could not just unwind
    overnight----
        Chairman Greenspan. No. The problem here----
        Chairman Shelby. It is very complicated.
        Chairman Greenspan. It is very complicated, and you have to
    be very careful not to undermine the GSE's in the process.
        Chairman Shelby. Because if you did, you could undermine
    some of the banking system----
        Chairman Greenspan. Absolutely.
        Chairman Shelby. --because the banking system are big
    investors here; is that right?
        Chairman Greenspan. This is the reason why I think this is
    a very sensitive question and the reason why it is an issue
    that I perceive to be necessary to be resolved in the longer-
    run.
        As I indicated early on, Senator, I think at the moment
    there is no evidence that there is any imminent systemic risk
    here, and that is precisely the reason why I think this is the
    time that you start to think about making certain it does not
    occur in the future.
        In the process of defining how this is done, remember, as
    you point out, that under existing statute, there is a
    conservatorship, not a receivership, which essentially says for
    all practical reasons that the Congress will bail out the GSE's
    in the event of a crisis.
        Chairman Shelby. It is another implied guarantee; is that
    right?
        Chairman Greenspan. Under existing rules, if there is a
    crisis, it is going to be very difficult for the Federal
    Government not to guarantee these assets. If that is not the
    decision of the Congress, something different has got to be
    done, and all I will say to you, as you very well understand,
    Mr. Chairman, this is a very difficult situation because we
    have extraordinarily viable GSE's.
        Chairman Shelby. That is right.
        Chairman Greenspan. Fannie and Freddie--I may criticize the
    issue of the subsidy, and that is basically because it is so
    starkly different for me in the sense that without the subsidy,
    as I have told my friends in both of these institutions, I
    think they would be far better off privatized, and one of the
    reasons is I think they are very well run.
        But if in the process of resolving this issue, we undercut
    these institutions, I think we will be doing the Nation a great
    disservice. So it is not a simple process as I see it.
        Chairman Shelby. Mr. Chairman, could we have a statement of
    public policy that we are very interested in--and we know why,
    for economic reasons, social reasons, and so forth--on private
    housing ownership in this country and at the same time state we
    are interested in sound financial institutions to help bring
    this about? Couldn't we do both, or can we?
        Chairman Greenspan. Mr. Chairman, I think we have to do
    both.
        Chairman Shelby. We have to do both. Okay.
        Fannie and Freddie are subject, as I understand it, to a 30
    percent risk-based capital add-on for operational risk. Is this
    sufficient to guard against operational risk?
        Chairman Greenspan. I do not know the answer to that.
        Chairman Shelby. Okay. Would you get back with us on that,
    maybe?
        Chairman Greenspan. I will get back to you, but I have a
    suspicion that it is a difficult question to answer unless you
    get involved----
        Chairman Shelby. Very complicated.
        Chairman Greenspan. --into the detail of what their
    potential operational risks could be.
        Chairman Shelby. Okay.
        Chairman Greenspan. But I will check and see if I can find
    somebody to address that.
        Chairman Shelby. Okay. Mr. Chairman, do you believe, or
    could you say that the GSE's now hold sufficiently diverse
    assets to protect against liquidity risk? You said you believe
    they are pretty well-managed.
        Chairman Greenspan. I would say generally they have quite
    adequate liquidity.
        Chairman Shelby. Mr. Chairman, we have had one hearing on
    Basel II here, and there has been some skepticism, as you know,
    from some of your regulator contemporaries expressed on some of
    the models that Basel II's framework would come about.
        You note in your testimony, ``In order to manage risk with
    little capital requires a conceptually sophisticated hedging
    framework'' and that--these are your words--``in essence, the
    current system depends on the risk managers at Fannie and
    Freddie to do everything just right.''
        If this is the case for Freddie and Fannie, who tout their
    risk management practices, shouldn't we have similar concerns
    with the reliance that Basel II would similarly place on such
    models, because they would change the whole capital structure
    as we know it, at least from up here?
        Chairman Greenspan. Yes. Fannie and Freddie are special
    cases which are quite different from the institutions that
    Basel II is directed at.
        In other words, this is a special case of highly leveraged,
    low credit risk, high interest rate institutions. I do not want
    to say they are unique, but they are close to that. The type of
    risk-based capital procedures that are involved in Basel II are
    far less complex types of issues than arise here, and also, it
    is a different type of risk management.
        Chairman Shelby. Okay. Mr. Chairman, one last question. You
    assert in your testimony that ``Fannie and Freddie's purchases
    of their own or each other's securities or their debt do not
    appear needed to supply mortgage market liquidity or to enhance
    capital markets in the United States.'' Those are your words.
        You suggest--and these are your words again--``deep and
    liquid markets that are provided by MBS's held by private
    investors.''
        What effect if any would we see on liquidity in the
    mortgage market where the GSE is prevented from holding these
    securities in their own portfolio?
        Chairman Greenspan. I do not think there should be a
    prohibition. I just think the size is what the issue is all
    about. In other words, to the extent that you need to hold
    securities for various different operations which facilitate
    the securitization operations of the GSE's, that is perfectly
    sensible.
        Chairman Shelby. Is that generally temporary, though?
        Chairman Greenspan. Well, the issue is not the temporary;
    it is a question that is a very small part of the portfolio
    they hold.
        Chairman Shelby. Senator Sarbanes.
        Senator Sarbanes. Thank you, Mr. Chairman.
        Let me just follow up on the question that the Chairman
    just put, because I think it is interesting. Some have argued
    that the GSE's provide important stability in the mortgage
    markets during periods of economic instability, and they cite,
    for example, the Asian debt crisis in 1998 or the business and
    bank recession of 1990-1992, and argue that the mortgage rates
    would have increased dramatically at that time--as in fact they
    did in the jumbo mortgage market and in other credit markets--
    but that the GSEs' ability to continue buying mortgages and
    mortgage-backed securities made a difference so that they
    helped play an important stabilizing role.
        What is your response to that?
        Chairman Greenspan. First of all, the reason that there
    were fairly significant purchases at that time is that during
    that crisis you had a flight to quality which pushed long-term
    Treasury rates down, and because the presumption was that the
    GSE debt was comparable to Treasury, its rates went down, and
    as a consequence of that, the margins opened up, and it became
    quite profitable to go in and purchase mortgages and mortgage-
    backed securities. So that the issue was not an endeavor to do
    something for the markets per se; it was a very sensible
    business decision.
        Senator Sarbanes. But did that endeavor contribute to
    stability?
        Chairman Greenspan. I think it did in part, yes; I said I
    think it did in part.
        Senator Sarbanes. Okay. Now, I was struck by your response
    to Senator Stabenow earlier on the effect of GSE's on mortgage
    rates in which you said, well, if it is 7 basis points, citing
    the Passmore study, and then you said, well, maybe it is 10 or
    maybe it is 12, and that was the range of your example. But are
    you familiar with the CBO study in 2001 that said the effect of
    GSE's on mortgage rates was 25 basis points?
        Chairman Greenspan. I am, Senator.
        Senator Sarbanes. And are you familiar with the CBO study
    in 1996 that said the effect of GSE's on mortgage rates was 35
    basis points?
        Chairman Greenspan. I am, Senator.
        Senator Sarbanes. I am interested why your range of example
    seemed to fall so significantly short of these other studies--
    excepting, at least in part, the argument that we have all
    these different studies, and we do not really know, which I
    think was the thrust of your argument, but then the range you
    gave really fell well short of these CBO studies.
        Chairman Greenspan. Well, I think you have to remember that
    as these studies progress, we are learning things, and each
    analyst has the ability to learn from previous estimates. The
    early estimates, as best I can judge, were much simpler in
    structure and in evaluation than those that have occurred more
    recently.
        Remember that Wayne Passmore and his colleagues who worked
    on this study were fully familiar with those previous studies
    and clearly, they had the choice of saying, well, they are
    right, or we can improve on them; and in the process, as best I
    can judge looking at the different techniques that are
    employed, the most recent study by Passmore and his colleagues
    is by far the most sophisticated and the one most likely to be
    accurate.
        Senator Sarbanes. There is considerable controversy over
    that.
        Chairman Greenspan. Oh, indeed, there is.
        Senator Sarbanes. Yes.
        Chairman Greenspan. And I might say that the one thing that
    I am quite pleased about, Senator, is that we are finally
    coming to grips with this issue, and I hope that a good deal of
    resources, private and otherwise, are applied in this
    direction. And as we said when we released the draft of the
    Passmore study, we hope that people will criticize it.
        Senator Sarbanes. Am I right in thinking that the rates
    offered by mortgage lenders are such that the rates on
    conforming mortgages are 25 to 30 basis points less than the
    jumbo loan rate?
        Chairman Greenspan. Let me say this issue that has been
    raised about--you can look in the newspaper, and you can find
    all these rates, and differ the jumbos look significantly
    different from the conforming--what Passmore and his colleagues
    did was basically to look at the actual transactions that
    occurred. Remember that these things that you read in the
    newspaper are list prices, and list prices have never, in any
    market, been a good reflection of what transactions were. And
    while there are questions about the quality of the transactions
    data--there is an issue there of whether or not there are sub-
    prime loans in those data----
        Senator Sarbanes. That is right.
        Chairman Greenspan. --but there is no question that you do
    not use posted prices or offers or listed prices when you have
    transaction prices, which is essentially the market, and it is
    the market which determines what the spread is between jumbos
    and conforming mortgages.
        Senator Sarbanes. What do you think that spread is?
        Chairman Greenspan. I think the numbers that came out of
    the Passmore studies look--since I did not do the actual
    numbers--they look to me like they did a fairly sophisticated
    job.
        Senator Sarbanes. What are those numbers?
        Chairman Greenspan. What is the actual number used in that?
    [Conferring.] Dr. Passmore says it is 16 to 19 basis points.
        Senator Sarbanes. That is Dr. Passmore there?
        Chairman Greenspan. That is Dr. Passmore.
        [Laughter.]
        And if you have questions for him, by all means go ahead.
        Senator Sarbanes. He actually exists.
        [Laughter.]
        He is not just a pseudonym in the Federal Reserve System.
        Chairman Shelby. He is real. Senator Sarbanes, he is real
    and breathing. We just saw him in action.
        Senator Sarbanes. I see that, I see that. Okay.
        Chairman Greenspan. Sorry I outed you, my friend.
        [Laughter.]
        Senator Sarbanes. Chairman Greenspan, Comptroller General
    Walker testified to this Committee that the Federal Housing
    Finance Board, FHFB, had just 10 examiners in July 2002 to
    examine the 12 Home Loan Banks--10 examiners--and the Board is
    planning to expand that to only 30 examiners by the end of this
    year.
        Now, most observers feel that the Federal Home Loan Banks
    are engaging in riskier activities than they used to be. This
    point of concern was raised by former Assistant Secretary of
    the Treasury Sheila Baer at a hearing held here last year.
        I understand, actually, that the OCC has as many as 20 or
    more examiners resident in each of the large national banks.
    What is your view of the capacity of the Federal Housing
    Finance Board to meet its supervisory responsibilities?
        Chairman Greenspan. The number seems quite low in the
    context of what the banking regulators' general relationship is
    between examiners and examined institutions. I do not know what
    the actual numbers are, but our number is very substantially
    greater, and I assume the Comptroller's is as well, than the
    numbers you cite.
        Senator Sarbanes. You said earlier that you thought the
    Federal Home Loan Banks should be brought under the umbrella of
    this supervisor of the GSE's, but I think it might be helpful
    to us if you gave us some of your rationale and reasons for
    thinking that.
        Chairman Greenspan. The reason basically is first that they
    too have a subsidy very similar to that of Fannie and Freddie.
    Indeed, the GSE subsidies are generally fairly consistent with
    one another.
        Then, of course, the major asset that is involved in the
    Federal Home Loan Bank System is mortgages. So both the assets
    and the liabilities are quite similar and have the same
    economic effects. And as a consequence, it would strike me that
    many of the principles that would be involved in supervising
    and regulating Fannie and Freddie would also be applicable,
    with some changes, to the Federal Home Loan Bank System.
        Senator Sarbanes. Well, the Chairman had to leave, and I am
    going to wrap it up. It is a great temptation, obviously, at
    this point, but I am going to forego that temptation and thank
    you, Chairman Greenspan, for coming before the Committee. We
    appreciate, as always, your testimony.
        The hearing stands adjourned.
        [Whereupon, at 12:13 p.m., the hearing was adjourned.]
        [Prepared statements and response to written questions
    supplied for the record follow:]
                 PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI
         As we are coming to the close of hearings on the regulatory
    oversight of the housing Government Sponsored Enterprises, we should
    take a step back to where we began. At that time, the focus of the
    hearings were on the accounting errors of Freddie Mac and whether the
    Office of Federal Housing Enterprise Oversight was sufficient in
    catching those errors in a timely and effective manner. Today, it is
    clear that the issues as well as our national housing agenda have
    become much broader than that.
         Not only are we discussing a new regulator for Freddie Mac and
    Fannie Mae but there has also been much discussion of whether to
    include the Federal Home Loan Banks into the system.
         Back in August, I sent a letter with a few of my colleagues to
    Treasury Secretary Snow that a new regulator for Fannie Mae and Freddie
    Mac should be established and that the new regulatory entity have
    sufficient resources and tools to oversee the complex financial
    instruments used by those two entities. In addition, I stated that the
    regulator must be independently financed. Today, I still believe that
    those issues are valid and necessary.
         Our housing market is still one of the most important driving
    sectors of our economy. That is due in large part to the Federal
    Reserve Board's ability to maintain low interest rates and from
    homebuyers being able to tap into the equity of their homes built upon
    the tremendous growth of the housing market. The housing industry bears
    little resemblance to what it looked like 15 years ago. However, from a
    rural State perspective, there are still improvements that can be made.
         As we debate the new regulatory structure of the Government
    Sponsored Enterprises, I believe that it is essential that we maintain
    the individual characteristics of Fannie Mae and Freddie Mac and the
    Federal Home Loan Banks. Wyoming, as a rural State, has benefitted from
    the unique nature of both systems. We must be cautious not to make any
    legislative changes that may limit the distinctions or cause those
    distinctions to disappear in the future. In addition, if the new
    regulator is to be entrusted with complete oversight of the
    Enterprises, the regulator must be structured as not to impede rural or
    Native American housing needs or the Enterprises ability to solve those
    difficult housing problems. I look forward to working with you, Mr.
    Chairman, and my colleagues as we will be considering legislation in
    the near future.
         Another vital component of the housing market is the need for
    reform of the real estate settlement process. The settlement process
    has helped us achieve the growth in the housing market. The Department
    of Housing and Urban Development has pending a regulatory proposal to
    amend the regulations implementing the Real Estate Settlement
    Procedures Act. This proposal has been very controversial both from a
    small and a large business perspective.
        Recently, I had the opportunity to meet with Acting Secretary
    Jackson. I told him that reform of the settlement process is essential,
    however, I strongly believe that it would be in the best interest of
    everyone involved that the rule be reproposed. This will allow everyone
    a fair opportunity to comment on whatever changes the Department
    intends to make. In addition, it will give the Department a chance to
    fix its flawed small business economic analysis. It is important this
    rule proposal be done properly otherwise it could significantly affect
    our strong housing market.
         Turning for a moment to topic unrelated to the housing industry,
    Chairman Greenspan, you recently stated before this Committee on the
    skills of our workforce, ``what will ultimately determine the standard
    of living of this country is the skill of the people.'' You went on to
    state, ``[w]e need a level of skills of our working population which is
    continuously becoming more conceptual to match the types of goods and
    services that consumers want.''
         The Workforce Investment Act Amendments is designed to accomplish
    the goal that you describe--preparing the 21st century workforce for
    21st century jobs. The well-being of our workers, their families, and
    our country depends on meeting this goal.
         This legislation has passed both the House and the Senate. In
    light of your comments, I am urging the leadership of both parties to
    appoint conferees on this vital legislation for the growth of our
    economy and for the jobs of our people.
         Thank you Mr. Chairman for holding this important hearing. And
    thank you Chairman Greenspan for being with us today.

                      PREPARED STATEMENT OF ALAN GREENSPAN

           Chairman, Board of Governors of the Federal Reserve System

                               February 24, 2004

        Mr. Chairman, Senator Sarbanes, and Members of the
    Committee, thank you for inviting me to discuss the role of
    housing-related Government Sponsored Enterprises (GSE's) in our
    economy. These GSE's--the Federal National Mortgage Association
    (Fannie Mae), the Federal Home Loan Mortgage Corporation
    (Freddie Mac), and the Federal Home Loan Banks (FHLB's)--
    collectively dominate the financing of residential housing in
    the United States. Indeed, these entities have grown to be
    among the largest financial institutions in the United States,
    and they now stand behind more than $4 trillion of mortgages--
    or more than three-quarters of the single-family mortgages in
    the United States--either by holding the mortgage-related
    assets directly or assuming their credit risk.\1\ Given their
    ties to the Government and the consequent private market
    subsidized debt that they issue, it is little wonder that these
    GSE's have come under increased scrutiny as their competitive
    presence in the marketplace has increased.
    ---------------------------------------------------------------------------
        \1\ Fannie Mae and Freddie Mac stand behind mortgages in two ways:
    The first method is to purchase mortgages, bundle them together, and
    then sell claims on the cashflows to be generated by these bundles.
    These claims are known as mortgage-backed securities (MBS). The second
    method involves Fannie's and Freddie's purchasing mortgages or their
    own mortgage-backed securities outright and financing those purchases
    by selling debt directly in the name of the GSE. Both methods create
    publicly traded securities and thus permit a wide variety and large
    number of purely private investors to fund mortgages. Using the first
    method, Fannie and Freddie are relieved of interest-rate risk but are
    still exposed to credit risk because they guarantee MBS investors
    against the risk that some homeowners will default on the underlying
    mortgages. The second method of funding mortgages increases Fannie's
    and Freddie's debt outstanding and expands their balance sheets. In
    this case, Fannie Mae and Freddie Mac must manage the interest rate,
    prepayment, and credit risks associated with the mortgages they
    purchase.
        In the conforming mortgage market, Fannie Mae and Freddie Mac,
    using these two methods, play dominant roles in funding and managing
    the credit risk of the mortgages, but they do not participate directly
    in the origination of mortgage credit. Depository institutions,
    mortgage bankers, and their affiliates originate most mortgages.
    However, the underwriting standards of Fannie Mae and Freddie Mac
    substantially influence which borrowers receive mortgage credit. As
    discussed below, because of Fannie Mae's and Freddie Mac's Government
    sponsored advantages, there currently is no secondary market for
    conforming mortgages other than that provided by Fannie Mae and Freddie
    Mac. If a bank chooses not to sell the mortgage that it originates, it
    must fund that mortgage and manage the associated credit and interest
    rate risks itself.
    ---------------------------------------------------------------------------
        In my remarks, I will not focus on the Federal Home Loan
    Banks, although much of this analysis applies to them as well.
    In fact, because the Federal Home Loan Banks can design their
    advances to encompass almost any type of risk, they are more
    complex to analyze than other GSE's and, hence, raise
    additional issues.
        During the 1980's and early 1990's, Fannie Mae and Freddie
    Mac (hereafter Fannie and Freddie) contributed importantly to
    the development of the secondary mortgage markets for home
    loans and to the diversification of funding sources for
    depository institutions and other mortgage originators.
    Although the risk that a home mortgage borrower may default is
    small for any individual mortgage, risks can be substantial for
    a financial institution holding a large volume of mortgages for
    homes concentrated in one area or a few areas of the country.
    The possible consequences of such concentration of risk were
    vividly illustrated by the events of the 1980's, when oil
    prices fell and the subsequent economic distress led to
    numerous mortgage defaults in Texas and surrounding states. The
    secondary markets pioneered by Fannie and Freddie permit
    mortgage lenders to diversify these risks geographically and
    thus to extend more safely a greater amount of residential
    mortgage credit than might otherwise be prudent.
        The key to developing secondary markets was securitization,
    and Fannie and Freddie played a critical role in developing and
    promoting mortgage securitization, the process whereby
    mortgages are bundled together into pools and then turned into
    securities that can be bought and sold alongside other debt
    securities. Securitization by Fannie and Freddie allows
    mortgage originators to separate themselves from almost all
    aspects of risk associated with mortgage lending: Once the
    originator sells the loan into the secondary market, he or she
    may play no further role in the contract. This development was
    particularly important before the emergence of truly nationwide
    banking institutions because it provided a dramatically
    improved method for diversifying mortgage credit risk. Fannie
    and Freddie demonstrated that, by facilitating the
    diversification of mortgage portfolios and insisting on the
    application of sound loan underwriting standards, the credit
    risk associated with holding conforming mortgages could be
    reduced to very low levels and could be distributed across a
    wide variety and large number of investors. This innovation in
    the mortgage market led to the securitization of many other
    assets and to the creation of many other types of securities.
    During the 1980's, the GSE's led the private sector in this
    innovation, and their contribution enhanced the stability of
    our financial markets.
        Mortgage securitization continues to perform this crucial
    function, and its techniques have now been applied by the
    private sector in many markets, including markets for
    automobile loans, credit card loans, nonconforming mortgages,
    and commercial mortgages. Asset-backed securities and the
    secondary markets in which they trade generally provide both
    households and businesses with excellent access to credit at an
    appropriate risk-adjusted interest rate. Moreover, credit
    supply is far more stable today than it was because it is now
    founded on a much broader base of potential sources of funds.
    The aspiring homeowner no longer depends on the willingness of
    the local commercial bank or savings and loan association to
    hold his or her mortgage. Similarly, the sources of credit
    available to purchasers of cars and users of credit cards have
    expanded widely beyond local credit institutions. Unbeknownst
    to such borrowers, their loans may ultimately be held by a
    pension fund, an insurance company, a university endowment, or
    another investor far removed from the local area. This
    development has facilitated the substantial growth of
    nonmortgage consumer credit. Indeed, in the United States, more
    than $2 trillion of securitized assets currently exists with no
    Government guarantee, either explicit or implicit.
        Given their history of innovation in mortgage-backed
    securities, why do Fannie and Freddie now generate such
    substantial concern? The unease relates mainly to the scale and
    growth of the mortgage-related asset portfolios held on their
    balance sheets. That growth has been facilitated, as least in
    part, by a perceived special advantage of these institutions
    that keeps normal market restraints from being fully effective.
        The GSE's' special advantage arises because, despite the
    explicit statement on the prospectus to GSE debentures that
    they are not backed by the full faith and credit of the U.S.
    Government, most investors have apparently concluded that
    during a crisis the Federal Government will prevent the GSE's
    from defaulting on their debt. An implicit guarantee is thus
    created not by the Congress but by the willingness of investors
    to accept a lower rate of interest on GSE debt than they would
    otherwise require in the absence of Federal sponsorship.
        Because Fannie and Freddie can borrow at a subsidized rate,
    they have been able to pay higher prices to originators for
    their mortgages than potential competitors and to gradually but
    inexorably take over the market for conforming mortgages.\2\
    This process has provided Fannie and Freddie with a powerful
    vehicle and incentive for achieving extremely rapid growth of
    their balance sheets. The resultant scale gives Fannie and
    Freddie additional advantages that potential private-sector
    competitors cannot overcome. Importantly, the scale itself has
    reinforced investors' perceptions that, in the event of a
    crisis involving Fannie and Freddie, policymakers would have
    little alternative than to have the taxpayers explicitly stand
    behind the GSE debt. This view is widespread in the marketplace
    despite the privatization of Fannie and Freddie and their
    control by private shareholders, because these institutions
    continue to have Government missions, a line of credit with the
    Treasury, and other Government benefits, which confer upon them
    a special status in the eyes of many investors.
    ---------------------------------------------------------------------------
        \2\ Conforming mortgages are mortgages that are eligible for
    purchase by Fannie and Freddie. Fannie and Freddie can purchase
    mortgages only below the conforming loan limit (currently $333,700) and
    will purchase only those mortgages that meet their underwriting
    standards, including, for many mortgages, the standard that the
    mortgage is equivalent in risk to a mortgage with an 80 percent loan-
    to-value ratio. This latter requirement makes it difficult to know the
    extent of the market, but market participants generally believe that
    Fannie and Freddie purchase a large share of the truly conforming
    mortgages.
    ---------------------------------------------------------------------------
        The part of Fannie's and Freddie's purchases from mortgage
    originators that they do not fund themselves, but instead
    securitize, guarantee, and sell into the market, is a somewhat
    different business. The value of the guarantee is a function of
    the expectation that Fannie and Freddie will not be allowed to
    fail. While the rate of return reflects the implicit subsidy, a
    smaller amount of Fannie's and Freddie's overall profit comes
    from securitizing and selling mortgage-backed securities (MBS).
        Fannie's and Freddie's persistently higher rates of return
    for bearing the relatively low credit risks associated with
    conforming mortgages is evidence of a significant implicit
    subsidy. A recent study by a Federal Reserve economist, Wayne
    Passmore, attempts to quantify the value of that implicit
    subsidy to the private shareholders of Fannie and Freddie. His
    research indicates that it may account for more than half of
    the stock market capitalization of these institutions. The
    study also suggests that these institutions pass little of the
    benefit of their Government sponsored status to homeowners in
    the form of lower mortgage rates.
        Passmore's analysis suggests that Fannie and Freddie likely
    lower mortgage rates less than 16 basis points, with a best
    estimate centering on about 7 basis points. If the estimated 7
    basis points is correct, the associated present value of
    homeowner savings is only about half the after-tax subsidy that
    shareholders of these GSE's are estimated to receive.
    Congressional Budget Office and other estimates differ, but
    they come to the essentially same conclusion: A substantial
    portion of these GSEs' implicit subsidy accrues to GSE
    shareholders in the form of increased dividends and stock
    market value. Fannie and Freddie, as you know, have disputed
    the conclusions of many of these studies.
        As noted by the General Accounting Office, the task of
    assessing the costs and benefits associated with the GSE's is
    difficult. One possible way to advance the technical discussion
    would be for the Congress to request disinterested parties to
    convene groups of technical experts in an effort to better
    understand and measure these costs and benefits.
        The Federal Reserve is concerned about the growth and the
    scale of the GSEs' mortgage portfolios, which concentrate
    interest rate and prepayment risks at these two institutions.
    Unlike many well-capitalized savings and loans and commercial
    banks, Fannie and Freddie have chosen not to manage that risk
    by holding greater capital. Instead, they have chosen
    heightened leverage, which raises interest rate risk but
    enables them to multiply the profitability of subsidized debt
    in direct proportion to their degree of leverage. Without the
    expectation of Government support in a crisis, such leverage
    would not be possible without a significantly higher cost of
    debt.
        Interest rate risk associated with fixed-rate mortgages,
    unless supported by
    substantial capital, however, can be of even greater concern
    than the credit risk. Interest rate volatility combined with
    the ability of homeowners to prepay their mortgages without
    penalty means that the cashflows associated with the holding of
    mortgage debt directly or through mortgage-backed securities
    are highly uncertain, even if the probability of default is
    low.
        In general, interest rate risk is readily handled by
    adjusting maturities of assets and liabilities. But hedging
    prepayment risk is more complex. To manage this risk with
    little capital requires a conceptually sophisticated hedging
    framework. In essence, the current system depends on the risk
    managers at Fannie and Freddie to do everything just right,
    rather than depending on a market-based system supported by the
    risk assessments and management capabilities of many
    participants with different views and different strategies for
    hedging risks. Our financial system would be more robust if we
    relied on a market-based system that spreads interest rate
    risks, rather than on the current system, which concentrates
    such risk with the GSE's.
        As always, concerns about systemic risk are appropriately
    focused on large, highly leveraged financial institutions such
    as the GSE's that play substantial roles in the functioning of
    financial markets. I should emphasize that Fannie and Freddie,
    to date, appear to have managed these risks well and that we
    see nothing on the immediate horizon that is likely to create a
    systemic problem. But to fend off possible future systemic
    difficulties, which we assess as likely if GSE expansion
    continues unabated, preventive actions are required sooner
    rather than later.
        As a general matter, we rely in a market economy upon
    market discipline to constrain the leverage of firms, including
    financial institutions. However, the existence, or even the
    perception, of Government backing undermines the effectiveness
    of market discipline. A market system relies on the vigilance
    of lenders and investors in market transactions to assure
    themselves of their counterparties' strength. However, many
    counterparties in GSE transactions, when assessing their risk,
    clearly rely instead on the GSEs' perceived special
    relationship to the Government. Thus, with housing-related
    GSE's, regulators cannot rely significantly on market
    discipline. Indeed, they must assess whether these institutions
    hold appropriate amounts of capital relative to the risks that
    they assume and the costs that they might impose on others,
    including taxpayers, in the event of a financial-market
    meltdown. The issues are similar to those that arise in the
    context of commercial banking and deposit insurance--indeed,
    they are the reason that commercial banks are regulated and
    subject to stringent regulatory capital standards.
        Traditionally, questions of capital adequacy for financial
    institutions have been evaluated with regard to credit and
    interest rate risks. However, in the case of the GSE's and
    other large regulated financial institutions with significant
    roles in market functioning, liquidity, and operation risks
    also need to be considered. Determining the suitable amount of
    capital for Fannie and Freddie is a difficult and technical
    process, and in the Federal Reserve's judgment, a regulator
    should have a free hand in determining the minimum and risk-
    based capital standards for these institutions.
        The size of Fannie and Freddie, the complexity of their
    financial operations, and the general indifference of many
    investors to the financial condition of the GSE's because of
    their perceived special relationship to the Government suggest
    that the GSE regulator must have authority similar to that of
    the banking regulators. In
    addressing the role of a new GSE regulator, the Congress needs
    to clarify the circumstances under which a GSE can become
    insolvent and, in particular, the resultant position--both
    during and after insolvency--of the investors that hold GSE
    debt. This process must be clear before it is needed;
    otherwise, should these institutions experience significant
    financial difficulty, the hands of any regulator, and of public
    authorities generally, would be constrained by uncertainties
    about the process. Left unresolved, such uncertainties would
    only heighten the prospect that a crisis would result in an
    explicit guaranteeing of GSE debt.
        World-class regulation, by itself, may not be sufficient
    and indeed, as suggested by Treasury Secretary Snow, may even
    worsen the situation if market participants infer from such
    regulation that the Government is all the more likely to back
    GSE debt. This is the heart of a dilemma in designing
    regulation for the GSE's. On the one hand, if the regulation of
    the GSE's is strengthened, the market may view them even more
    as extensions of the Government and view their debt as
    Government debt. The result, short of a marked increase in
    capital, would be to expand the implicit subsidy and allow the
    GSE's to play an even larger unconstrained role in the
    financial markets. On the other hand, if we fail to strengthen
    GSE regulation, the possibility of an actual crisis or
    insolvency is increased.
        Some observers have argued that Fannie and Freddie are
    simple institutions with a function that is clear to all. The
    evidence suggests that this is far from the case. The
    difficulties of creating transparent accounting standards to
    reflect the gains and losses associated with hedging mortgage-
    prepayment risk highlight that the business of taking on
    interest rate and prepayment risk is far from simple and is
    difficult to communicate to outside investors.
        Most of the concerns associated with systemic risks flow
    from the size of the balance sheets that these GSE's maintain.
    One way the Congress could constrain the size of these balance
    sheets is to alter the composition of Fannie's and Freddie's
    mortgage financing by limiting the dollar amount of their debt
    relative to the dollar amount of mortgages securitized and held
    by other investors. Although it is difficult to know how best
    to set such a rule, this approach would continue to expand the
    depth and liquidity of mortgage markets through mortgage
    securitization but would remove most of the potential systemic
    risks associated with these GSE's. Ideally, such a ratio would
    focus the business operations of Fannie and Freddie on the
    enhancement of secondary markets and not on the capture of the
    implicit subsidy.\3\
    ---------------------------------------------------------------------------
        \3\ Likewise, the ability of Federal Home Loan Banks to hold
    mortgages and mortgage-backed securities directly could also be
    limited, so that mortgage-related interest rate risks are managed by a
    variety of purely private investors.
    ---------------------------------------------------------------------------
        Limiting the debt of Fannie and Freddie and expanding their
    role in mortgage securitization would be consistent with the
    original Congressional intent that these institutions provide
    stability in the market for residential mortgages and provide
    liquidity for mortgage investors. Deep and liquid markets for
    mortgages are made using mortgage-backed securities that are
    held by non-GSE private investors. Fannie's and Freddie's
    purchases of their own or each other's securities with their
    debt do not appear needed to supply mortgage market liquidity
    or to enhance capital markets in the United States.
        The expansion of homeownership is a widely supported goal
    in this country. A sense of ownership and commitment to our
    communities imparts a degree of stability that is particularly
    valuable to society. But there are many ways to enhance the
    attractiveness of homeownership at significantly less potential
    cost to taxpayers than through the opaque and circuitous GSE
    paradigm currently in place.
        Even with a constraint on debt issuance, Fannie and Freddie
    would remain among the largest financial institutions in the
    United States and would be able to grow with the size of the
    mortgage markets. These are important organizations that,
    because of their implicit subsidy, are expanding at a pace
    beyond that consistent with systematic safety. They have made,
    and should--with less reliance on subsidies--continue to make,
    major contributions to the financial system of the United
    States.
        In sum, the Congress needs to create a GSE regulator with
    authority on a par with that of banking regulators, with a free
    hand to set appropriate capital standards, and with a clear
    process sanctioned by the Congress for placing a GSE in
    receivership. However, if the Congress takes only these
    actions, it runs the risk of solidifying investors' perceptions
    that the GSE's are instruments of the Government and that their
    debt is equivalent to government debt. The GSE's will have
    increased incentives to continue to grow faster than the
    overall home mortgage market. Because they already purchase
    most conforming mortgages, they, like all effective profit-
    maximizing organizations, will be seeking new avenues to expand
    the scope of their operations, assisted by a subsidy that their
    existing or potential competitors do not enjoy.
        Thus, GSE's need to be limited in the issuance of GSE debt
    and in the purchase of assets, both mortgages and nonmortgages,
    that they hold. Fannie and Freddie should be encouraged to
    continue to expand mortgage securitization, keeping mortgage
    markets deep and liquid while limiting the size of their
    portfolios. This action will allow the mortgage markets to
    support homeownership and homebuilding in a manner consistent
    with preserving the safe and sound financial markets of the
    United States.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                          FROM ALAN GREENSPAN

    Q.1 In recent years, Fannie Mae and Freddie Mac have tended to
    hold more loans and mortgage-backed securities in portfolio.
    Based on your review of available data and research, how would
    you respond to the assertion that these portfolio activities
    produce a greater reduction in interest rates than
    securitization activities?

    A.1. While it is possible that the GSEs' portfolio holdings
    might lower mortgage rates slightly more than their
    securitization activities, to date there is no credible
    evidence of this effect. Although one study claims to have
    found such an effect (Naranjo and Toevs, 2002), this study
    actually seems to compare overall GSE purchase activity
    (mortgages purchased to securitize and hold as well as
    mortgages purchased to securitize and sell), not the GSEs'
    portfolio holdings, to mortgage securitization. The study has
    other methodological problems as well. Wayne Passmore and Shane
    Sherlund, two economists at the Federal Reserve Board, have
    undertaken a similar study that improves the methodology and
    uses more recent data. Their results suggest that GSE portfolio
    purchases follow from higher mortgage rates, as the GSE's
    pursue profit maximization, but the resultant growth in GSE
    portfolios does not influence mortgage rates either up or down.
    I have included an appendix (see Appendix 1) that summarizes
    their method and results. As I suggested in my testimony, the
    Congress should consider asking a disinterested party to
    organize a series of conferences or papers for studying these
    important issues.
        In theory, there are two reasons why the GSEs' portfolio
    holdings might possibly yield lower mortgage rates relative to
    securitization. First, the GSE's might create some net new
    demand for mortgage assets through the debt issued to finance
    their portfolio. Second, the portfolio might transmit more of
    the GSEs' implied subsidy to homeowners than does mortgage
    securitization.
        With regard to net new demand, it is possible some
    investors might strongly prefer to hold GSE debt rather than
    mortgage-backed securities (MBS). Most likely, these investors
    have this preference because they wish to avoid prepayment
    risks associated with MBS or because they believe that GSE debt
    is implicitly backed by the U.S. Government and are looking for
    a higher-yielding alternative with the safety of Treasury
    securities. In the former case, the secondary market has
    established that it is capable of repackaging MBS and creating
    securities with minimal prepayment risk, and thus GSE
    securities are unlikely to create any net new demand because it
    does not tap a unique investor base for mortgage-related debt.
    In the latter case, the net new demand for mortgage assets
    comes from investors who are either confused about the status
    of GSE debt or who are sophisticated market participants who
    believe that regardless of what the Government says, it will
    bailout the GSE's should they encounter financial difficulties.
    This demand for GSE debt is the source of the systemic risks
    posed by the GSE's, as well as the source of large GSE profits,
    because these investors do not demand that the yields on GSE
    debt reflect the risks associated with GSE balance sheet
    expansion. Whether it is the source of lower mortgage rates for
    conforming mortgages is difficult to determine, but the
    potential costs associated with possible systemic problems from
    the GSEs' portfolios greatly exceed the costs of slightly
    higher mortgage rates that might result from making it clear to
    investors that the Government does not back GSE debt.
        The second way the GSE portfolio might lower mortgage rates
    is that the GSE's might pass through more of their portfolio
    subsidy to mortgage originators than they would pass through
    had they only securitized mortgages. The portfolio does indeed
    seem to account for a disproportionate share of the GSEs'
    subsidy. However, the GSEs' pricing advantage with regard to
    securitization alone seems to be adequate for enticing mortgage
    originators to sell conforming mortgages to Fannie Mae and
    Freddie Mac, suggesting that the higher subsidy associated with
    the mortgage portfolio (relative to mortgage securitization) is
    captured by the GSE shareholders.

    Q.2. The GSE's argue that the full benefit of their funding
    advantage is passed along to homeowners through reduced
    interest rates on conforming loans. When compared to the
    interest rates charged for jumbo loans, the reduction in
    interest rates is greater than the funding advantage, producing
    a greater than 100 percent pass-through of the subsidy. How
    would you respond to this characterization of the funding
    advantage and to the existence of a subsidy greater than 100
    percent?

    A.2. The definition of subsidy implied in this question seems
    to sum the GSEs' funding advantage (their implicit subsidy) and
    the value that GSE's add to the mortgage financing process. The
    GSE's do add value, which is one reason why I believe that if
    their implicit subsidy were eliminated, they would continue to
    be viable and important companies that could earn a normal
    economic rate of return. However, their value added is not part
    of the implicit Government subsidy.
        As for the assertion that 100 percent of the implied
    subsidy is passed through to mortgage borrowers, this appears
    to be false. As I noted in my testimony, Fannie Mae's and
    Freddie Mac's persistently higher rates of return for bearing
    the relatively low credit risks associated with conforming
    mortgages are evidence of a significant implicit subsidy. A
    study by Federal Reserve economist Wayne Passmore attempts to
    quantify the value of that implicit subsidy to the private
    shareholders of Fannie Mae and Freddie Mac. Consistent with
    studies conducted by the CBO, his study suggests that these
    institutions do not pass on much of the benefit of their
    Government sponsored status to homeowners in the form of lower
    mortgage rates.
        Indeed, Passmore's analysis suggests the amount that Fannie
    Mae's and Freddie Mac's implied subsidy lowers mortgage rates
    is likely less than 16 basis points, with a best estimate
    centering on about 7 basis points. Earlier studies yielded
    slightly higher figures. For example, analysis conducted by CBO
    (2001) estimated the effect to be between 18 basis points and
    25 basis points. Passmore's lower estimate is a result of newer
    data and a different technique that builds on earlier studies
    of this difference. Passmore's studies have been critiqued by
    several prominent economists. However, these critiques do not
    seem to change the results. I have attached an appendix (see
    Appendix 2) that responds to some of these critiques. As I
    mentioned above, the Congress may want to engage a
    disinterested party to examine these issues. We welcome
    comments on studies by Federal Reserve staff.

    Q.3.a. Fannie Mae's and Freddie Mac's outstanding debt and
    mortgage-backed securities are held by banks, pension funds,
    and foreign governments. In addition, their hedging activities
    link them to many other large financial institutions. How do
    bank supervisors currently monitor the GSE debt and MBS's
    holdings of insured institutions and how do they measure the
    potential risk of these holdings?

    A.3.a. Mortgage-backed securities of all types account for
    about 10 percent of the banking industry's assets, while agency
    securities (including direct obligations of GSE's) account for
    about 3 percent. Because these securities carry relatively
    little credit risk, they generally do not figure significantly
    in supervisory assessments of credit quality.
        Supervisors thus monitor a bank's mortgage-backed
    securities and, to a lesser extent, holdings of GSE debt as
    part of assessing the institution's interest rate risk
    exposure, These instruments can contribute significantly to a
    bank's interest rate risk position because of their multiyear
    maturities and, in the case of mortgage-backed securities, the
    embedded options they carry associated with prepayments on the
    underlying mortgage loans.
        As is discussed more fully in the response to question 5,
    supervisory efforts focus on assessing the adequacy of internal
    processes and risk measures relative to the institution's
    holdings and, more broadly, identifying ``outlier''
    institutions with potentially excessive levels of risk. All
    banking organizations are required to have management
    processes, controls and measurement systems that are
    commensurate with the risk characteristics of the instruments
    they hold. Banks with significant mortgage-related holdings are
    expected to have risk processes and measures that take account
    of the complexities present in such instruments, including the
    risks associated with prepayments.
        To assist supervisors (and the public) in monitoring these
    positions and the risks they may entail, commercial banks are
    required to provide information on GSE- and MBS-related
    holdings in their quarterly regulatory call reports. Banks
    provide information on the mortgage pass-through and other
    mortgage-backed securities they own, as well as direct
    obligations of GSE's and other Government agencies. Banks also
    report the contractual maturity of, and the presence of
    unrealized gains or losses on, their mortgage-backed
    securities, as well as the extent to which they are issued or
    guaranteed by Fannie Mae or Freddie Mac. Supervisors use these
    data in conjunction with a variety of screening tools to
    identify those institutions with the most significant risk
    profiles and devote greater attention to them in the
    examination process.

    Q.3.b. How do bank supervisors review the activities of the
    bank counterparties to Freddie and Fannie?

    A.3.b. Large banks that operate a dealer book in interest rate
    derivatives sell interest rate protection to their customers,
    including Fannie Mae and Freddie Mac, often as part of a
    broader business relationship that may include the provision of
    investment banking and other services to the GSE's.
        The ongoing supervisory process at these large institutions
    includes targeted examinations and continuous monitoring by
    resident examiners, much of which is directed at their dealer
    activities. Supervisors expect these banks to maintain the
    proper risk management processes and controls in their dealer
    operations including customer due diligence, ongoing
    measurement of counterparty credit risk exposures, clearly
    defined counterparty limits and thresholds, and appropriate use
    of credit mitigation techniques such as margin and collateral
    requirements. A significant portion of the supervisory process
    is devoted to the review of risk management processes,
    controls, and measurement tools, including measurement systems
    that estimate value-at-risk and the potential future credit
    exposure associated with derivative positions. Supervisory
    personnel routinely review internal reports from these
    institutions describing their exposures and positions,
    including listings of the bank's largest derivative
    counterparties and credit exposure to these counterparties.

    Q.4.a. Subordinated debt is valued as a tool in enhancing
    market discipline by proving a measure of the perceived risk
    profile of the issuer. How does GSE subordinated debt compare
    to GSE senior debt? Is the difference comparable to that of
    bank holding company subordinated debt versus BHC senior debt?

    A.4.a. The available evidence suggests that GSE debt spreads
    are sensitive to financial and political risks. GSE senior debt
    spreads over comparable maturity Treasury securities rose
    following the September 2002 Fannie Mae duration gap
    disclosure, the June 2003 Freddie Mac management shake-up, and
    the July 2003 announcement by the European Central Bank that it
    would eliminate its holdings of debt issued by Fannie Mae and
    Freddie Mac and that it would advise its national central banks
    to do the same (see figure entitled GSE Debt Spreads, top
    panel). Subordinated debt spreads over comparable maturity
    Treasury securities also rose in response to these events (see
    GSE Debt Spreads, middle panel).
        During the January 2002-December 2003 period, the average
    difference between subordinated debt spreads and senior debt
    spreads for the two GSE's were virtually identical, equaling
    about 46 basis points each for Fannie Mae and for Freddie Mac.
    Moreover, such differences did not increase after the events
    listed above, even though some of the events were specific to
    only one of these GSE's. Over the same period, the average
    differences between subordinated debt spreads and senior debt
    spreads for highly rated bank holding companies were
    considerably smaller. For example, Wells Fargo & Company and
    Citigroup (which had the same Moody's subordinated debt rating
    (Aa2) as did the two GSE's) had average differences between
    subordinated debt spreads and senior debt spreads of 16 and 30
    basis points, respectively.
        The differences between subordinated debt spreads and
    senior debt spreads are not directly comparable across GSE's
    and bank holding companies because GSE subordinated securities
    contain an interest deferral provision that is not a feature of
    bank holding company subordinated securities.\1\ It is the case
    that subordinated debt instruments issued by banks contain an
    interest deferral provision.\2\ When bank level differences
    between subordinated and senior debt spreads are compared with
    GSE differences between subordinated and senior debt spreads,
    they are more comparable and of similar magnitude (see GSE Debt
    Spreads, bottom panel). For example, the difference between
    subordinated and senior spreads for Wells Fargo Bank, N.A.,
    averaged 52 basis points during January 2003-December 2003,
    which is of similar magnitude to the difference between
    subordinated and senior spreads for Fannie Mae and for Freddie
    Mac, which averaged 47 and 48 basis points, respectively, over
    the same period.
    ---------------------------------------------------------------------------
        \1\ Under terms of the voluntary commitment, the payment of
    interest on all outstanding GSE securities must be deferred if: (1)
    core capital falls below 125 percent of its ``critical capital''
    requirement, or (2) core capital falls below minimum capital levels,
    and pursuant to the company's request, the Secretary of the Treasury
    exercises his or her discretionary authority to purchase the company's
    debt obligations under Section 304(c) of the Company's Charter Act.
        \2\ Under the system of Prompt Corrective Action, 60 days after a
    bank is determined to be critically undercapitalized, it cannot make
    payments on subordinated debt without regulatory approval.

    Q.4.b. Should the Congress consider permitting the new
    regulator to include sub debt as a component of capital? Is
    ---------------------------------------------------------------------------
    there a reason to treat GSE's differently than banks?

    A.4.b. As I stated in my testimony, the Congress should give
    the new GSE regulator clear authority to establish and modify
    the capital standards for the housing finance GSE's, which
    would include the ability to define what constitutes capital
    for purposes of these capital measures. Accordingly, the
    inclusion of subordinated debt as a component of capital should
    not be explicitly allowed or disallowed by statute. Rather, the
    decision of whether, how, or to what extent, subordinated debt
    should be treated as capital of a housing finance GSE should be
    delegated to the regulator, which can review and analyze these
    issues with a full understanding of the capital structure,
    operations, and risks of the GSE's.
        The Federal Reserve has found that the ability to establish
    and amend all relevant capital requirements and the definition
    of what constitutes capital is crucial to carrying out the
    mission of maintaining the safety and soundness of supervised
    institutions. Having the ability to establish capital adequacy
    requirements and amend them over time provides supervisors with
    the flexibility to update the requirements as needed to ensure
    that they adequately capture banking risks, which tend to
    change relatively rapidly given the fast pace of change in the
    industry and in the environment in which these institutions
    operate. In light of market innovations in capital instruments,
    revisions in accounting rules, advances in techniques for
    measuring exposure to risk, and the natural tendency of
    institutions to arbitrage capital rules, if the banking
    regulators did not have the ability to revise the capital
    adequacy rules, the standards over time would become
    increasingly disconnected from the supervised entities' actual
    risk profiles and their usefulness would diminish.

    Q.5. The current risk-based capital standard for Fannie Mae and
    Freddie Mac includes an interest rate component. The existing
    risk-based capital standard for commercial banks does not
    include such a component and is more focused on credit risks.
    How do bank supervisors evaluate the interest rate risk of
    banks? How does this assessment factor into a calculation of
    capital adequacy for each institution?

    A.5. Regardless of their size or complexity, banking
    organizations are required to have interest rate risk
    management and measurement systems commensurate with the level
    and complexity of their risk profiles. The adequacy of these
    systems is evaluated within the ongoing supervisory process.
    Beginning in 1997, a new component was added to the interagency
    CAMEL bank rating system, now called CAMELS with the ``S''
    standing for sensitivity. This new component evaluates an
    institution's ability to monitor and manage market risk, which
    in most cases is related to interest rate risk.
        Supervisors monitor interest rate risk positions of banks
    through the supervisory process, which is oriented to
    identifying those banks with relatively large risk positions--
    so-called ``outlier'' institutions. This approach reflects the
    experience that interest rate risk has historically not been a
    significant cause of failures in the commercial banking
    industry. This is due to the diversification of bank assets,
    the presence of significant core deposits as a funding source,
    and the strong capital positions typically maintained by banks.
        For smaller institutions, supervisors apply a variety of
    screening tools using data provided on regulatory reports to
    identify those banks with the most significant risk profiles.
    Given the prepayment options associated with mortgage-backed
    securities, holdings of these instruments factor into many of
    these screens. Examiners devote greater attention to interest
    rate risk issues in the supervision of ``outlier''
    institutions.
        At larger institutions, where positions are more difficult
    to assess using standard regulatory reports, supervisors rely
    more heavily on monitoring internal risk management reports
    through continuous supervision. This includes ongoing
    monitoring of internal risk measures, results of internal
    interest rate stress tests, limit reports and other tools
    routinely used in the management of the business. In
    particular, examiners consider in their assessments the
    internal estimates of the potential effect of stressful
    interest rate environments on the profitability and capital
    adequacy of the bank.
        It is important to add that the risk-based capital
    requirements include not only the specific quantitative
    standards but also a series of factors cited in regulation that
    are to be considered in assessing a bank's capital adequacy,
    including interest rate risk. A bank with an outsized interest
    rate risk position could thus be required by its supervisor to
    hold additional capital beyond the regulatory minimum in light
    of that position, or alternatively to reduce its risk
    exposures.

    Q.6.a. Your written testimony asserts that ``Fannie Mae's and
    Freddie Mac's purchases of their own or each other securities
    with their debt do not appear needed to supply mortgage market
    liquidity or to enhance capital markets in the United States.''
    You suggest ``deep and liquid markets'' that are provided by
    MBS's held by private investors. However, what effect, if any,
    would we see on liquidity in the mortgage market were the GSE's
    prevented from holding these securities in their portfolio?

    A.6.a. I am not aware of any evidence that convincingly shows
    we would see an effect on liquidity if the Congress channeled
    GSE activity toward mortgage securitization and away from
    holding mortgage-backed securities in portfolio. It is
    securitization itself, not the GSEs' purchases of their own
    securities, that provides the liquidity benefits and there are
    many purchasers of GSE mortgage-backed securities in the
    markets. Thus, it is not clear why there would be any effect
    during periods of normal market functioning because capital
    markets in the United States are deep and liquid. When
    financial markets are in trouble, such as in 1998, investors
    often flee to the safety of Treasury securities--a so-called
    ``flight to quality'' that I noted during my testimony. Prices
    for corporate bonds, for State and local government bonds, for
    mortgage-backed securities, and for other asset-backed
    securities fall and their yields rise relative to yields on
    Treasury debt as the markets attempt to reassess the extent and
    depth of the crisis. At the same time, the prices of Treasury
    securities rise and their yields fall, as investors pay more
    for the safety and soundness provided by Federal Government
    debt.
        Because Fannie Mae, Freddie Mac, and the Federal Home Loan
    Banks have ties to the Government, investors treat GSE debt as
    a near-substitute for Treasury debt. Thus, during market
    crises, the prices of implicitly insured GSE debt rise and
    their yields fall because some market participants flee toward
    GSE debt. Fannie Mae and Freddie Mac do what any profit-making
    financial entity would do when their funding costs fall and the
    yields on the assets they purchase rise--they issue more debt
    and they buy more assets. They undertake these activities not
    because of a concern for financial stabilization but because
    they maximize profits for their shareholders. This response may
    contribute to stability, but there is nothing unique about it
    with regard to Fannie Mae and Freddie Mac being GSE's. Other
    profit-maximizing entities in the financial markets behave in a
    similar manner.
        As I noted in my testimony, for those who continue to have
    a concern about the GSEs' portfolio holdings, directing Fannie
    Mae's and Freddie Mac's activities toward mortgage
    securitization would still leave the GSE's with substantial
    portfolios and would allow them to grow with the mortgage
    markets. Whatever liquidity benefits they bring to the markets,
    if any, likely can be supported by GSE's with a greater
    emphasis on mortgage securitization and with less emphasis on
    enhancing their subsidy by holding their own MBS.

    Q.6.b. Would this be true in both good and bad economic times?

    A.6.b. As I stated above, I am not aware of a convincing
    argument that suggests that GSE's are a necessary part of
    market liquidity in either good or bad times. The Federal
    Reserve has, in the past, acted to stabilize markets and once
    we have acted, profit-maximizing entities reenter financial
    markets. The GSE's may sometimes tend to enter more quickly
    than other entities after the Federal Reserve has stabilized
    markets because their access to implicitly insured Government
    debt may yield greater profits during these times, but this
    aspect of the subsidy is not needed for financial
    stabilization.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR ALLARD
                          FROM ALAN GREENSPAN

    Q.1. As you know, as a conservator OFHEO currently has no legal
    authority to reorganize or liquidize if their liabilities
    exceed their assets. In our last hearing on GSE's, Comptroller
    Walker of the General Accounting Office asserted that the
    authority of receivership should be in the ``toolbox for
    extreme cases.'' Would you please share your thoughts on
    whether or not the new regulator should have receivership
    authority in order to be able to resolve a potential shortfall
    in assets?

    A.1. Financial markets do not behave well with ambiguous law
    and hence it is highly desirable that the process for resolving
    an insolvent GSE be clarified by the Congress before such a
    process is needed. Current law permits the Director of OFHEO to
    act as conservator of a financially troubled GSE and, in this
    role, continue to operate the Enterprise. However, in order to
    continue to operate the Enterprise as a going concern, OFHEO
    would need funds to pay the insolvent Enterprise's obligations
    as they became due and, to avoid disruptions in the mortgage
    market, fulfill the Enterprise's commitments to purchase
    mortgages. Because the Enterprise in conservatorship would, by
    definition, be experiencing significant financial difficulties,
    it likely would not be able to borrow against the Enterprise's
    own creditworthiness. Current law does not answer the question
    of how OFHEO quickly would obtain the billions of dollars
    needed to continue the Enterprise's operations and meet its
    existing obligations.
        The financial markets have interpreted the ambiguous nature
    of current law, and the lack of a clear and credible process
    for ensuring that the creditors of an insolvent Enterprise bear
    some risk of loss, as equivalent to a de facto guarantee that
    the U.S. Government would step in to provide funding to an
    Enterprise experiencing financial difficulties. If the Congress
    believes the financial markets are correct in this assumption,
    then it should consider making this guarantee explicit and
    removing the disclaimer from GSE debt that currently states
    that GSE debt is not guaranteed by the U.S. Government.
        On the other hand, if GSE debt is not in fact supported by
    an implicit or explicit guarantee, then the Congress should
    establish a clear and credible framework for the resolution of
    an insolvent Enterprise that includes the authority and
    processes for ensuring that the creditors of the Enterprise
    bear some risk of loss. There are several ways that the
    Congress may choose to establish such a framework. For example,
    one option would be to provide a mechanism for the
    reorganization of an insolvent Enterprise under the Bankruptcy
    Code. The Bankruptcy Code provides the framework for the
    resolution and reorganization of other private entities that
    are not backed by Government guarantees or creditor protection
    schemes and its rules, procedures, and consequences are both
    well-developed and well-understood by market professionals.
    Alternatively, the Congress could seek to develop another
    framework for the resolution of an insolvent Enterprise that
    explicitly provides for the ``haircutting'' of creditors. If
    the Congress decides to follow this route, however, it should
    be careful to ensure that the framework established is clear
    and comprehensive and does not create or perpetuate a
    perception that the debt of Fannie Mae or Freddie Mac--both of
    which are private companies--bears implicit or explicit
    Government backing.

    Q.2. I understand that you believe a housing regulator should,
    like other major bank regulators, have the authority to
    prescribe minimum and risk-based capital standards. If the
    regulator is given the statutory authority to determine capital
    standards, is there an existing model that you believe would
    work well to carry out this duty? Or rather, would an entirely
    new model need to be created, given the magnitude of the GSE's?

    A.2. In my view, the broad statutory authority the banking
    agencies have to establish capital standards and safety and
    soundness regulations for their supervised institutions
    provides an appropriate model for the statutory authority that
    should be granted to the housing finance GSE regulator. Under
    existing law, the Federal banking supervisors have explicit
    statutory authority and broad flexibility to define capital and
    establish capital standards for banks. For example, the banking
    agencies have the ability to set the leverage and risk-based
    capital thresholds at which an institution becomes
    undercapitalized, significantly undercapitalized, or critically
    undercapitalized, and have the ability to establish additional
    capital standards for banking institutions other than the
    existing leverage and risk-based standards. Moreover, while
    banks are subject to one statutory capital requirement (a
    tangible equity to total assets ratio of 2 percent), the
    banking agencies have the ability to raise this threshold if
    they deem it appropriate. In addition and importantly, the
    Federal banking agencies have broad statutory authority to
    adopt regulations or take other actions that are necessary or
    appropriate to ensure the safety and soundness of banking
    institutions. This authority, which is an important complement
    to the capital authority, allows the banking agencies to
    address financial and operational weaknesses at an institution
    before these weaknesses undermine the institution's capital.

    Q.3. In nature, Fannie Mae and Freddie Mac differ from the
    Federal Home Loan Banks. For example, Fannie and Freddie differ
    from the Federal Home Loan Banks in terms of ownership--Fannie
    and Freddie are owned by their private shareholders while the
    Federal Home Loan Banks are owned by their members, who are,
    for the most part, private financial institutions. Some have
    proposed that having one regulator for all three entities is
    the way to go. As this may end up being the case, what do you
    believe would be an appropriate structure to address the
    differences between Fannie and Freddie and the Federal Home
    Loan Banks within the regulating body?

    A.3. As I have said previously, I believe it would be
    appropriate for the new regulator of Fannie Mae and Freddie Mac
    to also be responsible for the Federal Home Loan Banks
    (FHLB's). Traditionally, the FHLB's have been portfolios
    lenders who acted mainly as intermediaries between capital
    markets and mortgage lenders. They essentially pass-through
    capital market funding to the mortgage lenders, taking a
    passive role in the process. Over the past decade, however, the
    FHLB's have evolved into active portfolio managers who offer
    financial options to their members. With their large
    portfolios, the risks involved in hedging these options can be
    large and, as with Fannie Mae and Freddie Mac, difficult to
    evaluate and worrisome given the size and scope of the
    portfolio.
        One check on growth in the FHLB System has been its
    cooperative ownership structure and its need not to compete
    directly with its owners. The force of these traditional
    checks, however, appears to have diminished over time and the
    FHLB System seems to be functioning more like a profit-seeking
    enterprise, looking for new investment opportunities and
    products. I believe this is a development that the Congress
    should monitor closely and that a new GSE regulator should have
    full authority to review and approve these activities.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                          FROM ALAN GREENSPAN

    Q.1.a. In your written testimony on February 24, 2004, you
    conclude that various studies indicate that a ``substantial
    portion of these GSEs' implicit subsidy accrues to GSE
    shareholders in the form of increased dividends and stock
    market value'' instead of homebuyers. In light of their stellar
    recent financial performance and the implied Federal benefits
    that are not passed on to homebuyers, what more do you believe
    the GSE's could be doing to increase homeownership?

    A.1.a. As I stated in my testimony, Fannie Mae's and Freddie
    Mac's persistently higher rates of return for bearing the
    relatively low credit risks associated with conforming
    mortgages are evidence of a significant implicit subsidy.
    Forcing the GSE's to pass through to homeowners more of the
    implicit subsidies generated by their large portfolios and
    associated debt issuance could involve potential systemic
    problems for the GSE's that would, in my view, greatly exceed
    possible benefits from the lower mortgage rates that might
    result from creating such a system. This is particularly true
    since these benefits could be realized by actions that focus
    the GSE on mortgage securization and not on portfolio holdings.
        Homeownership is not well-served if the methods used to
    finance mortgage debt also create the possibility of systemic
    financial difficulties that potentially could adversely affect
    many households, as the current system does. If the Congress
    desires to efficiently pass through the Government's credit
    advantages through GSE's to homeowners and also to avoid
    systemic risk problems, it should consider explicitly insuring
    GSE debt and limiting GSE profits. If the Congress does not
    wish to explicitly insure GSE debt, it could pursue on-budget
    homeownership initiatives that deal directly with households'
    downpayment and credit history difficulties, which research
    suggests are significant barriers to homeownership.

    Q.1.b. In your testimony, you suggest that the Affordable
    Housing Goals set by HUD for Fannie and Freddie are an
    ``inefficient method'' of passing the Fannie's and Freddie's
    implied Federal benefits to homeowners. Furthermore, in Mr.
    Rice's written testimony for the February 25, 2004 hearing, he
    suggests that the FHLB's Affordable Housing Program is a more
    effective method of achieving housing mission goals than
    Affordable Housing Goals: ``Though we appreciate the goals the
    other housing GSE's maintain, we believe that in addition to
    greater consumer access to credit, one of the best ways of
    passing along our subsidy is through our Affordable Housing
    Program and the direct 10 percent contribution made by each of
    the 12 Home Loan Banks annually.'' How might the GSEs' implied
    Federal benefits be passed more efficiently on to homeowners?
    Please elaborate.

    A.1.b. As I urged in my testimony, one way for the Congress to
    achieve this goal would be to refocus Fannie Mae's and Freddie
    Mac's activities toward mortgage securitization and away from
    holding their own mortgage-backed securities in their
    portfolios. If the estimates of Wayne Passmore and others are
    correct, the GSE's are inefficient mechanisms for the transfer
    of a subsidy to homeowners because the shareholders of the
    GSE's effectively extract a large portion of the benefits from
    their implied subsidy. On the other hand, mortgage
    securitization by itself appears to be sufficient for
    transmitting the benefits of the secondary mortgage markets to
    homeowners.
        If the same mortgage rate reduction can be achieved through
    mortgage securitization as through the GSE mortgage
    portfolios--as it seems likely--then focusing the GSE's on
    securitization would be a more efficient method of using the
    GSE's to influence mortgage rates. Under this scenario, the GSE
    shareholders would not absorb as much of the benefits from the
    Government's ambiguity about GSE status.
        As I mentioned above, another way for the Congress to more
    efficiently pass through the advantages of the Government's
    credit worthiness to homeowners would be to explicitly insure
    GSE debt and limit GSE profits. I would also note that
    encouraging GSE's to subsidize affordable housing through
    contributions from income can lead to unintended consequences.
    In the case of the FHLB's, such a requirement (along with
    requirements to make REFCORP payments) led to a ballooning of
    the FHLBs' nonadvance portfolio, leading to even greater
    issuance of GSE debt and increasing concerns about systemic
    risks. The GSE's can apparently borrow at subsidized rates
    without any realistic limit and invest the proceeds in any
    asset whose price is market determined. It can thus
    automatically profit from the investment. Taxing their income
    to
    support affordable housing will encourage them to expand their
    portfolios all the more.

    Q.1.c. You mention in your testimony that ``there are many ways
    to enhance the attractiveness of homeownership at significantly
    less potential cost to taxpayers than through the opaque and
    circuitous GSE paradigm currently in place.'' Please elaborate
    on these other potential less costly ways to promote
    homeownership.

    A.1.c. As I stated above, one possible method would be for the
    Government to adopt on-budget homeownership initiatives that
    deal directly with downpayment and credit history difficulties
    of potential homebuyers, factors that research suggests are
    significant barriers to homeownership. While such programs
    would contain some funding costs, they would not present the
    potential for systemic risk embedded in the current GSE system.

    Q.1.d. Similarly, do you believe that the GSE's should be doing
    more to promote affordable multifamily housing? If so, what
    specifically would you suggest the GSE's should do to promote
    affordable multifamily housing? Please elaborate.

    A.1.d. The Congress should evaluate the GSEs' effectiveness in
    promoting multifamily housing and other affordable housing
    initiatives. The Federal Reserve's primary interest is that GSE
    activities are conducted in a safe and sound manner that does
    not increase or promote systemic risk in the financial system.

    Q.1.e. In the context of GSE regulatory reform, the
    Administration has suggested creating new affordable housing
    goals and subgoals. Do you believe that these proposed goals
    and subgoals are as rigorous as should be, in light of recent
    GSE financial performance and the implied GSE benefits? Why or
    why not?

    A.1.e. If the Congress desires the GSE's to pursue affordable
    housing goals and to lower mortgage rates, it should put in
    place rigorous systems to measure and evaluate the extent that
    these goals are being accomplished. As I stated in my
    testimony, a more efficient approach, and one that greatly
    reduces the potential for systemic risk, would be to encourage
    the GSE's to pursue mortgage securitization without the
    accumulation of enormous GSE mortgage portfolios and for the
    Congress to pursue affordable housing goals through on-budget
    programs targeted toward homeownership.

    Q.2.a. In GAO's 1997 Report, ``Advantages and Disadvantages of
    Creating a Single Housing GSE Regulator (GAO/GGD-97-139),'' GAO
    argues, ``Having an independent board would allow it to be
    structured to provide equal links to HUD, due to its role in
    housing policy and Treasury, due to its roles in finance and
    financial institution oversight. Having a single director,
    rather than a board, as head of the regulatory agency might
    provide for management efficiencies and clearer accountability.
    However, such an arrangement would sacrifice the advantages of
    having the different perspectives, expertise, prestige, and
    stability a board could provide.'' Do you concur with this
    preference for a board over a director agency structure? Why or
    why not?

    A.2.a. As I stated in my testimony, world-class regulation, by
    itself, may not be sufficient and indeed, may even worsen the
    situation if market participants infer from such regulation
    that the Government is all the more likely to back GSE debt
    during a financial crisis. This is the heart of a dilemma in
    designing regulation for the GSE's. On the one hand, if the
    regulation of the GSE's is strengthened, the market may view
    them even more as extensions of the Government and view their
    debt as Government-backed. The result, short of a marked
    increase in capital, would be to expand the implicit subsidy
    and allow the GSE's to play an even larger unconstrained role
    in the financial markets. On the other hand, if we fail to
    strengthen GSE regulation, the possibility of an actual crisis
    or insolvency is increased. Regardless of whether the Congress
    creates an independent board or an agency director, the key
    issue is whether the Congress intends to bailout a GSE in the
    event of default. Any structure created by the Congress should
    incorporate clear and detailed provisions that spell out how
    the regulator is to deal with a GSE that has failed.

    Q.2.b. In your testimony, you argued that the Chairman of the
    Board of Governors of the Federal Reserve System would have a
    substantial conflict of interest if placed on a board having
    oversight over the housing GSE's, as proposed by Chairman
    Shelby in a question to Comptroller-General Walker on February
    10, 2004. You
    recommended against including the Chairman of the Board of
    Governors of the Federal Reserve System on the proposed board.
    Chairman Shelby also suggested that the proposed board also
    include the Chairman of the Securities and Exchange Commission.
    Do you think there is a similar conflict of interest with
    placing the Chairman of the Securities and Exchange Commission
    on the proposed board?

    A.2.b. Other financial market regulators may or may not have
    conflicts of interest that might lead them to not want to be
    involved directly in the affairs of the GSE's. In general, the
    Congress may decide that it is best not to place regulators on
    a GSE board who, in the course of their primary duty, may be
    involved in situations that require judging the actions of a
    GSE and, perhaps, coming into conflict with its regulator. The
    Congress should assess whether or not such a conflict would
    exist with the Chairman of the Securities and Exchange
    Commission.

    Q.3.a. In the same report, GAO argues that, ``Our ongoing work
    has strengthened our belief that the housing GSE regulators
    would be more effective if combined and authorized to oversee
    both safety and soundness and mission compliance. Nothing we
    have observed has caused us to modify our criteria for an
    appropriate regulatory structure.'' For the record, do you
    support having a single regulator over all housing GSE's,
    Fannie, Freddie, and the Federal Home Loan Banks? Please
    elaborate.

    A.3.a. Yes. These GSE's play essentially a similar role in the
    mortgage finance system and should be governed by the same
    regulatory framework.

    Q.3.b.1. In your testimony, you appear to concur with this
    position. You said, ``In my remarks, I will not focus on the
    Federal Home Loan Banks, although much of this analysis applies
    to them. In fact, because the Home Loan Banks can design their
    advances to encompass almost any type of risk, they are more
    complex to analyze than other GSE's and, hence, raise
    additional issues.'' Please elaborate on what you believe are
    the complexities involved with the risk profiles of the Federal
    Home Loan Banks.

    A.3.b.1. The Federal Home Loan Banks (FHLB's), until recently,
    did not buy mortgage loans but instead provided loans
    (advances) to mortgage lenders who used their mortgage loans as
    collateral for the FHLB advances. In the past, advances simply
    passed on to mortgage lenders the borrowings of the FHLB's.
    Nowadays, however, FHLB advances can be custom designed for
    lenders, can include many financial options, and thus can pose
    complicated risks. Moreover, the mortgage loan portfolio of the
    FHLB's has increased significantly in recent years. The
    Congress should evaluate the growth in both the size and
    complexity of the FHLBs' portfolios and evaluate whether this
    growth is consistent with Congressional goals for the FHLB
    System and the safety and soundness of the financial system.

    Q.3.b.2. Similarly, please elaborate on what you believe are
    the additional issues raised by such complexities.

    A.3.b.2. As I stated above, traditionally the FHLB's have been
    portfolio lenders who acted mainly as intermediaries between
    capital markets and mortgage lenders. The FHLB's essentially
    passed-through subsidized capital market funding to mortgage
    lenders, taking a passive role in the process. Over the past
    decade, however, the FHLB's have evolved into active portfolio
    managers who offer financial options to their members. With
    their large portfolios, the risks involved in hedging these
    options can be large and, as with Fannie Mae and Freddie Mac,
    difficult to evaluate and worrisome given the size and scope of
    the portfolio.

    Q.3.b.3. What important concepts do you recommend that Congress
    consider if and when designing legislation to create a single
    regulator for all housing GSE's? Please elaborate.

    A.3.b.3. As I explained in my testimony, the regulator must be
    structured in a way that does not reinforce investors'
    perceptions that the Government implicitly backs GSE debt.

    Q.4. In his testimony to the Committee on February 25, 2004,
    Chairman Raines submitted a chart detailing the differences
    between 30-year conforming and jumbo mortgage rates in 2003 to
    demonstrate a 21 basis point difference in Fannie's mortgage-
    backed securities yields. In addition, after including guaranty
    fees, servicing costs, ``carry'' costs, and other miscellaneous
    mortgage rate expenses, he argued that there was a 26 basis
    point difference between the conforming and jumbo rates that
    are offered to homebuyers. How do you respond to such evidence?
    Don't these data demonstrate the difference in mortgage
    transaction costs, as well as the mortgage transaction prices?
    Why or why not?

    A.4. There is clearly a difference between GSE and non-GSE
    yields in the MBS market, as well as a difference between
    conforming and jumbo mortgage rates. As shown in Wayne
    Passmore's study, jumbo mortgage rates are usually 15 to 18
    basis points higher than conforming mortgage rates. The
    question is, how much of the difference can be attributed to
    the GSE status of Fannie Mae and Freddie Mac? Passmore's study
    indicates that most of these differences are due to the
    economies of scale and other pricing efficiencies of the
    conforming loan and MBS markets. These market attributes would
    likely continue to exist even if Fannie Mae and Freddie Mac
    were not GSE's. The implicit subsidy is the element of the
    difference that would disappear should investors become
    convinced the GSE's were not Government-backed. According to
    Passmore's work, about 2 to 4 basis points of the conforming
    guarantee fee (embedded in the total guarantee fee, which is
    shown as 18 basis points in the chart you mention) is due to
    the subsidy. Indeed, if Fannie Mae and Freddie Mac were passing
    through some of their implied Government subsidies, one might
    generally expect the guarantee fee for conforming MBS to be
    less than the equivalent fee in the jumbo market, both because
    conforming mortgages are generally very safe assets and because
    Fannie Mae and Freddie Mac do not need to provide the same
    degree of credit enhancements for their MBS because of their
    implicit Government backing. In the Fannie Mae example, the
    guarantee fees are assumed equal.

    Q.5. In the context of reviewing the regulation of the housing
    GSE's, do you believe that the current minimum capital standard
    of 2.5 percent for Fannie and Freddie is too low or too high?

    A.5. Determining the appropriate minimum level of capital for
    the housing finance GSE's is a difficult and technical process
    that is best accomplished by the housing finance GSE regulator,
    which should have full access to information concerning the
    GSEs' activities, risks, risk management, and controls. The
    Federal Reserve generally does not have access to nonpublic
    information concerning the housing finance GSE's and has not
    conducted the analysis that would be required to express an
    opinion on the adequacy of the current minimum capital standard
    for the housing finance GSE's.

    Q.5.a. On what basis do you believe the minimum capital
    standard should be set?

    A.5.a. The housing finance GSE regulator should be encouraged
    to consider the three pillars of the proposed Basel Capital
    Accord in setting a minimum capital standard--the minimum
    capital requirements, the supervisory review process, and the
    market discipline or disclosure pillars.
        Minimum capital standards should be established by the
    housing finance GSE regulator at a level that ensures that the
    major risks to which the housing finance GSE's are exposed--
    credit, interest rate, liquidity, and operational risks--are
    adequately covered, taking into account their ability to manage
    these risks. Ideally, one could rely primarily on a risk-based
    capital standard, but risk-based capital standards are not
    perfect and are still under development. Indeed, it likely will
    be many years before regulatory capital measures will be able
    to fully quantify and appropriately reflect all of the risks to
    which an entity may be subject over time. A leverage ratio
    places an overall constraint on the degree to which an
    institution can leverage its capital with debt that is
    implicitly or explicitly subsidized by the Government and works
    to limit the extent to which an institution can arbitrage the
    capital standard. It has been the Federal Reserve's experience
    that it is difficult for a banking organization to arbitrage
    simultaneously both the risk-based and leverage capital
    standards, which helps to ensure that the overall level of
    capital in the institution remains adequate in relation to its
    risk exposure.
        In addition and importantly, the housing finance GSE
    regulator should have broad statutory authority to adopt
    regulations or take other actions that are necessary or
    appropriate to ensure the safety and soundness of the
    institutions it supervises. This authority, which is an
    important complement to the capital authority, would allow the
    housing finance GSE regulator to address financial and
    operational weaknesses at an institution.

    Q.5.b. Do you believe that allowing Fannie and Freddie's
    regulator to have discretion only over risk-based capital is
    insufficient to maintain the safety and soundness of the GSE's?
    Why or why not?

    A.5.b. As noted in my response to the prior question, a
    leverage ratio provides an important complement to a risk-based
    capital standard because risk-based standards are still
    relatively new and require significant ongoing development to
    encompass the many risks and arbitrage possibilities that exist
    in today's financial markets. Both types of standards are
    needed and, in my view, it is
    important for the Congress to provide the housing finance GSE
    regulator with clear authority to adjust standards for the
    entities under its jurisdiction.
        History indicates that supervisors need the ability to
    revise and modify both the risk-based and leverage capital
    standards to ensure that these capital measures appropriately
    reflect changes in the financial markets, capital instruments,
    and the structure, operations, and risks of supervised
    institutions. In the banking area, the Federal banking
    supervisors have modified the leverage capital requirement in
    several significant ways since it was first adopted in the
    early 1980's. Most of these revisions altered the definition of
    capital as used under the leverage ratio requirement in
    response to accounting changes, financial product innovations,
    and market developments. The Congress should provide the
    housing finance GSE regulator with similar flexibility to
    update the minimum capital requirements for the GSE's as needed
    to ensure that they adequately capture risks and reflect the
    rapidly changing housing
    finance industry.

    Q.5.c. Do you believe that it would harm the ability of Fannie
    and Freddie's regulator to perform its oversight functions if
    Congress placed restrictions on its ability to adjust the
    minimum capital standards? Why or why not?

    A.5.c. Statutory restrictions on the ability of the housing
    finance GSE regulator to adjust the minimum capital standards
    would
    impede the ability of the regulator to modify those standards
    to respond in a timely way to market innovations in capital
    instruments, revisions in accounting rules, advances in
    techniques for measuring exposure to risk, and the natural
    tendency of institutions to arbitrage capital rules.
    Accordingly, such restrictions have the potential, over time,
    to cause the minimum capital standards to become increasingly
    disconnected from the supervised entities' risk profiles, and
    to significantly diminish their usefulness in ensuring their
    safety and soundness.

    Q.5.d. At a staff briefing given by Fannie Mae on the issue of
    minimum capital, a Fannie representative said that raising
    minimum capital would require the GSE's to raise mortgage rates
    in order to keep earnings per share at current levels. In the
    context of capital standards, is there a way to ensure that
    more of the implied GSE benefits go toward the GSEs' housing
    mission, and less to the shareholders?

    A.5.d. In my view, capital standards should be used solely as a
    mechanism to ensure the safety and soundness of supervised
    entities, rather than as a mechanism to promote the GSEs'
    housing mission. As I mentioned in my testimony, channeling the
    activities of the housing finance GSE's toward mortgage
    securitization could help to ensure that more of the implied
    GSE benefits accrue to the housing mission rather than
    investors. Refocusing the housing finance GSE's in this manner
    also would be consistent with the original Congressional intent
    that the GSE's provide stability in the market for residential
    mortgages and provide liquidity for mortgage investors.

    Q.6. Do you believe the fact that current law gives authority
    to oversee new GSE programs and activities to HUD, and safety
    and soundness oversight to the Office of Federal Housing
    Enterprise Oversight (OFHEO), have undermined OFHEO's ability
    to oversee the safety and soundness of Fannie and Freddie? Why
    or why not?

    A.6. Under current law, the Federal Reserve Board serves as the
    safety and soundness supervisor for bank holding companies and
    also has primary responsibility for reviewing and approving (or
    disapproving) proposals by bank holding companies to engage in
    new activities. (In some instances, the Board must coordinate
    its review of new activities with the Treasury Department.)
    Importantly, this authority permits the Board to review the
    potential risks involved with a proposed new activity, and the
    systems and procedures a bank holding company will use to
    monitor and control these risks, before the activity is
    commenced by a bank holding company. This authority also
    provides the Board with the ability to prevent bank holding
    companies from commencing any new activity that would present
    unacceptable risks to the safety and soundness of the banking
    organization or that is not authorized by applicable law.
        As I mentioned in my testimony, I believe the GSE regulator
    should have authority similar to that of the banking
    regulators. This would include the authority to review and
    approve (or deny) proposals by a GSE to engage in new business
    activities, to place conditions on any such approvals to ensure
    that any new business activity commenced by a GSE is conducted
    in a safe and sound manner and is consistent with applicable
    law, and to enforce these prior approval requirements and any
    decisions made by the GSE regulator under this authority.

    Q.7. In your testimony, you reiterated your support for
    privatization of the housing GSE's. However, in response to a
    question from Senator Sarbanes, you also appeared to disavow
    one of your previous recommendations advocating for redirecting
    capital away from housing and toward other, more ``productive''
    uses. In a May 19, 2000 letter to Representative Baker, you
    said, ``. . . these organizations alter the housing finance
    markets only to the degree that they pass through to homebuyers
    part of their Government subsidy. They accomplish this by
    diverting real resources from other market-determined uses.''
    Later in that letter, you stated, ``Subsidies accorded to the
    GSE's are, of necessity, at the expense of other Federal or
    private sector initiatives.'' In a subsequent August 25, 2000
    letter to Representative Baker, you said, ``If the lower costs
    associated with these implicitly subsidized funds are passed
    through to the mortgage market in the form of lower mortgage
    rates, then housing will expand relative to nonhousing
    investment, including private sector initiatives such as
    investment in productivity-enhancing plant and equipment.'' If
    the GSE's were privatized, wouldn't it result in capital being
    redirected away from housing toward other sectors of the
    economy, reducing liquidity in the secondary market, and thus
    resulting in higher mortgage rates for homebuyers? Why or why
    not?

    A.7. In recent years, I have become impressed with how
    important wide homeownership has been to a general acceptance
    of property rights as a pillar of our society. This is not an
    issue I had given adequate thought to previously. Hence,
    although subsidizing of homeownership does divert capital from
    more ``productive'' uses, it is, in my judgment, a small price
    to pay for the benefits.
        Subsidizing homeownership, as I indicated earlier, is far
    more efficiently implemented by on-budget programs. Too large a
    part of subsidies granted implicitly to GSE's is diverted to
    shareholders. None is diverted from on-budget subsidies.
        Whether or not privatization of the GSE would raise
    mortgage rates or reduce liquidity in the secondary market
    depends on how much the GSEs' status as Government Sponsored
    Enterprises, and the implied subsidy that flows from this
    status, actually influences mortgage rates or provides
    liquidity. The evidence to date is that their influence on
    mortgage rates is small. The consequences of privatization do
    not seem to be significant except to the extent that it may
    cause Fannie Mae's and Freddie Mac's portfolio growth rates to
    lessen, thus reducing the systemic risk associated with such
    portfolios. As I indicated during my testimony, even after any
    privatization, it is likely Fannie Mae and Freddie Mac would
    continue to play important roles in the housing and mortgage
    markets.

            RESPONSSE TO WRITTEN QUESTIONS OF SENATOR DOLE
                          FROM ALAN GREENSPAN

    Q.1. In your testimony you state ``GSE's need to be limited in
    the issuance of GSE debt and in the purchase of assets, both
    mortgages and nonmortgages.'' You explain earlier in your
    testimony that these mortgage investments ``. . . concentrate
    interest rate and prepayment risks at these two institutions.''
    Some have argued that these mortgage investments help Fannie
    and Freddie to fulfill their mission. What are your thoughts on
    that?

    A.1. Federal Reserve staff is not aware of any evidence that
    convincingly shows that channeling GSE activity toward mortgage
    securitization and away from holding mortgage-backed securities
    in portfolio would negatively impact liquidity in mortgage
    markets. Whatever liquidity or other benefits the GSE's bring
    to the markets, if any, likely can be supported by GSE's with a
    greater
    emphasis on mortgage securitization and with less emphasis on
    enhancing their subsidy by holding their own MBS. Moreover, as
    I noted in my testimony, any proposal to direct the flow of
    Fannie Mae's and Freddie Mac's activities toward mortgage
    securitization would still leave the GSE's among the largest
    financial institutions in the United States and would allow
    them to grow with the mortgage markets.

    Q.2. Chairman Greenspan, the General Accounting Office has
    warned us that the incentives to use the benefits of Government
    sponsorship to increase shareholder value could, over time,
    erode the public mission. Do you agree with that warning?

    A.2. Given the large nonmortgage portfolios held by the GSE's,
    I can understand GAO's concern.

    Q.3. In your testimony you state: ``. . . if the regulation of
    the GSE's is strengthened, the market may view them even more
    as extensions of the Government and view their debt as
    Government debt.'' Do you believe there is any practical way of
    strengthening their regulation without expanding the
    misperception of an implicit subsidy?

    A.3. The practical way is to create GSE receivership provisions
    and make the method by which creditors of the GSE's can take
    losses clear and credible to the investing community.

                            PROPOSALS FOR IMPROVING
                         THE REGULATION OF THE HOUSING
                        GOVERNMENT SPONSORED ENTERPRISES

                                  ----------

                          WEDNESDAY, FEBRUARY 25, 2004

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 2:34 p.m., in room SD-538, Dirksen
    Senate Office Building, Senator Richard C. Shelby (Chairman of
    the Committee) presiding.

            OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

        Chairman Shelby. The hearing will come to order.
        This afternoon, the Committee holds its fifth hearing on
    needed improvements to the regulation of Government Sponsored
    Enterprises. The Committee will hear from Mr. Franklin D.
    Raines, Chairman and Chief Executive Officer, Fannie Mae; Mr.
    Richard F. Syron, Chairman and Chief Executive Officer, Freddie
    Mac; and Mr. Norman B. Rice, President and Chief Executive
    Officer of the Federal Home Loan Bank of Seattle.
        It is my intention that today's hearing will be the final
    session in our series of hearings. After today's hearing, we
    will have heard from a wide variety of witnesses, and we will
    have an extensive record to review in our deliberations.
    Several Members of this Committee introduced their own
    proposals to reform GSE regulation, and I want to commend
    Senators Hagel, Dole, Sununu, and Corzine for their hard work
    in this regard and their ideas and their approach, and also for
    their participation in the hearing process. They have been very
    involved.
        It is time for the process to move forward. The Committee
    will be working over the next several weeks to assemble a
    legislative package. I know that all of the Members of this
    Committee share a goal of putting in place a strong, credible
    regulator that will ultimately benefit the GSE's, protect
    taxpayers, and preserve the prominent role of housing in our
    economy, which we all support.
        I want to thank all the witnesses for appearing here today,
    and we look forward to your testimony and also the question
    period.
        Senator Johnson, do you have an opening statement?

                    STATEMENT OF SENATOR TIM JOHNSON

        Senator Johnson. Yes, a brief statement. Thank you, Mr.
    Chairman, for calling today's hearing, another in a series to
    determine the best way to improve the regulatory framework for
    the housing GSE's. I look forward to hearing this distinguished
    panel. Following Chairman Greenspan's testimony yesterday, I
    think it is timely and important that we carefully consider the
    testimony of today's witnesses on the important mission our
    housing GSE's carry out every day to help advance the dream of
    homeownership for millions of low- and middle-income American
    families.
        I simply do not agree with Chairman Greenspan's view that
    housing GSE's should be privatized. I am also growing
    increasingly concerned that officials of the Bush
    Administration, most recently Gregory Mankiw, Chairman of the
    Council of Economic Advisers, have called into question the
    real and perceived benefits Fannie and Freddie receive because
    of their Congressional charter. These benefits the
    Administration continues to attack come with critically
    important public policy responsibilities and mandates from
    Congress, including requiring Fannie and Freddie to meet
    affordable housing goals and targeted minority homeownership
    goals.
        Congress provided these tools to the GSE's to help low- and
    middle-income Americans realize the dream of homeownership, and
    they are also restricted from participating in the marketplace
    for higher-end homes. There are important policy reasons that
    we need to address in considering regulatory reform, including
    whether to include the Federal Home Loan Bank in a new
    regulatory entity, appropriate minimum capital standards,
    receivership, and program approval authority.
        I intend to work with my colleagues to reach a consensus on
    these and other issues, and I continue to believe that changes
    are needed to ensure the integrity of the system. However, I
    have to caution that continued statements by the Administration
    questioning the need for a Federal-private partnership through
    the Government Sponsored Enterprises makes reaching agreement
    on reforming the regulatory structure of these entities all the
    more difficult. The goalposts keep shifting, and I find this
    troubling.
        In my home State of South Dakota, many community financial
    institutions rely heavily on products offered by Fannie Mae,
    Freddie Mac, and the Federal Home Loan Bank of Des Moines to
    help finance quality, affordable housing in small rural
    communities. Without the important private-public partnership
    demonstrated by our housing GSE's, I have to wonder how many of
    my low- and middle-income constituents in rural South Dakota
    would be significantly hindered in becoming homeowners.
        The Administration, in the name of economic efficiency, has
    tried to convince us that exporting jobs is good, and now we
    are urged to leave our housing needs to the marketplace and
    hope for the best. As we move forward on regulatory reform of
    the housing GSE's, we have got to keep in mind the fundamental
    role that these institutions play and ensure that whatever
    changes we make to the regulatory structure, whether in the
    areas of minimum capital, receivership, or other issues, we do
    not inadvertently harm the housing mission of the GSE's.
        As the creator of these important institutions, we in
    Congress have a special obligation to ensure that the GSE's are
    meeting their unique role while at the same time ensuring that
    the regulatory structure for the GSE's is strong, independent,
    and credible.
        Mr. Chairman, while finding a consensus on these issues may
    be difficult, I am committed to working with you and my
    colleagues on this Committee to find solutions that balance the
    ability of Fannie Mae, Freddie Mac, and the Federal Home Loan
    Banks to meet their critical missions with the need for world-
    class regulation of the GSE's.
        Thank you, Mr. Chairman.
        Chairman Shelby. Senator Hagel.

                    STATEMENT OF SENATOR CHUCK HAGEL

        Senator Hagel. Mr. Chairman, thank you.
        Mr. Chairman, I add my welcome to our distinguished panel.
    Chairman Raines, Chairman Syron, President Rice, thank you for
    appearing.
        As we know, the secondary market plays a critical role in
    housing finance. Congress should not diminish this role.
    However, as Government Sponsored Enterprises like Fannie Mae
    and Freddie Mac dominate this landscape, Congress has a greater
    responsibility for strict oversight and comprehensive
    supervision. The stakes are profound, particularly when
    questions are raised about the implicit U.S. Government
    guarantee and the GSE's' growing relevance to our financial
    system.
        Have these institutions become too big to fail, as some
    would argue. Will a financial crisis ensue if they are left
    inadequately supervised, as I believe Chairman Greenspan asked
    yesterday in his testimony.
        Clearly, the existing regulatory framework requires
    strengthening to ensure that prevailing risks are mitigated.
    This is in the interest of the housing industry, the private
    capital markets, investors, and the American taxpayer. Few
    would argue the importance of housing to the national economy
    and the increasing role of the GSE's.
        There are currently over $7.2 trillion in mortgage loans in
    the United States; 45 percent of all those loans are owned or
    guaranteed by Fannie Mae and Freddie Mac. This Committee should
    bear in mind that other companies also engage in the primary
    and secondary markets as well. These private companies face
    extensive regulatory oversight from multiple supervisors,
    including Federal and State banking agencies and the Securities
    and Exchange Commission. This comprehensive oversight can
    require, if certain conditions exist, prior product approval,
    limitations on growth, minimum capital standards, and even
    receivership.
        Clearly, a gap exists in the regulatory framework of
    financial institutions and the Government Sponsored
    Enterprises. In introducing the Federal Enterprise Regulatory
    Reform Act, S. 1508, the intent sought by Senators Sununu,
    Dole, and I is to create a fundamentally strong regulatory
    framework, an agency with the capacity to establish capital
    guidelines, and, when necessary, have the discretion and
    authority to limit its activities.
        These are integral regulatory rules that have been
    successfully applied by the U.S. Federal banking agencies. They
    are principles founded on the premise of curtailing risk when
    conditions are necessary. I am confident these measures will
    serve to enhance the confidence in the mortgage industry as
    well.
        I might add, Mr. Chairman, also the intent of our bill was
    not to undo GSE's, nor to put GSE's out of business. That may
    come in a different era at a different time, but that has not
    been the intent of our legislation.
        I again thank you, Mr. Chairman, for your leadership on
    this issue and look forward to our distinguished witnesses. And
    I might add I will probably not be able to engage the entire
    time since I am due to chair a hearing here shortly. But I
    wanted to be here to at least give the witnesses an opportunity
    to make their statements so I could benefit from what they have
    to say, and I will stay longer if I can. But, again, thank you
    for coming, gentlemen.
        Chairman Shelby. Thank you, Senator Hagel.
        Senator Crapo.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you very much, Mr. Chairman, and also
    to Chairman Raines, Chairman Syron, and President Rice, we
    appreciate your coming before us today and look forward to your
    discussion with us. These are very critical issues.
        As this Committee considers creating a new independent
    regulator for Fannie, Freddie, and the Federal Home Loan Banks,
    it is important that we recognize that although these GSE's
    have much in common, these entities are structurally different.
    And as we approach this issue, the first question that we must
    address is whether all three should be included under the same
    regulator, where the regulator will be located, and the level
    of independence of that regulator. And if they are all
    included, I am interested in learning today how you believe
    this regulator should be structured so that it can maximize the
    value and benefit of each GSE.
        Would you support creating divisions within the regulatory
    structure? Should there be an advisory body in addition to or
    as a part of this regulator? If so, who should be included, and
    what value would this advisory body provide?
        Additionally, there has been a lot of discussion about
    capital standards, and I have asked questions on it in, I
    believe, every hearing that we have held. Can each of you
    explain your capital standards and how they work and how each
    of your capital requirements compares to the commercial banks
    or the circumstances that you might face under such an
    independent regulator as we are talking about?
        There are questions as to whether capital standards should
    be addressed statutorily, as a floor of some sort with broad
    discretion in the regulator, or whether the legislation that is
    established should instead not worry about setting any
    particular levels, but setting the standards by which capital
    should be evaluated by the regulator.
        In yesterday's testimony, Chairman Greenspan said, ``World-
    class regulation, by itself, may not be sufficient and, indeed,
    as suggested by Treasury Secretary Snow, may even worsen the
    situation if market participants infer from such regulation
    that the Government is all the more likely to back GSE debt.''
    I wonder what your responses are to the issues raised by
    Chairman Greenspan with regard to this implied guarantee that
    the marketplace seems to place on GSE debt.
        I do have to take issue to some extent with those who would
    say that the Administration is critical of Government's role in
    and support of making sure we have strong, affordable housing
    in the United States. I certainly do not believe that any of
    the efforts that are undertaken by any of those who have
    introduced legislation or by those who have supported the idea
    of an independent regulator is intended to diminish the value
    of our Government's commitment to developing the best approach
    to affordable housing that this Nation can put together. The
    question instead is: How do we protect the U.S. taxpayer? How
    do we make certain that the housing industry and the mortgage
    industry are operating as efficiently and as safely as possible
    so that we do not face some of the very terrible circumstances
    that we have faced in other arenas? And how do we make certain
    ultimately that we achieve our objective of solid, affordable
    housing available to the maximum extent possible in our
    society?
        I look forward to working with you on these issues and
    welcome your expertise and advice today. I should also say, Mr.
    Chairman, that like Mr. Hagel, I have not only another hearing
    but also I think half of my constituents from the State of
    Idaho are in Washington, DC, today.
        [Laughter.]
        And so I may have to slip out. But I can assure you, I will
    listen to as much as I can, and I will read every word of your
    testimony and listen to the points that you have made.
        Thank you very much.
        Chairman Shelby. Senator Stabenow, do you have an opening
    statement?

                  STATEMENT OF SENATOR DEBBIE STABENOW

        Senator Stabenow. Thank you, Mr. Chairman. I do have a few
    comments. I would say to Senator Crapo, though, that I think
    the other half of the people here in town are from Michigan
    today, so I apologize in advance. Many of us are trying to be
    in many places at once today. But welcome to those who are
    here. We appreciate very much your leadership and your
    testimony today, and I think this is such an important topic,
    and I hope we will be focused on what is in the best interest
    of the American people and the important role that GSE's have
    played in helping to create a housing market that is affordable
    and available to people and to help keep the economy moving
    forward by the fact that we have had the housing market
    continue to be strong even in the face of other very
    challenging times in the economy. And I know that each of you
    have played a role in that.
        Yesterday, we were able to hear from Federal Reserve
    Chairman Greenspan, and I must say that the views he offered I
    did not agree with, and some of the comments. And I hope that
    there is, in fact, not going to be support for privatizing
    GSE's. I do not believe that is in the best interest of the
    families that I represent in Michigan or people across the
    country.
        I think the relationship between GSE's is unique. There is
    no doubt about it. But there is immense value to the public in
    the relationship that we have together. In return for a limited
    amount of Government benefits, the American public sees great
    rewards, in my judgment.
        We task the GSE's with important projects like meeting
    affordable housing goals, and this allows these private sector
    companies to do good work simply by doing the business that you
    were set up to do. In addition, we are able to see great
    rewards to the public through the mortgage cost savings that
    the GSE's create.
        I do think there are important questions for the Committee,
    Mr. Chairman, and I appreciate your ongoing efforts. I would
    hope that we would ask questions such as: How can we ensure we
    have a strong, respected, independent regulator, with adequate
    and reliable funding? How can we create a regulatory
    environment where Fannie and Freddie can innovate and create
    new products without burdensome and bureaucratic approval
    processes by Federal regulators? How do we make sure that
    accounting problems like those at Freddie Mac never happen
    again? And how can we raise the bar and ensure that Fannie Mae
    and Freddie Mac do as much as possible to expand homeownership
    opportunities to first-time homebuyers and minority homebuyers
    and working-class families who are good credit risks but lack
    the funding for a downpayment or closing costs?
        I think we have important work in front of us, Mr.
    Chairman, and I appreciate your ongoing efforts in the hearings
    that we have had. Thank you.
        Chairman Shelby. Your written testimony will be made part
    of the record in its entirety. Mr. Raines, we will start with
    you, if you will sum up your testimony.

                    STATEMENT OF FRANKLIN D. RAINES

            CHAIRMAN AND CHIEF EXECUTIVE OFFICER, FANNIE MAE

        Mr. Raines. Thank you very much, Mr. Chairman, and thank
    you, Members of the Committee, for an opportunity to testify
    before you once again on this important legislation concerning
    strengthening the safety and soundness of Fannie Mae.
        On behalf of Fannie Mae, let me express all of our
    appreciation for the hard work this Committee has put in over
    the years and particularly in the last several months on this
    very important topic.
        I would just like to make four points in my summary
    statement.
        First, as I have testified before Congress previously,
    Fannie Mae supports legislation to establish a strong, well-
    funded, and respected safety and soundness regulator for the
    housing GSE's, and we do so because it is good for housing, the
    financial system, and our company. Private investors provide
    the capital that we use to purchase mortgages and to capitalize
    our business. They believe Fannie Mae is a good investment, but
    not because of any implied Government guarantee of our
    obligations. Instead, they count on the Government to apply
    rigorous oversight to the company because our mission is so
    critical to the national housing policy. Investor trust and
    confidence, combined with our low-risk and highly efficient
    business that focuses exclusively on mortgages, lowers our
    borrowing costs and that allows us to purchase and guarantee
    lower-cost mortgages for homebuyers.
        The second point I would like to make is about our capital.
    Fannie Mae believes our regulator should have flexibility over
    our capital regime, which Congress established in 1992 with two
    parts. We have a minimum capital standard. It is bolstered by a
    risk-based capital requirement with a stress test which
    requires us to hold enough capital to survive sustained
    depression-like economic conditions. Our capital requirement is
    still ahead of its time. Nevertheless, we support legislation
    that would provide our regulator with full flexibility over our
    risk-based capital requirement since it is the regulator's
    premier tool to ensure that we are well-capitalized.
        We also understand the interest in being prepared for
    unanticipated events, so we believe that if any unanticipated
    safety and soundness risk should arise, a risk not covered by
    our risk-based capital requirement, then our regulator should
    have the ability to temporarily increase our minimum capital to
    protect against that specific risk. Then when the risk goes
    away, the capital surcharge would go away as well. But we would
    urge Congress to ensure our minimum capital standard does not
    become a tool to alter National housing policy by restricting
    the flow of capital into housing.
        And, finally, to fully match our capital against our risk,
    we recommend that our regulator should take into account our
    total capital as bank regulators do for banks. Specifically,
    banks can earn the rating of ``well-capitalized'' if they boost
    their total capital level beyond their regulatory requirement.
    Four years ago, Fannie Mae volunteered to issue subordinated
    debt to boost our capital, bringing our total capital today,
    including loan loss reserves and subordinated debt, to 4
    percent of our balance sheet assets. Offering the regulatory
    designation of ``well-capitalized'' for our total capital would
    encourage future management to maintain this high standard. All
    told, we have $35 billion in total capital, plus $14 billion in
    subordinated debt. A recent Federal budget document suggested
    that a small mistake could harm our company. The opposite, of
    course, is true. It would have to be a colossal blunder to
    deplete $49 billion in capital and subordinated debt.
        My third point is in the unlikely event of a large
    catastrophe that would threaten our company, our financial
    regulator would need the authority to step in and take over the
    business. The question has been whether our regulator should
    have the authority to impose a receiver or a conservator.
    Receivership makes sense for Federally insured banks. The
    deposit insurance fund must be reimbursed from the assets of
    the bank when it makes depositors of failing banks whole. So
    the Government has to ensure that it has the first claim to
    assets before other creditors are paid. For Fannie Mae,
    conservatorship makes more sense.
        Here the task in the unlikely event of failure would be to
    conserve the assets of the corporation for debt holders since
    that is their only source of repayment. Because the Government
    has no investment in the company, there is no need for a
    receiver to protect the Government's investment. There is
    certainly no reason to complicate matters for debt holders who
    have invested in our securities based on the current
    arrangement.
        My fourth point is about mortgage innovation, which created
    the best housing finance system in the world and is critical to
    meeting this growing Nation's growing housing needs in the
    future.
        A few weeks ago, Fannie Mae launched a major expansion of
    our American Dream Commitment, a pledge we made 4 years ago to
    provide $2 trillion for 18 million minority and underserved
    families to own or rent a home before the decade was over.
    Because the housing market has been so strong, we met our top-
    line goals after only 4 years. So we launched an expanded plan
    focused on three goals: First, to create 6 million new
    homeowners, 1.8 million of them minorities, over the next
    decade; second, to help families at risk of losing their homes
    to stay in their homes; and, third, to expand the stock of
    affordable housing.
        To carry out this plan, which will advance the President's
    goal to narrow the minority homeownership gap in America, we
    plan to launch immediately about 60 different mortgage
    initiatives with a range of lending and community partners, and
    ultimately the initiatives could exceed 100.
        We believe that our financial regulator should have the
    authority to review at any time any activity by our company
    from a safety and soundness standpoint. We also support current
    requirements for prior approval of new programs.
        But we oppose expanding the reach of prior approval to
    include mortgage activities and processes because such
    micromanagement would harm our ability to achieve these goals
    and respond to market needs, which is exactly what Congress
    intended us to do.
        We would have to ask what public policy purpose would be
    achieved by slowing or stopping our ability to fight predatory
    lending, to expand low downpayment lending to teachers, police
    officers, and fire fighters, to help families with slightly
    imperfect credit get a low-cost loan, or to help minority
    families become first-time homebuyers.
        In conclusion, Mr. Chairman, Congress has helped to create
    the best housing finance system in the world, a system other
    countries envy and want to emulate. By strengthening our
    financial regulator, Congress can further strengthen this
    system to ensure all Americans have the best housing
    opportunities in the world.
        With that goal in mind, I have tried to make four points
    today: Fannie Mae supports having a strong, credible, well-
    funded financial regulator; we support having a strong capital
    regime matched to our risk; we believe that conservatorship is
    the best way to protect our creditors in the remote chance of
    failure; and we urge Congress to support mortgage innovation.
        These are not esoteric issues. This is important. There is
    a lot at stake. On the front page of The Washington Post last
    week, there was an interesting article about the economy. It
    opened with a story of Greg and Mary Beardmore of Green Bay,
    Wisconsin, who were struggling on a reduced income in a tough
    job market. Yet they were unusually sunny about their future.
        As the article stated, the Beardmores have kept their heads
    above water by refinancing their mortgage, lowering monthly
    payments, and taking heart in the swelling equity in a home
    that has gained $100,000 in value since they moved in 8 years
    ago. Mary Beardmore said, ``I do not feel like I am losing
    ground because I have the security of my home. If we had to
    sell our house to stay afloat, we would do it very quickly. So,
    you know, I think it is okay.''
        I mention the Beardmores because families like them are
    depending on us to get reform right and to do no harm to
    housing. And Fannie Mae stands ready to work with this
    Committee and the Congress to achieve this goal that we share.
    And thank you very much for the opportunity to testify.
        Chairman Shelby. Thank you, Chairman Raines.
        Chairman Syron.

                     STATEMENT OF RICHARD F. SYRON

           CHAIRMAN AND CHIEF EXECUTIVE OFFICER, FREDDIE MAC

        Mr. Syron. Thank you, Chairman Shelby and Members of the
    Committee. I must say it is an honor to be here today. I am the
    new kid on the block, but I could aspire to no greater legacy
    than to restore public trust to an institution chartered by
    Congress to ensure the stability, liquidity, and accessibility
    of the Nation's mortgage markets.
        I must say I approach the issues before the Committee today
    largely from the perspective of a regulator, having been
    President and CEO of the Federal Reserve Bank of Boston. But
    like most Americans, I am also a homeowner. I grew up in Boston
    in a two-family home financed by a VA loan that my father was
    able to get when he came home from World War II.
        I have only been on the job 2 months, but I am convinced
    that legislation is essential to enhance the GSE regulatory
    oversight structure. I think it may even be overdue. World-
    class regulatory oversight is critical to the achievement of
    Freddie Mac's mission and to maintaining the confidence of the
    Congress, the public, and financial markets.
        Today, I want to talk about two things: Why we exist and
    why regulatory reform is needed, and our position on some of
    those issues.
        Homeownership, as we all know, is at a record high.
    Families build wealth. Kids do better in school. Neighborhoods
    are safer. And in recent years, housing has been referred to as
    the backbone of our Nation's economy, actually accounting for
    more than a third of the growth in nominal GDP in the last
    couple of years.
        These are real benefits. They are real outcomes of a
    bipartisan decision to support homeownership by creating two
    institutions with the singular job of making mortgage markets
    stable and liquid. Unfortunately, sometimes we tend to take the
    GSE model of housing finance for granted.
        In a vain search for greener pastures, this important
    debate today is at risk of wandering from a focus on real
    things to philosophical debates on issues such as
    privatization.
        Freddie Mac strongly supports enactment of legislation to
    strengthen the GSE regulatory structure. Thus, we would
    respectfully encourage the Committee to focus on specific ways,
    as you have, to improve the GSE regulatory structure and avoid
    becoming sidetracked by side issues. To put it bluntly, let's
    get a top-notch regulatory structure in place and then get back
    to the job of putting more people, particularly minorities, in
    homes.
        Now, just very quickly, a little background. GSE
    privatization may sound attractive in theory. But while the
    real benefits are there, the potential benefits of
    privatization are highly speculative.
        Specifically, are we willing to risk the widespread
    availability of America's mortgage product of choice: 30 year,
    fixed-rate, prepayable mortgages without penalty?
        Other countries are not able to offer their citizens the
    double benefit of this type of loan. For example, just across
    the border in Canada, the typical fixed-rate mortgage has a
    term of 7 years, a downpayment requirement of 25 percent, and
    punitive penalties for refinancing. And I would like to submit
    for the record, Mr. Chairman, just a sheet that----
        Chairman Shelby. Without objection, it will be made part of
    the record.
        Mr. Syron. Thank you, sir.
        Perhaps I am a conservative at heart, but when the stakes
    are high and the risks of failure are substantial, I will stick
    with known benefits. This is not the time to begin dismantling
    the world's finest housing finance system or to place limits on
    its growth. The 20-percentage-point gap between white and
    minority homeownership rates indicates there is more work for
    us to do.
        Now let me turn to the imperative for regulatory reform.
    Regulatory oversight of the GSE's is essential. Given the known
    benefits of the Nation's housing finance system, it is crucial
    to proceed with an abundance of care, however, as we do this.
    Borrowing a phrase from our friends at the Homebuilders, I urge
    the Committee to ``measure twice and cut once.''
        Any one of the key provisions under consideration, if done
    inappropriately, could have negative effects similar to
    privatization.
        Given my time constraints today, my comments will be
    limited to three issues that go to the heart of the regulatory
    debate. The first is capital.
        Capital adequacy is absolutely key to the continued
    confidence of the Congress, the public, and investors. Compared
    to institutions I have personally regulated, the GSE's have the
    most sophisticated risk-based capital standard. Although our
    present regulator has significant discretion in adjusting the
    risk-based capital requirements, I would support providing the
    new regulator additional discretion.
        My strong preference for risk-based capital standards can
    be traced to my tenure at the Federal Reserve Bank of Boston
    during the infamous credit crunch of the early 1990's. While
    many financial institutions in the Northeast were well-
    capitalized on a risk-adjusted basis, the cautionary raising of
    pure simple leverage ratios required them to liquidate a
    substantial portion of their assets. This resulted in a drying
    up of commercial credit that turned a 2-year mild recession
    into a 5- to 6-year severe slump, causing a lot of lost
    businesses, lost jobs, and lost homes.
        Notwithstanding my philosophical differences, I would
    support regulator discretion to increase the GSE leverage ratio
    in the event of a finding of an unsafe and unsound practice.
    However, in my mind, parameters should be put in place that
    define the circumstances under which such an increase could be
    undertaken, as well as the parameters for returning to the
    statutory minimum once the problems had been addressed.
        The second issue I would like to mention is
    conservatorship.
        Now, while it may be appropriate to draw on certain banking
    provisions to improve the GSE regulatory oversight structure,
    we strongly believe that liquidation is not one of them.
        Receivership is an appropriate disposition mechanism when
    you are dealing with thousands of Federally insured depository
    institutions whose failure could have an impact on depositors
    and on deposit insurance funds.
        However, receivership is widely perceived in the market to
    have little practical application to large financial
    institutions, whether they be commercial banks or the GSE's. As
    a result, in my mind, it is not appropriate for dealing with
    the two GSE's, whose funding comes from world capital markets
    increasingly and not depositors and whose closure would have
    substantial economic, market, and public policy consequences
    for the Nation.
        While receivership might provide theoretical benefits, it
    would introduce substantial uncertainties into the global debt
    markets as well as the MBS markets. This would have significant
    implications on our ability to finance 30-year, prepayable
    mortgages.
        For these reasons, we believe retaining conservatorship is
    the right approach, in the unlikely event that a GSE were to
    experience extreme financial distress. Receivership would serve
    little practical purposes and would be interpreted by global
    capital markets as a first step toward privatizing the GSE's.
        Finally, the benefits of debt financing or the issue of the
    retained portfolio.
        The availability and cost of mortgages for America's
    homeowners would be negatively affected by efforts to constrain
    our retained portfolio. The fact is buying mortgages and
    mortgage-backed securities for our retained portfolio is
    essential to fulfilling our housing mission.
        First, our purchases create price competition and reduced
    mortgage rates for consumers.
        Second, our retained portfolio ensures we can continue
    providing liquidity during periods of market stress. For
    example, during the 1998 Asian debt crisis, lending in many
    sectors of the economy was disrupted as investors fled to the
    safety of Treasury securities. To boost falling demand for
    mortgages, Freddie Mac and its colleague Fannie Mae remained
    steadfast in the market. As a result, America's homebuyers were
    able to obtain low-cost mortgages during that period of stress.
    This would not have been possible if we had to rely solely on
    securitization.
        Our issuance of debt securities likewise benefits the
    housing market by allowing us to tap the global financial
    markets to the benefit of U.S. homebuyers. Many investors
    prefer the predictability of GSE debt over mortgage-backed
    securities, which are sensitive to prepayment risk. Restricting
    the use of this important funding mechanism likely would result
    in a reduced supply of funds and higher costs for
    homeownership.
        In closing, I would like to say a few words about Freddie
    Mac.
        I am sadly aware that Freddie Mac's accounting issues are
    the source of much of the current controversy regarding the
    role of the GSE's, and I apologize to this Committee and the
    rest of the Nation for that. However, as with any episode such
    as this, it is critical to get the ship back on course without
    overreacting at the tiller.
        One of my top priorities is to work with you to enact
    legislation that enhances our safety and soundness regulation.
    Regulatory reform is critical in light of the key role the
    GSE's play in our economy and in the achievement of the fondest
    hopes and dreams of Americans.
        Equally important, I am focused on expanding Freddie Mac's
    commitment to mission. Freddie Mac is an institution with
    special privileges, and special responsibilities come with
    that. I am very concerned specifically about meeting the
    housing needs of minority families. We have to do that better,
    and we will.
        Senators in today's New York Times on the front page, there
    is a picture of a family who is the third generation in that
    family to be living in a cellar. I am not talking about a
    basement apartment. I am talking about living in a cellar with
    no windows, next to a boiler and a sanitation system, because
    they can find no place else to live. We, as the GSE's, are not
    fully doing our jobs as long as that remains a widespread
    practice in this country, and we are committed to do better.
        Thank you very much for the opportunity to appear before
    the Committee today, and I look forward to answering whatever
    questions you may have.
        Chairman Shelby. Thank you.
        Mr. Rice.

                      STATEMENT OF NORMAN B. RICE

                 PRESIDENT AND CHIEF EXECUTIVE OFFICER

                   FEDERAL HOME LOAN BANK OF SEATTLE

        Mr. Rice. Good afternoon, Chairman Shelby, Ranking Member
    Sarbanes, and Members of the Committee. I am Norman B. Rice,
    Chief Executive Officer of the Federal Home Loan Bank of
    Seattle.
        I would like to start today by underscoring the critical
    importance of this Committee's work--and that of Congress and
    the Administration--in supporting a world-class regulatory
    structure that ensures and enhances the safety soundness, and
    economic viability of the housing Government Sponsored
    Enterprises.
        In my role representing the Council of Federal Home Loan
    Banks, I wanted to very clearly state our support for this
    effort.
        The Federal Home Loan Banks are acutely aware of how much
    is at stake in this process for American taxpayers and our
    member shareholders. We understand that this Committee is
    considering the creation of a new agency. If so, it is
    imperative that the agency you create improves the oversight,
    the mission delivery, and the effectiveness of the business
    activities of the housing GSE's, and not hinder them.
        When I testified before this Committee in October 2003, I
    outlined a set of four principles that framed the Bank System's
    bottom-line needs regarding a new regulatory structure. They
    include: Number one, preserving and reaffirming the Bank
    System's mission; number two, maintaining a strong, independent
    regulator; number three, preserving the Bank System funding
    through the Office of Finance; and, number four, preserving the
    unique cooperative and regional nature of the Bank System.
        More specifically this afternoon, I would like to speak to
    the proposed regulatory structure we understand is currently
    under discussion, that of an independent agency that operates
    outside of a Cabinet-level department.
        There are three key aspects of this proposed structure that
    I would like to address with the Committee today.
        Number one, ensuring regulatory independence. A regulator
    lacking true independence is often subject to a wide range of
    demands and influences that we believe would be detrimental to
    the supervision, business activities, and the mission
    fulfillment of the GSE's. It is critically important that this
    new world-class regulator not be hampered by a cumbersome board
    structure and not be dominated by any single agency represented
    on the board. This new regulatory body must have the authority
    to govern in a truly independent manner.
        Number two, agency oversight responsibilities. The Bank
    System believes this independent regulator should have the
    following authorities:
        Ensuring the safety and soundness of the housing GSE's.
        Overseeing all mission-based goals and programs. There are
    obvious differences in the mission-based goals and programs of
    the two housing GSE's and the Federal Home Loan Banks. However,
    we believe a proposed new regulator should have the authority
    to review, approve, and monitor all mission-based goals and
    programs. Our current regulator has that authority, and we
    believe it should be preserved.
        Setting capital standards. Along with independence, any
    world-class regulator must have the authority to set both
    leverage- and risk-based capital standards. As you know,
    Congress conducted an extensive review and revision of our
    capital structure in the Gramm-Leach-Bliley legislation, and
    the Finance Board was given this broad authority in the Act. We
    believe any new regulatory agency should have the authority to
    raise and lower capital requirements as deemed appropriate and
    necessary. And anything less, in our opinion, would be a
    significant step backward.
        Approving new business activities and programs. We believe
    a world-class regulator should preserve the Bank System's
    ability to innovate around existing products and services. In
    turn, the regulator should be diligent in examining and
    approving these innovations and exploring areas that represent
    new risks to the GSE's.
        Speaking on behalf of the Seattle Bank, I believe our
    mortgage purchase program is a good example of where our
    regulator insisted on close oversight and examination prior to
    approving a new business line.
        Number three, creating separate divisions for the Federal
    Home Loan Banks and the publicly traded housing GSE's.
        While Fannie Mae and Freddie Mac and the Federal Home Loan
    Banks all share GSE status, we are fundamentally very
    different.
        The Federal Home Loan Banks are cooperatively owned and
    capitalized by our members, most of whom are community banks
    occupying and delivering benefits to Main Street, while the
    other two housing GSE's must meet the quarterly earnings
    expectations of Wall Street investors.
        To that end, the Bank System believes that creating
    separate divisions within a regulatory structure would add
    efficiencies in the provision of oversight and supervision.
        In conclusion, I want to emphasis to the Committee that the
    onus of strengthen our system lies not only with Congress and
    the regulators, but also with the housing GSE's themselves.
        We must be willing to take the steps necessary to
    efficiently manage our financial institutions in a safe and
    sound manner and provide world-class financial transparency and
    disclosure regarding our business operations. On that point
    there is no debate.
        Where there is a difference of opinion among the Banks, and
    where there has been much discussion with our regulator and
    others, is concerning who should have authority over the
    financial disclosures and transparency--the SEC or the housing
    GSE regulator.
        From the Bank System's perspective, we believe that a
    world-class regulator would potentially be better able to set
    the framework and supervision for the level of financial
    disclosure now being demanded of our system.
        However, if Congress were to choose the SEC to regulate
    these financial disclosures, the Bank System believes some very
    specific accommodation are necessary.
        As you move forward in this legislative process, I would
    ask that you keep in mind that we are a cooperative system,
    owned by more than 8,000 banks, thrifts, credit unions, and
    insurance companies. That means every dollar of value we create
    is passed through to our members and their communities. That is
    why Congress created the Bank System, and that is why we exist
    today.
        So, I thank you for your time this afternoon, and I will be
    happy to answer your questions regarding my testimony.
        Chairman Shelby. Thank you, Mr. Rice.
        Yesterday, as everyone knows, Chairman Greenspan
    recommended, among other things, that the GSE's be limited in
    their issuance of debt and in their purchases of assets. At the
    same time, he spoke favorably regarding the securitization
    process and its value to the housing market and to homeowners.
        Would you agree that there is greater risk in holding
    mortgages and MBS's in portfolio?
        Mr. Raines.
        Mr. Raines. I think, Mr. Chairman, the answer is it depends
    on how you have hedged your portfolio and that you can, in
    fact, reduce the risk of a mortgage portfolio----
        Chairman Shelby. And the quality of the portfolio?
        Mr. Raines. It depends on the quality of the portfolio, but
    as well how you would hedge the portfolio in order to
    demonstrate the amount of risk that is actually there. And
    there is a simple way to illustrate that, Mr. Chairman, that I
    think would be useful as we discuss these issues, if I can find
    it.
        Chairman Shelby. Do you want to come back to that?
        Mr. Raines. It is illustrated by our risk-based capital
    standard because it is a very important concept that Dick Syron
    was pointing out and that I also think is vital in
    understanding this whole discussion.
        Under our risk-based capital standard, how much capital we
    have to hold depends on how much risk we have in our portfolio,
    and this chart illustrates in a simple way how the amount of
    capital that you should have depends on the level of risk.
        Chairman Shelby. Can you speak into the mike just a little
    more?
        Mr. Raines. Yes, sir. So, for example, on the far left it
    indicates that if you match your holdings of mortgages with 80
    percent callable debt, you can reduce the capital requirement
    down to about 1 percent, which gets you down at the same level
    as credit risk.
        On the other hand, if you finance your mortgage assets, as
    most banks do, by short-funding, using primarily deposits, you
    need 10-percent capital.
        So how much capital you need to have depends on how much
    risk you have. Typically, Fannie Mae has a duration match and
    50-percent callable debt, which requires us to have about 3-
    percent capital. However, if we change the risk, the capital
    requirement would go up.
        Chairman Shelby. But a world-class regulator, if we create
    one through legislation, would hopefully know all this, would
    they not, when they are assessing the risk that you are taking?
        Mr. Raines. They would hopefully know it.
        Chairman Shelby. Otherwise, if they were not up to the job,
    they would not know, but the kind we are trying to create or
    hopefully would create would understand these risks. And if
    they understood these risks, it would help them understand who
    they are supervising better, would it not?
        Mr. Raines. Yes, sir, I think it would help. But we have
    the example that the banking system to this day does not have a
    capital standard that takes into account interest rate risk.
    There is no interest rate risk included in the Basel standard
    that we have. Nor is there interest rate risk included in the
    proposed Basel standard.
        So this capital standard that we have is actually quite
    unique as being the only one that captures credit risk and
    interest rate risk and operations risk.
        Chairman Shelby. So why do the GSE's--I will just speak to
    Fannie Mae first and then call on the others--hold mortgages in
    the portfolio? Is it because you have a better return? There is
    a reason why you hold them rather than securitize them.
        Mr. Raines. Well, actually, Mr. Chairman, the reason that
    Fannie Mae holds them is the first thing we did as a company
    was hold mortgages.
        Chairman Shelby. I know that.
        Mr. Raines. When we were founded in 1938, until the 1980's,
    that is all we did. But our research shows that for the
    incremental billion dollars of securitization versus a billion
    dollars of purchases by our portfolio, purchases by the
    portfolio have a 30-percent greater impact on lowering interest
    rates. And it is simple to understand. It introduces new demand
    into the market that otherwise would not be there. People who
    invest in our debt have chosen that they do not want to invest
    in mortgage-backed securities. So we actually attract more
    investors into mortgages than would otherwise be there.
        So it is pretty clear from our research that the portfolio
    has a bigger impact on reducing interest rates than our
    securitization program.
        Chairman Shelby. But the holding of the debt in your
    portfolio causes great concern to Chairman Greenspan, for whom
    we all have a lot of respect.
        Mr. Raines. As do I.
        Chairman Shelby. As far as risk.
        Mr. Raines. As do I, although I found it curious that
    although banks are the largest holders of mortgages in
    portfolio, and although banks have the highest ratio of
    mortgages on their books today that they have ever had and have
    been growing at the fastest rate that they ever have, that was
    not mentioned, even though banks do not hedge interest rate
    risk and Fannie Mae and Freddie Mac do.
        So, I found that a curious point that the companies who, in
    fact, hedge the risk were viewed by the Chairman as being more
    risky as compared to banks who do not.
        Chairman Shelby. I am sure we will get into that when the
    Chairman comes back. He spends a lot of time up here.
        [Laughter.]
        Mr. Raines, back in the early 1980's, it is my
    understanding that Fannie Mae experienced some problems with
    mortgages it had bought in portfolio. Didn't they encounter
    some difficulties during the early 1980's? And wasn't
    securitization viewed as a positive means to ensure that
    interest rate risk was not entirely concentrated with the GSE
    holding a mortgage portfolio? I think in your own organization
    you had some problems.
        Mr. Raines. Two things happened, Mr. Chairman. In the early
    1980's, Fannie Mae operated like a big S&L. It borrowed short
    and lent long. And, fortunately, unlike the S&L's, it learned
    the lesson in time and was able to convert. And it did two
    things. One, it created the mortgage-backed securities program
    that gave it the ability to have an alternative execution. But
    the second and most important thing it did was create callable
    debt that allowed Fannie Mae to have liabilities that matched
    up with its assets.
        And so it was those two innovations, not just the
    securitization but the creation of a large, liquid, viable,
    callable debt market that matched up with the mortgages that
    allowed us to move forward with an on-balance-sheet portfolio.
        Chairman Shelby. Mr. Syron, I will ask you this question,
    and then see whether the others have any comments. Chairman
    Greenspan also said yesterday most investors have apparently
    concluded that during a crisis the Federal Government will
    prevent the GSE's from defaulting on their debt, the so-called
    implicit guarantee.
        Do you believe there is an implied guarantee backing the
    creditworthiness of GSE debt? Are you aware of Wall Street
    analysts making such claims? And if Fannie Mae or Freddie Mac
    were to become insolvent--which we pray they won't--would the
    Government have any moral obligation to make the creditors
    whole?
        Now, I am familiar with your background as head of the Fed
    in Boston, so you bring that experience here. The Fed is the
    lender of last resort, is it not?
        Mr. Syron. First, sir, to answer your last question first,
    I am not sure that the Federal Government would have any moral
    obligation. I think in reality, to answer your question
    honestly, that financial markets, both domestically and
    internationally, tend to look at financial institutions, and
    some of this is reflected specifically in some of the treatment
    in some of the FDIC laws.
        Chairman Shelby. They would treat it as a national problem,
    would they not? And if it is treated as a national problem----
        Mr. Syron. I think that is correct.
        Chairman Shelby. --they wouldn't have a problem.
        Mr. Syron. I think that is correct, sir. You know, whether
    I believe that there are moral obligations or not is not what
    matters. What matters, as you imply, is what investors believe.
    I would argue that there is a whole family of these things,
    that if you were to go to the average purchaser of commercial
    paper for the very largest commercial banks in New York, that
    there are a lot of people that would believe that the
    Government wouldn't allow those institutions to go, and we have
    had experiences in that regard.
        Chairman Shelby. The ``too big to fail'' syndrome?
        Mr. Syron. Yes, sir. And I think it would be naive for me
    to say that Freddie and Fannie and perhaps the Federal Home
    Loan Banks are not considered as part of that.
        Chairman Shelby. Do you agree with that, Mr. Raines?
        Mr. Raines. I believe that there is a perception that these
    institutions are so important that the Government will ensure,
    as best it can, that they are run well enough that they will
    not get into trouble; and if they are not run that way, that
    they will replace the leadership and make sure that the
    companies are run well. And that is the biggest guarantee. It
    is not that the Government is going to write a check. It is
    that the Government is not going to be indifferent. And the
    fact that the Government is not indifferent to the fate of
    these institutions, in the same way it is not indifferent to
    the fate of other large institutions, is the extra boost that
    is provided to them in the market.
        Chairman Shelby. Mr. Rice.
        Mr. Rice. The underpinning of the Federal Home Loan Banks
    is the joint and several liability, and that is a case where
    all the banks will have to stand behind any failure in the
    system, and that has been the hallmark and underpinning of how
    we operate. And I really do believe that that is what we step
    up to, and I think that is an important ingredient in where we
    have to go. But I do believe that should the crisis be
    exacerbated beyond any of the other banks to back up a problem
    in the system, then it will be of a nature that all of us would
    want to solve it.
        Chairman Shelby. It was also mentioned more than just in
    passing yesterday about how do we curb the growth of the GSE's.
    I do not know that we would want to curb the growth, as long as
    they were adequately capitalized. Most financial institutions,
    if they are adequately capitalized or well-capitalized and
    well-regulated, nobody tries to curb their growth. Is that
    right, Mr. Syron?
        Mr. Syron. I think that is absolutely right, Mr. Chairman.
    And if I could, just touching back on your question to Chairman
    Raines, in looking at the capitalization of commercial banks
    versus the GSE's, actually, you know, in the proposed Basel II
    standards, risk-based standards for what banks across the
    world--and some of this is already reflected in practice--would
    be required to hold against mortgage-backed types of assets. I
    believe that is actually slightly lower than the 2.5 percent
    that we statutorily are required to hold now.
        Chairman Shelby. That is what is causing some of the
    regulators some heartburn, is not it?
        Mr. Syron. It is causing them a lot of heartburn.
        Chairman Shelby. Lowering the capital standards.
        Mr. Syron. But I think if you look at what Chairman
    Greenspan said yesterday, you know, that these institutions--
    and I am new to this, so I am not going to brag on the
    management of my own organization--have extraordinarily
    sophisticated hedging systems, extraordinarily sophisticated
    risk control systems, I mean to the extent where I every day at
    5 o'clock, get a whole family of measures on my rim on exactly
    how we finished the day with respect to our exposure to
    interest rate risk. We have lots of measures of tests that we
    are within and whether we are meeting up to what is required.
        Chairman Shelby. Senator Dodd, I believe you are next.

                COMMENTS OF SENATOR CHRISTOPHER J. DODD

        Senator Dodd. Thank you, Mr. Chairman, and I apologize for
    stepping in and out of the room here.
        First of all, let me thank you, Mr. Chairman. You have done
    a very fine job--both you and Senator Sarbanes in having this
    series of hearings on this issue. And I think it has been
    tremendously worthwhile, so let me express my gratitude to you.
        Let me thank all three of you as witnesses. I had a chance
    to listen to a couple of you talk and express yourselves, as
    well as read your testimony. And we thank you for it and for
    your ideas and suggestions.
        I would just briefly say, Mr. Chairman, obviously like most
    of us here this is one of the great success stories of all
    time, and we do not want to lose sight of that. And as has been
    pointed by all, by our witnesses here, obviously the 70 percent
    of Americans who own their own homes today in no small measure
    due to the work that has been done here, and that should not be
    lost in this debate and discussion. And I think the points that
    have been raised by our witnesses emphasize that, and I
    certainly want to associate my own thoughts and feelings with
    those comments. And looking at how we can regulate these
    institutions in a way that will complement their jobs and the
    goals desired here is something we should embrace with a sense
    of caution, and I emphasize that word, that we do not do it in
    a way with a sledgehammer when a scalpel may be the appropriate
    tool so that we get maximum benefits out of these institutions
    rather than doing great damage to what has been one of the
    great engines of economic success in the last 30 or 40 years.
    So I thank them.
        I do not know if you have raised this question while I
    stepped out of the room. If you have, then I will just step
    back. I heard Mr. Syron talking about it, and I know Frank
    Raines raised it as well, and that is the issue of receivership
    versus conservatorship. And I do not know if the question has
    been raised or not.
        Chairman Shelby. That is a good question, and timely, too.
        Senator Dodd. Why do not you just walk us through your
    concerns again? I heard briefly what you had to say, and I do
    not know if you disagreed with what each other had to say about
    this. I know you agreed mostly. And, Mr. Rice, as well, if you
    have some thoughts on this, I would like to hear them. But if
    you might give us your concerns with this recommended change
    that has been raised. And from your perspective what are the
    problems with providing a future regulator with the ability to
    place a GSE in receivership? And what are the potential market
    impacts of such a change?
        Mr. Syron. Senator, if I might just start on this, I think
    one of the great geniuses that Congress resulted with in
    creating these GSE's was an ability to transfer interest rate
    risk, particularly interest rate risk on 30-year, fixed-rate
    mortgages, from the homeowner to the capital markets.
        Now, with the retained portfolio, given international
    investors' preferences not for mortgage-backed securities but
    preferences for the actual debt of these institutions, the
    GSE's, particularly Fannie and Freddie, we have found a way to
    sell more and more of our debt overseas, thereby shifting the
    interest rate risk, if you will, from homeowners in the United
    States to investors in foreign capital markets. And I think
    that is a substantial gain to the United States at a time when
    we have a lot of international trade issues, and it is not
    something that we very lightly want to give up.
        I am not implying that there are not issues that have to be
    faced with this, but I think the best way to facing the issues
    of the size of our portfolio and the growth of our portfolio is
    the same way that you deal with the institutions as a whole,
    and that is, as my colleague said, making sure that you have
    good capital standards, that you have a very strong regulator,
    the regulator is able to change the capital standards on a
    frequent basis if it deems necessary because of change of risk,
    rather than specifically coming in and saying we are going to
    bless certain types of obligations and we are going to prohibit
    other types of obligations.
        Thank you.

                  COMMENTS OF SENATOR PAUL S. SARBANES

        Senator Sarbanes. Did you indicate how much of your debt
    went overseas in your testimony?
        Mr. Syron. Yes, I think--now, Senator, I will apologize for
    being relatively new in this, but my understanding--and I only
    know our recent offerings. But in our recent offerings, I think
    somewhere on the order of about 34 percent has gone overseas.
        Senator Sarbanes. Of that offering, but how about your
    total debt, how much of it is overseas?
        Mr. Syron. I would have to get back to you on that.
        Mr. Raines. For Fannie Mae, of our benchmark debt
    securities, 32 percent are purchased by investors outside the
    United States. It is a very large part of our funding.
        But, Senator Dodd, directly to your question, I think there
    is a lot of misunderstanding on this issue, and I think there
    has been a lot of back and forth on the names receiver and
    conservator. The key things are the powers. Typically, a
    receiver's major power that is different than other powers is
    the ability to take a contract and say it is no longer
    effective. That is the big power. It is able to take one
    position and put somebody else ahead of you and say they get
    paid before you do.
        If you are the Government and have a bank insurance fund,
    you want to make sure you have paid the depositors and you are
    first in line to get repaid. And you need a receiver's power
    because, otherwise, everybody else will say you just showed up.
    We get paid first, you get paid last. So the job of the
    receiver is essentially to push everybody else out of the way,
    and pay the Government first. And then from whatever is left,
    the receiver can pay the others.
        In our case, the Government is not involved, so there is
    nobody to be pushed out of the way. Our bond holders are simply
    saying, ``Whatever there is left, pay me, but do not let
    someone else come in ahead of me.'' And when you say
    ``receiver'' in that kind of a case, they have a right to say,
    ``Well, exactly who is this receiver supposed to shove out of
    the way? Is it me? And for whom? Who is putting money in? I am
    the only one putting money in. The shareholders are behind me,
    so that is fine. But who is it who wants to come ahead of me,
    the senior debt holder?'' If you are a senior debt holder, you
    have to ask that question: ``Why do they want this? Who do they
    want to have ahead of me? What is the point?''
        I think it is far better to make it very clear--and I think
    Chairman Greenspan even suggested this yesterday--to make it
    very clear that the investors in the Enterprises have only
    access to the assets of the Enterprises and they get only what
    their contracts say they will get. And that is how we read the
    statute now. If others do not read it that way, we are
    perfectly happy to have it clarified that that is what is
    meant. But we think it would be a huge mistake for enterprises
    that have trillions of dollars of outstanding obligations for
    someone to come in and say, ``Well, you know, we are not so
    sure about what those contracts mean. We are not so sure of how
    they will be enforced in the future.''
        I think that would be a terrible mistake to no advantage.
    So that is why it is so important to get this right. We
    shouldn't get hung up on the names. You can call the person
    ``Bob'' as far as I am concerned, as long as they do not have
    the power to push aside our debt holders and say they do not
    have access to the assets to pay off the debt holders, even if
    you do not get paid 100 percent. But they do not want someone
    else coming in and saying, someone else has the first access to
    those assets.
        Mr. Rice. In the case of the Federal Home Loan Banks the
    case is already laid out. It is called joint and several
    liability, and should one bank falter, then the other banks are
    required to step up to the plate to cover the debt. So the
    Federal Home Loan Bank structure in my mind is resilient where
    each Federal Home Loan Bank is individually capitalized, but
    they are backed up by the other banks due to the joint and
    several aspects of that nature.
        I think that one of the things that we really understood in
    this whole process of capital and looking, with Gramm-Leach-
    Bliley we review the capital of the Federal Home Loan Banks and
    raise the standard is what we needed to have as far as where we
    need to be. So, I think we were clearly under the magnifying
    glass for how we manage risk-based capital and leverage, and I
    think that will serve us well.
        Senator Dodd. Mr. Chairman, could I ask one more question?
        Chairman Shelby. Go ahead.
        Senator Dodd. One of the biggest concerns raised by
    Chairman Greenspan yesterday, one of the largest questions
    raised by him yesterday is that the Fannie Mae and Freddie Mac
    pose a systemic risk as a result of unsustainable growth, was I
    think the quote, almost a direct quote. Challenge that
    statement if you will.
        Mr. Syron. Senator, first of all I would say these
    organizations have undeniably grown very fast in the last
    number of years, but let us face it, we have had the best
    mortgage market, not just in the history of the United States,
    in the history of the world probably. Just given the changes
    that are happening in the economy, it is inevitable that the
    retained portfolios of these institutions are not going to grow
    as fast in the future and may even decline, and particularly in
    relationship to the public debt, I think as someone said, Greg
    Mankiw said, to the publicly held debt of the United States,
    given our own reasons of what is happening with the deficit,
    that is going to increase greatly.
        Chairman Shelby. I know it is Senator Dodd's time, but
    could you address specifically the concern of Chairman
    Greenspan to holding the debt in portfolio, because he spent
    some time on that yesterday.
        Mr. Syron. He spent a lot of time on it.
        Chairman Shelby. Obviously, it is a great concern to him.
        Mr. Syron. But I think now--I do not want to get into
    quibbling about, debating about exactly each of his words--I
    happened to watch his testimony again last night, and he
    focused a lot on the rate of growth of the debt from the
    current base, and he said that, paraphrasing, that he saw
    nothing in these institutions that gave him any current concern
    from a safety and soundness systemic perspective.
        The issue he raised I think was that if you looked at the
    recent rate of growth of these portfolios, that he would have
    substantial concerns. What I am saying, quite honestly, is I do
    not think because of the expectation they have on what is going
    to happen on the mortgage market, that these portfolios are
    going to begin to have that rate of growth in the next few
    years as they have had in the last several years. That is a
    factual issue.
        Beyond that, I think the way to deal with this--and I may
    be repeating myself here--but is to have a strong safety and
    soundness regulator, and as I have already said, in terms of
    their ability to look at us, we are going to be holding more
    capital. It may be unpopular. Then the maybe unpopular Basel II
    ratio would have some of the largest financial institutions in
    the world hold against similar securities.
        Senator Sarbanes. But that is just a proposal in Basel II
    and a lot of people are complaining very strongly about that.
        Chairman Shelby. All over the world.
        Senator Sarbanes. I do not think you can take a proposal
    about which considerable question is being raised and use that
    as the benchmark to make your argument.
        Mr. Syron. But I would come back then and I would say what
    we should look at is what has been the historical risk exposure
    of these types of assets. Both of these GSE's, exclusively
    housing GSE's, have a requirement to meet quite strict stress
    tests on the different types of scenarios, and my understanding
    of it is, having gone through the exercise a couple of times,
    is that they meet those stress tests quite well. Your point is
    well taken, Senator, that it is a proposal and not a fully
    endorsed proposal by lots of people.
        Mr. Raines. Let me take a crack at this from another
    perspective. Clearly we are big, and we have grown as the
    market has grown. There are a couple of points that I would
    make, and that is that not only have we gotten big, but also
    everyone in the mortgage market has gotten big. Remember, the
    size of the mortgage market doubled in the last decade. It went
    from $3 trillion to $6 trillion, and we think it is going to
    double in this decade if we are going to meet the housing
    demand.
        But look at this chart at what has happened since 1999 when
    we had $5 trillion of mortgage debt outstanding and in 2003 we
    went over $7 trillion. Freddie Mac's share of that went from 6
    percent to 8 percent, Fannie Mae's went from 10 percent to 12
    percent. The largest commercial banks went from 16 percent to
    20 percent of the market. It is not simply the case that only
    these two institutions have gotten big.
        There was a time when we thought Fannie Mae was about to be
    the largest company in America. Right now we are going
    backward. Why? Because banks are growing faster than we are. It
    is simply not enough to say these institutions have gotten big,
    because if that is the problem, you are going to have a problem
    across the board. You are going to have big banks, and we are
    in a country that is not used to having big financial
    institutions. We are a country where in many States it was
    illegal to be big. You could only have one branch. But we are
    now in a world in which we are going to have larger financial
    institutions. That is the first thing.
        The second thing is: What are these institutions doing with
    these mortgages? Where is the risk?
        Senator Sarbanes. Who are the others before you leave that
    chart?
        Mr. Raines. The other largest holders?
        Senator Sarbanes. No. You have others, 52 percent in one
    and 47 percent in the other. Who is that?
        Mr. Raines. Primarily that is the holders of our mortgage-
    backed securities.
        Senator Sarbanes. Your mortgage-backed securities?
        Mr. Raines. Ours and Freddie Mac's, as well as the private
    label mortgage-backed securities that have been issued by
    banking institutions. So that is mutual funds and insurance
    companies----
        Senator Sarbanes. Of those mortgages, what percentage of
    them are yours and Freddie's?
        Mr. Raines. Of the total there is about 44 percent are a
    combination of Fannie Mae and Freddie Mac, where we have the
    credit risk. This is a measurement of who has the interest rate
    risk because we were talking about the concern about interest
    rate risks in portfolios. For about 44 percent of mortgage
    debt, Fannie Mae and Freddie Mac have the credit risk.
        Chairman Shelby. What do you mean by that? What is your
    guarantee on that, because there is a risk there.
        Mr. Raines. We guarantee the timely payment of principal
    and interest on the obligations. This is looking at who has the
    interest rate risk, and contrary to opinion, Fannie Mae and
    Freddie Mac do not own the interest rate risk on all the
    mortgages in America. We have a combination of about 20 percent
    on our portfolio. The other 80 percent is in other
    institutions, many of them quite large.
        The second point is: How much risk do they have and what do
    they do with that risk? Because that is where you have to
    determine what is happening. This is a complicated chart, but I
    will make it quite simple. It is just simply a measure of what
    is the growth risk you have, that 12 and 8 percent I said
    before. What is the net? What is left after you have hedged?
    Fannie and Freddie do a pretty good job of taking the risk that
    they got in the beginning and passing on about half of that
    risk to others. Look what happens when you get to depository
    institutions. They pass on almost none of the risk that they
    take on when they buy mortgages. They keep it. So again, if I
    am worried about risk in financial institutions, I would be a
    lot more worried about those who take it and keep it than those
    who pass it on.
        Senator Sarbanes. What percent of their assets in the
    financial institutions are reflected by mortgages?
        Mr. Raines. Today about 34 percent.
        Senator Sarbanes. I thought the figure was about 21
    percent.
        Mr. Raines. If you look at the financial assets of banks
    and thrifts, about 34 percent are made up of mortgage assets.
        Senator Sarbanes. What percent of your assets are made up
    of those items?
        Mr. Raines. Ninety-six. I mean we are specialists. This is
    what we do. In between banks and us would be thrifts, who have
    a large share as well.
        Senator Sarbanes. Would that not lead to the conclusion, if
    there is some concern about the risk here, and you are an
    institution in which 96 percent of your assets are in that
    category, that there is reason for heightened concern there as
    opposed to an institution in which 32 percent of its assets are
    in that category? Would that not simply follow, before you get
    to the hedging issue?
        Mr. Raines. You cannot ignore the hedging because we would
    not buy the asset if we did not do the hedging. It is not
    optional to us as to whether or not we are going to----
        Chairman Shelby. Mr. Raines, just for the record, and I
    know it is Senator Sarbanes--Senator Dodd's time.
        [Laughter.]
        On the other hand, I think Senator Bennett's time is coming
    up. But, Chairman Raines, what is the source of your data, and
    would you furnish that for the record?
        Mr. Raines. I would be delighted to do that.
        Chairman Shelby. Because our Committee would like to see
    that.
        Mr. Raines. I would be delighted to share it. This is an
    issue that obviously we spend a lot of time on. But it is a
    question I think the Committee can rightly ask: Are you better
    off having people who specialize in an asset, and this is all
    they do, or are you better off to have someone who has assets
    all over the board? Banks do 20 different things. They do junk
    bonds. They do Third World debt. In whose hands would you
    rather have these assets? Someone is going to have this risk,
    unless of course we tell consumers, you cannot have a fixed
    rate mortgage. We can solve this problem. It is solved all over
    the world by telling people, you have the risk, you the
    homeowner. We are not going to have the banks take the risk.
    You have it.
        In this country we have done something different, and in
    fact, that is why Fannie Mae was created in 1938, was to buy
    this newfangled mortgage that someone came up with, which was
    the FHA 30-year, fixed-rate, refinanceable mortgage. Today,
    over 60 years later, we are still doing the same thing.
        Senator Sarbanes. Of course, Chairman Greenspan was
    critical yesterday of that concept. I mean he is in here in a
    sense pushing adjustable rate mortgages yesterday, and throwing
    this risk back on the consumer, and in fact made the argument
    that the consumer would come out ahead. Of course, that is
    going to, it seems to me, require a fairly smart consumer who
    is going to have to know when to jump in and jump out and so
    forth. But he, in effect, is downing the 30-year fixed rate
    mortgage and pushing up the adjustable rate mortgage.
        Mr. Raines. Absolutely, Senator. You said it as plainly as
    I think it can be said, and the choice is really Congress's
    choice. It is a choice of whether or not you think consumers
    should have access to long-term fixed rate mortgages or they
    should not. And one can disagree on that. It is not as though
    that there is only one answer, but if you want them to have
    that choice, this is the only country who has figured out how
    to do it, and we figured out how to do it with a housing
    finance system that works.
        Senator Dodd. Particularly, if you are talking about
    serving underserved constituency. Adjustable rate mortgages,
    for a low income constituency, is a nightmare.
        Mr. Syron. If I may just inject something. Adjustable rate
    mortgages would have been a terrific instrument to have in the
    last 8 years or so when we have had one of great bull markets
    in bonds in the history of the republic. They would not have
    been such a great instrument to have had you taken out an
    adjustable rate mortgage in 1974, 1978, or any other points in
    the business cycle.
        The plain fact is, as a matter of national policy--it
    happens to be national policy I agree with, but as Frank says,
    it is your choice--we have decided that as Americans that we
    would prefer to shift the risk, the interest rate risk from
    homeowners to a sector that is better able to bear it. Other
    nations have not tried to do that. Many are exploring doing it
    now. The EU, as you know, is looking at setting up a GSE, but
    that is a decision we have made.
        Chairman Shelby. Senator Bennett, you have been very
    patient.

                 STATEMENT OF SENATOR ROBERT F. BENNETT

        Senator Bennett. Thank you, Mr. Chairman. I have had all my
    questions already asked.
        [Laughter.]
        There is an advantage of waiting.
        I have not had this conversation with Chairman Greenspan,
    and I would like to because I would like to understand his
    thinking a little better. All I have done is read about it in
    the newspaper, and I have long since learned that is not always
    a reliable source.
        I think Chairman Greenspan shares my devotion to the
    market, and allowing the person who is getting the mortgage to
    make the choice whether he wants an ARM or a fixed rate. I have
    never had an ARM in my lifetime. I have always had a fixed
    rate. I have had various terms, 15 years as opposed to 30 years
    for a variety of reasons. No. As a matter of fact, I just
    signed up for an ARM. I lied. I am sorry.
        [Laughter.]
        Forgot that. That was just last week.
        Chairman Shelby. We will correct the record.
        [Laughter.]
        Senator Bennett. Yes, correct the record on that.
        As I listen though I think you are saying that if we decide
    as a matter of national policy we are going to limit the
    ability of the GSE's to grow, that means once we reach the
    ceiling, however or whatever we choose as the way and place to
    set it, that means that you have to wait till somebody pays off
    his 30-year mortgage before somebody else can get one. Is that
    an oversimplification if the pot is full? Some of the people
    behind you are shaking their heads.
        Mr. Syron. It is not totally the case because we still
    could secure it, take and securitize the 30-year mortgage.
        Senator Bennett. I see. The limit would come only from that
    which is supported by debt?
        Mr. Syron. Yes, that is right. Before I give up totally, do
    not forget that if we were to do that, we would be giving up
    the ability to tap foreign capital markets.
        Senator Bennett. I understand that. So there would still be
    some growth.
        Mr. Syron. Yes, sir.
        Senator Bennett. But it would limit the amount.
        Mr. Syron. It would have some limit on the amount.
        Senator Bennett. Back to my philosophical point. I do not
    like any form of governmental wage and price or product
    control. I like to let the marketplace decide what people get
    paid and what they can buy, and I think you are saying that the
    consumer is choosing this; even though the ARM is available,
    the consumers are making a choice.
        The question is: Is that choice subsidized by virtue of the
    implied guarantee? In business I have never been able to cash
    in on an implied guarantee. I always prefer it in black and
    white, and I still do not understand where the implied
    guarantee--I guess it is the too-big-to-fail argument that we
    have heard here. Answer that question.
        Mr. Raines. There is no difference. We buy adjustable rate
    mortgages. We buy fixed rate mortgages. It is the consumer who
    is deciding, and consistently the consumer decides 80 percent
    of the time they would like a fixed rate mortgage. But in the
    market we are not in, in the jumbo market is only 50 percent
    fixed rate mortgages, and that is because the market we are not
    in cannot support the same level of fixed rate mortgages. In
    fact, right at the line where the loan limit exists, as soon as
    a loan falls into an area that we can buy, all of a sudden the
    market shifts over to fixed rate mortgages. So this is the
    consumer's choice. Fannie Mae, today I believe, has 1,000
    different adjustable rate mortgages that we are willing to buy.
    There is no lack of choice. You name an index. You name a
    feature. Somewhere in there we have in our system that mortgage
    and the ability to buy that mortgage.
        Consumer choice is vital here, and every occasion I have
    seen where consumers have had the choice to fix their largest
    single expenditure, particularly in the lowest interest rate
    environment we have had in 30 years, they take that choice.
    Some people, because of the cost, have to take on more risk
    because they can get a lower initial rate. So they get that
    rate and take on that risk because they want to get in the home
    so badly, but as soon as they can, our experience is, they flip
    out of that adjustable rate mortgage into a fixed mortgage.
        Senator Bennett. Except for the jumbo market.
        Mr. Raines. Except in the jumbo market where it is simply
    so much more expensive that it just does not make as much sense
    for them to be in----
        Senator Bennett. What is the line of the jumbo market these
    days?
        Mr. Raines. $333,700.
        Senator Bennett. You can see where I am going. My concern I
    have expressed to Mr. Rice when we had this hearing before,
    obviously safety and soundness has to be our primary goal here,
    but at the same time the way to be sure we have absolute safety
    and soundness is to require you to keep gold and make no loans
    whatsoever. That is pretty safe and sound, although with the
    commodity price maybe not even that is very good. We had to
    perform the mission. The question before the Committee, I
    believe, Mr. Chairman and Senator Shelby, is how do we
    construct a regulatory framework that gives us the ability to
    sleep at night on the safety and soundness issue and does not
    constrain the mission which the three of you and the
    organizations you represent have taken on and performed so
    admirably, that we do indeed lead the world by a very wide
    margin--this is not a close horse race--a very wide margin of
    homeownership, and that is a very difficult balancing act, and
    into it comes the new element that I had not thought of before
    this recent controversy raised by Chairman Greenspan of how do
    we do it in such a way that does not distort the market choices
    of the consumers that are taking out the mortgages, which is
    part, in my view, of fulfilling your mission. But it is a part
    which I had not addressed before. We have to make sure that the
    Government does not start picking winners and losers in product
    that is made available to the individual who takes out his
    mortgage, that he or she remains free to make, unimpeded by
    Government regulatory pressure, the right choice for him, and
    to switch if he decides he starts with an ARM and wants to go,
    we have to make sure that product is available for him to go.
    Is that a fair summary of the dilemma that we are facing here?
        Mr. Raines. It is, Senator, and it is going to get harder
    for you because the demand for mortgage credit in this decade,
    as I mentioned before, is going to double, and so we not only
    have to figure out how we continue to raise the $7 trillion
    that we are raising now, but we are also going to have to
    figure out how we get to $11 to $13 trillion while maintaining
    consumer choice and holding risk down.
        If we had a static world where all we were doing was having
    to move around the current problem, it would be a lot easier,
    but we do not have a static world. These companies are going to
    have to figure out what investor have we not tapped? What part
    of the world has not invested enough in the United States? Who
    are we going to get to invest more than they have ever invested
    before in our housing market as opposed to their housing
    market? Our challenge is huge. This is what I worry about all
    the time. I do not worry about whether or not we know how to
    manage the mortgages we have on our books today. I worry about
    where we are going to find the money that is going to house
    this 30 million people who are going to be here in 2010,
    because if we do not, it is going to be a very simple result.
    We are going to have a shortage of housing capital. There will
    be higher prices to clear the market. Fewer people will
    qualify. So we will have a lower homeownership rate in the
    future than we have today, fewer people becoming homeowners,
    because we failed to come up with that additional $6 trillion
    of capital. So this is a huge, huge problem.
        One of the reasons that I am so anxious for this Committee
    and this Congress to resolve these regulatory issues is so we
    can get about the work of doing this. We need a stable
    structure in order to take on this job. If it is up in the air,
    I cannot tell you that as we have in these prior decades, that
    we will be able to meet the task in the coming years.
        Chairman Shelby. Stable structure including a stable
    regulator.
        Mr. Raines. Exactly.
        Senator Bennett. If I can just ask one question, to which I
    do not want an answer, but to get it on the record so that we
    might look at it, I wonder if some study could be made of how
    much that increased demand is being driven by our present tax
    laws that say you cannot deduct credit card debt but you can
    deduct home debt, and how much demand for mortgages is being
    driven by an effort to get their debt into a situation where
    the interest can be deductible, as it used to be? I remember
    filling out my 1040 and used to be able to deduct interest in
    any place, and now the only place it is deductible--and you see
    all of the ads on the television saying: Consolidate all your
    bills and get yourself into our home mortgage situation and
    then all the interest is deductible. At some point we should
    have a study done to see whether or not the tax laws are
    driving an artificial amount of people going into their home
    loans that might be changed. As I say, it is a question to
    which I do not want an answer here. Thank you for your
    indulgence.
        Chairman Shelby. Before I call on Senator Carper I just
    want to respond to something you said, Chairman Raines. You
    were talking about specialization earlier. Banks have asked for
    expanded authority over the years for activities, as they say,
    to reduce risk through diversification. Fannie, as I understood
    it now, is engaging in one less risky activity. Does that not
    contradict the standard investment theory to spread your risk?
    You see what I am getting at?
        Mr. Raines. Actually, Mr. Chairman, there is a lot of
    debate and there has been some good work on this question of
    how much you can diversify away certain risk. It is not clear
    to me, and I think our experience is not such, that looking at
    banks, that this diversification across businesses has been
    successful. The counter argument is if you are in many
    businesses, how many of them can you be good at? And how many
    management teams can you bring together to manage all of these
    businesses? The experience I think in the banking sector has
    been if one of those businesses goes down, the diversification
    does not seem to have any effect whatsoever. I am much more a
    believer in putting your eggs in the basket; and watching the
    basket.
        Chairman Shelby. Senator Carper.

                 STATEMENT OF SENATOR THOMAS R. CARPER

        Senator Carper. Thanks, Mr. Chairman. To our witnesses,
    welcome and thank you for being with us today.
        Mr. Raines, I walked in after you had given your testimony
    and Mr. Syron was just beginning his and I heard his testimony
    and that of Mr. Rice. I did not hear your testimony, and I am
    not going to ask you to give your testimony, but I what I would
    like for you to do is take just maybe a minute and just recap a
    couple of key nuggets that you would have us take out of here.
        Mr. Raines. I just tried to make four points in the
    testimony, that primarily we need to focus on the important
    goal of maintaining the best housing finance system in the
    world. Getting capital right is a very important part of that.
    Getting the receivership question resolved appropriately so it
    does not introduce new uncertainty into the marketplace is a
    very important part of that as well. And we have to make it
    possible to have innovation and not have it tied up in
    bureaucratic process.
        Senator Carper. Thank you. Yesterday, when Chairman
    Greenspan was here I asked him a question. I am going to ask
    you the same question. I asked him: What wrong are we trying to
    make right in this process, and what risk or what harm are we
    seeking to avert? Let me just ask each of you the same
    question. Mr. Rice, if we could just start with you.
        Mr. Rice. I ask that question often, but I think what I
    really believe is at issue is a strong independent regulatory
    structure in order to manage the risk that is inherent with our
    business, and that by giving that regulator the powers to
    manage capital, to have independence, have the oversight
    responsibilities that are necessary, can restore a lot more
    confidence in this whole process.
        I think that as you begin to pile on, so to speak, or look
    at other ancillary issues beyond, then it becomes a little more
    complex. I really do think that we are going to have to figure
    out and create a structure that allows an independent regulator
    to be accountable to the Banking Committee and Congress and
    engage in that dialogue of change rather than trying to
    statutorily try to make all those changes, because I think this
    is not just a turn of the screw and things are all right. I
    think it is a long-term discussion with trust and support for
    an independent regulator.
        Senator Carper. Mr. Syron, let me ask the same question.
    Again, the question is: What wrong are we seeking to make right
    and what harm are we seeking to avert?
        Mr. Syron. I think that is a very good question, Senator,
    because I think there is a confusion on it. First, in terms of
    what is right, I think we have the most effective housing
    finance system in the world and the people in the rest of the
    world will tell us that. The wrong, in my mind, that we need to
    make right is I do not think we have an adequate regulatory
    structure for the GSE's, an adequately funded regulatory
    structure, and I do not know if it is an adequately structured
    regulatory structure. I think that is the issue that we need to
    make right.
        The issue that I do not think is broken and that we do not
    need to make right is to reexamine the entire housing finance
    system of the United States to explore the issue of whether we
    want to privatize these organizations and radically change the
    way we provide housing finance in the United States.
        Senator Carper. Mr. Raines.
        Mr. Raines. I think the legitimate issue that we would
    encourage the Congress to look at is whether the regulatory
    regime for these important institutions is appropriate given
    the need in the future. The last time Congress did this was
    1992, and in 1992 it made big changes. We did not have a safety
    and soundness regulator before 1992. We did not have real
    capital standards before 1992. We did not have housing goals
    before 1992. All of that happened in the 1992 Act. I think it
    made the system better. I think it made Fannie Mae better. I
    hope that through this process you prepare these companies for
    the task that we have going forward, which is to carry out the
    national policy of making homeownership and affordable rental
    housing more available, and to meet the needs of a growing
    country.
        In crafting a better arrangement from a regulatory
    standpoint, do not harm the underlying mission of the
    companies.
        Senator Carper. I am sure you heard from the critics of
    GSE's, particularly private sector competitors of the GSE's who
    really believe that you have an unfair advantage here, and it
    is something they would like to change. What do you say to
    those people?
        Mr. Syron. Unfair advantage, I have found is always very
    much in the eyes of the different competitors. Our different
    competitors have advantages of their own. They have, in many
    cases, depository insurance. They have an ability, which we are
    not looking for, to come in and out of markets. They will come
    in and out of these markets at the--excuse the expression--drop
    of a dime, depending on where things are most advantageous from
    their perspective. At least speaking for the two housing GSE's,
    our responsibility is to be focused on the housing industry.
    Business in the United States is the reason we are as effective
    as a Nation as we are is a very, very competitive situation.
    But everyone will look at their own situation and say someone
    else has an unfair advantage. When was the last time you heard
    a CEO come to you and say, ``My company has an unfair
    advantage?''
        Mr. Raines. Senator, I think there is a lot of myth and
    legend about who has what unfair advantage. When you look at in
    terms of unfair advantages and you say, who has the best deal?
    I would love to have the deal the banks have. Why? We have to
    fund our balance sheet by issuing long-term debt in the capital
    markets. They fund most of their balance sheet with deposits,
    and those deposits are backed up by insurance and they are also
    backed up by the Fed window that allows them to borrow. This
    has a huge impact, and this goes to what I think is the biggest
    myth, that is, that Fannie Mae has the lowest cost of funds out
    there.
        What I have plotted on this chart is since 1994 the cost of
    funds for commercial banks and for Fannie Mae. If you look at
    the cost of funds for the commercial banks, they are the low
    end, but it is cheating a little bit because they actually have
    to run branches and things to collect these funds, so it is not
    free. We have adjusted for that cost. As you see, throughout
    this entire period banks have had a lower cost of funds than
    Fannie Mae, and as my CFO likes to say, the real proof of this
    is that banks buy Fannie Mae debt. We do not buy deposits. We
    cannot make money buying deposits, but they make money buying
    Fannie Mae debt. Indeed, some people say they buy too much
    Fannie Mae debt, but there is no doubt that they buy Fannie Mae
    debt. How could they buy our debt, which is our cost of funds,
    if their cost of funds was higher than ours?
        The great myth here is that Fannie Mae is sitting with a
    much lower cost of funds. Banks, if they want to grow their
    mortgage portfolio, do it, and we step aside. When they stop
    wanting to grow their mortgage portfolio, we step up. They may
    say, ``Ah, but you can go into the agency market.'' I showed
    you before they do not use long-term debt very much in their
    funding, but they can go in the agency market too through the
    Federal Home Loan Banks. Their primary job is to fund banks out
    of the agency market. So they borrow at essentially the same
    cost that we do and pass it on to banks. So they have lower
    cost deposits and the same long term funding cost as we have.
    So that is a pretty good deal.
        The tears that are shed on behalf of the banks that somehow
    we have an unfair advantage against them, I do not see it. I
    see them able to grow whenever they want to grow, to move from
    business to business whenever they want to, to merge into very
    large institutions without anyone being concerned that somehow
    there is systemic risk being created or the system is at risk.
    I think they do a great job as diversified financial
    institutions. We do a pretty good job as institutions who are
    focused on the housing market.
        Chairman Shelby. Senator Carper, could I just interject?
        Senator Carper. Sure.
        Chairman Shelby. A lot of the banks say you have, the GSE's
    the unfair advantage and so forth. What is your answer to that?
    Is that your answer?
        Mr. Raines. I say on the cost side it is pretty clear that
    we do not. They have never been able to explain to me why they
    buy our debt if our debt is lower than their cost of funds. But
    even on the capital side we do not have an advantage. In fact,
    I would be willing to trade with them. If they are willing to
    take our capital standard and be subject to the OFHEO risk-
    based capital standard where they have to have sufficient
    capital to withstand huge movements in interest rates and
    depression level credit losses----
        Chairman Shelby. They are into a lot of things that you are
    not into in the whole panoply of financial services. You are in
    a specialty.
        Mr. Raines. That is one reason why they need to hold a lot
    more capital because most of the things they are in outside of
    housing are far more risky.
        But our capital standard is so rigorous that we had a firm
    a couple of years ago look at it and see what would happen to a
    thrift, which was the closest comparison to us without all
    these other businesses. If OFHEO capital standard were applied,
    the thrift would have to have 50 percent more capital.
        Again, there is a lot of myth and legend that has been
    repeated over and over again that Fannie Mae has an easier
    capital standard, that we have cheaper cost of funds. The fact
    of the matter is that we do not.
        Senator Carper. I would like to yield back the balance of
    my time to Senator Dodd.
        Chairman Shelby. That was kind of you.
        Senator Sarbanes.
        Senator Sarbanes. Thank you, Mr. Chairman.
        I want to ask first what your position is on whether
    approval from the regulator should be required with respect to
    new product lines or product activity?
        Mr. Syron. Senator, I think it depends on how one defines
    those terms.
        Senator Sarbanes. Let me stop you right there. Do you agree
    with that?
        Mr. Raines. With what he just said so far?
        Senator Sarbanes. Yes.
        Mr. Raines. Yes, it does.
        Senator Sarbanes. Do you also agree with that, Mr. Rice?
        Mr. Rice. We operate under a situation today that they
    approve any new business activity, the Finance Board.
        Senator Sarbanes. And do you think the regulator should
    have that power?
        Mr. Rice. I have no problem with it.
        Senator Sarbanes. Even under a new structure here, okay. Do
    you agree with that statement?
        Mr. Syron. As I understand the statement, I agree with it.
        [Laughter.]
        I will not claim that I understand it, Senator.
        Senator Sarbanes. Rather than giving me all the
    qualifications, each of you tell me what power you think the
    regulator should have in this area?
        Mr. Syron. Can I try to answer that? Let me give you a case
    in which I think they should not be required to approve it and
    a case in which I think they should be required to approve it.
    Should we decide--we are not about to do this--but should we
    decide that we wanted to offer something like mortgage
    insurance or to go further toward the retail end, toward the
    origination end, I totally agree that the regulator----
        Senator Sarbanes. No, no. I have to get you down into the
    ball game. I have to get you onto the ball field. It does not
    help me to get these examples that are outside of the ball park
    because if we are going to have a regulator, the first question
    is are they going to have power in this area. Everyone, as I
    understand it, has said, yes, but it has to be properly
    defined, and I am trying to get a definition out of you. I want
    to know where you see the line, how do you define that line?
        Mr. Raines. Let me take a crack at that. I believe that the
    line should be exactly where it is today, at the program level.
    If we are doing something brand new, then the regulator should
    have the ability to preapprove that.
        Chairman Shelby. Or reject it.
        Mr. Raines. Or reject it. But, for example, one of the
    first things I did when I came in as Chairman of Fannie Mae is
    we had never been in the business of helping people with
    impaired credit. It was within our loan limit. It was a
    conventional loan. It was a mortgage. We had simply set our
    standards at a level that made them not qualify. I do not think
    I should have had to go to a regulator and say: Well, what do
    you think? Do you think that we should be able to do that? We
    cut down payments. I do not think we should have had to go to
    the regulator with that. I announced 3 or 4 weeks ago our
    expansion of our American Dream Commitment, 60 different
    initiatives. I do not think that the regulator should have been
    telling me whether or not I should set a goal of increasing the
    minority homeownership rate to 55 percent. I do not think they
    should be in the business of telling me that we should or
    should not be able to tighten up our predatory lending
    standards. I think that should be left to private management.
        But for example, we had never been in the business of doing
    acquisition, development, and construction financing, which is
    different. We took that to HUD and HUD looked at it and they
    approved it. They could have said no. But that was a wholly
    different thing. It was not a mortgage where we were changing
    around the criteria. It is a wholly different business that we
    had been encouraged to get into, and we experimented with in
    cooperation with HUD. They approved that. So that is the
    distinction.
        If every time I have a new product or a new activity, and I
    have to get approval, do you have any idea how long it would
    take me to get the 60 initiatives approved, even just to put
    together the request and to have all of the evidence that a
    regulator would want to look at? That is not a business. That
    is running a bureaucracy, and I do not think that the Congress
    should want to turn these companies that have been innovative
    companies with private management, into simply an extension of
    a bureaucracy.
        Chairman Shelby. Excuse me. I know it is Senator Sarbanes'
    time. How would you compare that to a bank regulator for a bank
    to get into various things, do they have to deal with a
    regulator?
        Mr. Raines. Banks do not have prior approval as long as
    they are within banking. Only if they are going into one of
    these new powers do they have to go and get approval. So it is
    quite similar. The term ``new activity'' is probably the most
    pernicious aspect of this because every time we change a
    process, we would have to go and get approval from a regulator.
    I think it would stifle not only these businesses but also any
    business. I cannot see how any entrepreneurial enterprise,
    public or private, could operate having to ask permission every
    time they wanted to have an innovation.
        Senator Sarbanes. Mr. Raines and Mr. Syron, everyone
    asserts that you get a subsidy flowing off of the implicit
    guarantee, and then there are various figures as to what
    portion of that subsidy gets passed through in order to benefit
    the consumer. What do you think the figure is that passes
    through to benefit the consumer?
        Mr. Raines. I think I can illustrate it for you pretty
    easily because we see it every day, and we can calculate it for
    you, and this may be a little bit different way than you have
    seen it before, but it is pretty clear as to what happens. This
    chart compares our market, the conforming market, below the
    $333,700 in the jumbo market. What I am comparing at the top is
    the yield on a mortgage-backed security issued by Fannie Mae
    versus a mortgage-backed security issued by a bank or someone
    else in the jumbo market. You can see that the difference in
    the yield between the two is about 21 basis points. That is
    what we bring to the party. The way we reduce rates is to bring
    down the yield on our mortgage-backed securities. We do that by
    increasing liquidity and by buying them ourselves through our
    portfolio. That is our contribution.
        Everything after that is our cost of a guarantee fee and
    lender costs. When you get down to the primary rate, the rate
    that you find out in the market, the consumer is paying 5.93
    percent versus 6.19, actually it expanded. Our 21 basis points
    became 26 basis points. This is why we say we pass on more than
    all of the benefit. If you give the ``implied guarantee'' all
    the credit for that 21 basis points at the top--which we do
    not, we think we actually do some things here; our liquidity
    actually is a big piece of that. But if the Government got 100
    percent of the credit for that 21 basis points, by the time it
    gets to the consumer it turned into 26 because our system is
    more efficient than the jumbo system. Ours has more liquidity.
    Lenders have to compete more because we have more small lenders
    who are competing in our market than in the jumbo market.
        This is not based on some fancy equation. This is simply
    going into the market and looking at every element between the
    issuance of that mortgage-backed security, which is the cost of
    funds for that mortgage, and the rate the consumer gets. I
    offer that up to you as far better proof than econometric
    models that try to calculate the same thing, not by observing
    what happened in the market, but by running mathematical
    equations to simulate what happens in the market.
        Senator Sarbanes. Is it your position that whatever subsidy
    you get is entirely passed through and that none of it stays
    within the confines to benefit the shareholders of the company?
        Mr. Raines. That is indeed our position. The shareholders
    in the company are----
        Senator Sarbanes. No one else has come here and taken that
    position.
        Mr. Raines. I have taken that position for years, and
    Fannie Mae has taken that position for years, and there are a
    number of studies that have been taken on, that have been
    conducted by conservatives, by liberals and others, who have
    come to exactly the same conclusion. We can provide the
    Committee with those studies that have examined that issue.
        Chairman Shelby. Could you do that?
        Senator Sarbanes. If we were to look at all these studies,
    your and others, and conclude that the subsidy was not being
    entirely passed through, what do you think should be done about
    that if anything?
        Mr. Raines. You have to ask the question, what is it that
    we do? If you believe that some of the ``subsidy'' was not
    being passed on, let us look and see where all the money that
    we make goes, and we can figure out where we think there is an
    excess. This chart shows for last year our total pretax
    earnings. This goes to the question, where does it go? Twenty-
    five percent of it the Federal Government gets in income taxes.
    We are a full Federal income taxpayer, probably one of the
    largest in the country. Twenty-five percent goes there. Fifty-
    seven percent goes to capital, to bolster that capital which is
    the safety that we have been talking about. Our shareholders
    only get 18 percent of it now. So if there is a dollar of
    subsidy that we get, this is a pretty good idea of where it
    goes now. The question is: Who should it be taken from if it is
    going to go some other place? Are we going to take it out of
    capital? Are we going to take it out of the taxes or are the
    shareholders supposed to give up of the 18 percent they get of
    the funding? There is no magical----
        Senator Sarbanes. How is it your shareholders do so well on
    a comparative basis, double figure payoffs and----

                   COMMENTS OF SENATOR JON S. CORZINE

        Senator Corzine. Would the Senator yield?
        Senator Sarbanes. Certainly.
        Senator Corzine. I do think that the build-up in capital
    has something to do with shareholder value. If I am not
    mistaken, it does increase the book, and therefore somebody has
    some perspective on what value is created.
        Mr. Raines. Except the only problem here is that they can
    never liquidate the firm. So the only way they can----
        Senator Corzine. They can liquidate the stock. The
    marketplace has decided the value.
        Mr. Raines. Because they cannot liquidate the firm the
    capital is stuck inside the firm.
        Senator Corzine. That is true.
        Mr. Raines. But also with regard to the returns, let us be
    brutally honest here. Fannie Mae has a price-to-earnings ratio
    of about 9, which is half of the P/E ratio of the S&P 500
    average. So we are half of the average companies' P/E. This is
    not a sign that shareholders think they are getting a fabulous
    deal. If they thought they were getting a fabulous deal, our P/
    E ratio would at least be equal to the average company.
        I am not poor-mouthing, saying that somehow you need to
    help us. I am just simply saying the idea that somehow that our
    shareholders are getting a bonanza, when in fact, our stock has
    not performed even at the same level as other financials have
    over the last 5 years, says something about our relative
    position. It may be a good thing to be a financial, although
    all the financials have relatively low P/E's, but this is not
    the market indicia of a company that is collecting what
    economists would call rent, ordinarily having a return higher
    than the market, not lower.
        Senator Sarbanes. Is it your position that you cannot
    assume any greater burdens of responsibilities with respect to
    affordable housing because you are really stretched right out
    to the limit; is that right?
        Mr. Raines. No, just the opposite. I just announced the
    largest commitment to affordable housing any company in the
    world has ever made, and since I have been Chairman of this
    company we have committed $2 trillion. We have just committed
    to help create another 6 million new homeowners. I do not think
    there is any company who has done as much as Fannie Mae or
    promised to do as much as Fannie Mae, and we are not done. We
    believe we can do more, but we do not think it is a question of
    subsidies. We think it is a question of making the system work
    better, and if we make the system work better we can make more
    homeowners. I guess the proof is in the pudding, and if you
    would bear with me for one last chart, and I promise I will try
    not to do another one.
        This is a comparison with our friends at the FHA, who have
    for years been leaders in providing service. It shows you the
    difference that can be made over time. I can show you this in a
    variety of ways. This is just looking at minority borrowers. I
    could show it looking at low-income borrowers or in poor areas.
        Back in 2000, the FHA did substantially more service to
    minority borrowers than Fannie Mae, significantly more. We made
    a commitment that we were going to be the leaders in service to
    minority households. In 2001, we did 50 percent more than the
    FHA. In 2002, we did 2.5 times as much as the FHA. We do not
    where they are in 2003, but given that we increased our service
    by 70 percent, I daresay I do not think that they are going to
    be close to us there. This is real service to real people. The
    FHA is a Government owned, Government guaranteed, Government
    subsidized entity that can make loans in the same markets we
    make loans in, and we are able to provide dramatically more
    service through a private sector, private capital entity. This
    is a success story. This is not something for us to go and be
    sad about. We are serving more people than we ever were serving
    before. This is because we have reached out, we have tried to
    do more, and we keep pushing the envelope. I can pledge to you
    as long as I am Chairman of Fannie Mae, that we will continue
    to push the envelope of what we can do in the confines of
    private capital.
        What we cannot do is be a subsidy source, where we are
    simply taking money and not investing in a business but giving
    it out as a subsidy. That will be the death of these companies
    and will prevent us from this type of service.
        Senator Sarbanes. I have one question for Mayor Rice. I
    want to get him into the--and I say Mayor. You know, Averell
    Harriman----
        Mr. Rice. I accept the title.
        Senator Sarbanes. --insisted on being called Governor, even
    though he had been Secretary and Ambassador and everything
    else.
        Mayor Rice, I am going to ask you a very simple question.
    What do you see in the current context as the purpose of the
    Federal Home Loan Bank System?
        Mr. Rice. First of all, we are a cooperatively owned
    system, 8,000 members, and we serve our members to provide
    housing, financing, and liquidity for those members. One of the
    things you said earlier, what do we do with our subsidy? I
    think the CBO report that was laid out in 2001, the banks are
    cooperatively owned by retail financial institutions, they have
    elected to become members of the System, and they are eligible
    to borrow from the Federal Home Loan Bank for financing and
    advances.
        Because the members are both owners and customers of the
    Federal Home Loan Banks, it is more likely that almost all the
    benefit of the GSE status is passed through to them either in
    the form of concessions on the advances or our dividends,
    because actually retail lending is highly competitive, and
    members may be forced, and often do, pass most of the benefit
    on to their customers in order to be competitive.
        Senator Sarbanes. Why do we have this facility? Why do we
    provide this facility to which the member banks can go and get
    advances at a reduced rate? Why do we do that?
        Mr. Rice. Well, I think when you look at several of our
    members, they do not all have access to the capital markets in
    the same way. I think this is a way to give them liquidity.
    This is a way in which they can still be competitive in those
    smaller areas and those rural communities all throughout
    America where they are not large in scale, they are actually
    small and need that ally and that assistance. They also come to
    us periodically for new ideas and new opportunities such as to
    sell their mortgages, which we are undertaking and reviewing,
    and we try to respond to their needs.
        Senator Sarbanes. That sounds good, but then you start
    looking at the statistics beneath the surface. According to a
    report cited by the May 2001 CBO study of the housing GSE's, 52
    percent of the mortgages held by FHLBank System members which
    are used as collateral for system advances, are jumbo loans. In
    fact, according to the CBO study, only 300 million out of 3
    billion in total Federal subsidies received by the System
    benefits conforming mortgage borrowers. What is the public
    policy rationale for providing a Federal subsidy for jumbo
    borrowers?
        Mr. Rice. I do not have those statistics. I do not agree
    with them totally, but I will say this. Remember though, you
    have to look at the whole range of what we are responding to
    do. Ten percent of our net income goes for affordable housing
    direct. Twenty percent of our net income goes for reducing the
    REFCORP debt. The sum of what we do is still intricately
    important in I think financing housing, financing and mortgage
    lending in our districts.
        Senator Sarbanes. If these statistics are correct, would
    they give you concern? Let us assume they are correct for the
    moment. Does that give you concern?
        Mr. Rice. The jumbo loans and the 52 percent of what is
    held?
        Senator Sarbanes. Yes. Why are we providing this.
        Mr. Rice. I think what I would like to see with the figures
    is by which members of our bank, because I think there are
    large members and there are small members, and they may very
    well be held by a class of members that are not representative
    of all 8,000 member institutions.
        Senator Sarbanes. I understand the 10 top members out of
    the 8,000 have 25 percent of the advances in the Federal Home
    Loan Bank System. Is that right?
        Mr. Rice. I think that if you are part of a cooperative and
    members can join, I do not see anything wrong with that. I
    think really the idea is----
        Senator Sarbanes. Why are we providing this special status?
    Why do we have it if the advances are going to a concentrated
    number of large institutions, and if it is supporting jumbo
    loans, why are we doing this? What is the purpose of this?
        Mr. Rice. I think the financial industry has changed
    drastically from when we started, and there is a barbell
    effect. There are large members on one side and there are small
    members on the other end of that barbell. I think that when you
    have a cooperative you cannot start discriminating between
    large and small. You have to afford the members of the
    cooperative access to the services that you have, and that is
    part of how we operate. I think if you start to begin to
    differentiate and begin to try to draw those lines, I think it
    become harder to manager.
        Senator Sarbanes. If it becomes highly concentrated, is it
    not reasonable for policymakers to start asking the question
    why do we have this system in any event? What is the purpose of
    it?
        Mr. Rice. I still think that the purpose is to provide
    liquidity to financial institutions in need that do not have
    choice. I think it is also to offer those financial
    institutions choice in the marketplace, and whether size or
    not, that is the choice that we should offer our members.
        Chairman Shelby. Senator Corzine, you have been very
    patient. We should have given you most of the afternoon, given
    your background. Anyway, go ahead.
        Senator Corzine. I would only make one comment, that I
    suspect those P/E ratios would go up a lot faster if we were
    not debating how they were going to be structured for the next,
    whatever, but I think it is also a worthwhile discussion. I
    thank you, Mr. Chairman, for what I think is a very thoughtful
    discussion that we are having about these overall issues.
        It seems to me that the systemic risk question that
    Chairman Greenspan raised yesterday continues to linger. I am
    not sure that I agree with it, but it lingers in the sense that
    diversification of risk, by some people' views, as I think the
    Chairman mentioned, is one of the principles at least some of
    us learned in Finance 101, and that there is a concentration of
    risk here, and therefore does that create another type of risk,
    beyond interest rate and credit, such as operational risk,
    which maybe we have seen displayed by the current circumstances
    of restatements of earnings and other issues, that unintended
    consequences tend to get bigger in a world where you do not
    have----
        So, I guess I would like to hear whether you think the
    concentration of risk deserves some greater attention in the
    risk-based modeling than now is the case. As I see it, maybe it
    is what stimulated Chairman Greenspan to worry about systemic
    risk, if we are going to have grow $6 trillion over the next
    decade and mortgage debt outstanding being held. I guess not
    held, but creation.
        I think it is a fair question. You know, is there some
    reductio ad absurdum number that these institutions should not
    grow beyond? Maybe it is not where we are today, but maybe it
    is some incredible number as you go on with the trillions here.
    I think that is the question that really is on the table, and
    particularly I was struck, Mr. Raines, by your comment that
    securities held are 30-percent more powerful in driving that
    26-basis-point subsidy.
        I would actually like to see the, I mean, it sounds like
    supply and demand being applied to the market, but I think on
    all of these issues, I would like to see some objective support
    for the arguments that one is talking about, and I accept that
    the 26 basis points looks like it is rational from this
    analysis, but we hear other people talking about maybe 10,
    maybe 15. Some of the studies that we have seen, I think we
    need to compare, and contrast and understand why there is such
    a broad difference and why there has--it is great that we are
    taking steps to help minority homeowners, those numbers look
    great, but what is the history and is it broad-based within the
    GSE's?
        So all of those questions seem to me fair game in this
    overall discussion, but I think still the most important is the
    systemic risk by what is too big for any institution in the
    system. And I think we have gotten into ``too big to fail''
    concepts in our financial system, whether it is GSE's or
    private-sector institutions. Therefore, we need, since the
    Government is sponsoring these institutions, the standard maybe
    is higher than it would be for private institutions.
        And so I think that is why we are having this debate about
    minimum capital standards or whether we have risk-based
    standards and are the risk-based standards appropriate for the
    circumstances, particularly in the concentration of risk that
    is ahead.
        I throw this out mainly because I do think that there
    becomes some diminishing return in concentration at some point,
    being an old believer in diversification. And so I think that
    is the burden you all have to talk to us about with regard to
    the standards.
        Mr. Raines. Well, Senator, I think you posed the question
    very well, and it is a central issue as to does our current
    regime encourage the right kind of behaviors given this focus
    in one asset class in one company. I would argue that it does,
    and let me just state a couple parts of that argument.
        Because we have a risk-based capital standard that punishes
    keeping risk and rewards dispersing risk, we, unlike banks,
    have a very strong incentive to disperse risk to other holders.
    Because banks get no credit if they use mortgage insurance,
    they do not use mortgage insurance, and so they take all of the
    credit risk. Because banks do not get any credit if they use
    callable debt, they do not use callable debt. They take all of
    the interest rate risk. Their capital is fixed, essentially,
    regardless of their posture from a risk standpoint, and this
    distinguishes American banks from European banks, for example,
    and Canadian banks, where American banks on a dollar-for-dollar
    basis have more risk than European banks and Canadian banks
    because only in the United States do we have a fixed leverage
    requirement and because it is fixed, banks want to have the
    risk that would give them the return on that capital.
        Our risk-based capital standard, on the other hand, rewards
    us if we get rid of risk. So if we use mortgage insurance, our
    capital requirement goes down. If we use more callable debt,
    our capital requirement goes down. So we had a very strong
    incentive to disperse risk.
        I do not view Fannie Mae and Freddie Mac as being
    repositories of risk. I view us as being intermediaries, where
    we take risk from the consumer, and we transform that risk into
    forms that the capital markets are most likely to want to value
    highly. They will not value that loan. But if we can take that
    loan, put it into a mortgage-backed security and have that
    mortgage-backed security sold, or we can take that loan, issue
    our debt, and own it on our balance sheet, the market values
    that consumer risk more highly. And so our goal is not to stock
    up on risk. Our goal is to be a risk dispersal mechanism and to
    get a reasonable return for our shareholders, but not by
    increasing our risk profile.
        Indeed, last July, we completed a year-long study in which
    we set a mandatory parameter of our risk appetite, and we set a
    very high standard. We wanted to be, on a stand-alone basis,
    without any GSE trappings, a AA, AA-minus company. We wanted to
    have, from both interest rate risk and credit risk, a lower
    volatility of earnings than your typical AA company.
        As you know, we do not have a lot of AA-rated financial
    institutions. That is a very high standard to aspire to. We did
    not say, ``Well, we are a GSE we get away with being an A, and
    could not we rock-and-roll then if we took on more risk.'' We
    instead said we think it is better for us to have a low
    tolerance for risk because that will facilitate our long-term
    access to the market through all conditions and maximize our
    mission and our shareholder value.
        Senator Corzine. How about the concept of operational risk?
        Mr. Raines. Operational risk is I think a vital piece of
    it. Unlike other capital standards----
        Senator Corzine. Do you think the capital standards that
    OFHEO now has in place actually take that into consideration?
        Mr. Syron. Excuse me. There is a 30-percent weight in our
    capital standards for operational risk, and it is appropriately
    so because I think the issue that you raised, as you become
    larger, I am not convinced that your operational risk on a
    proportional basis does diminish. So that is a reasonable
    question, but we do have a 30-percent, if you will, surcharge
    for operational risk in our capital ratios.
        Mr. Raines. Which is being debated in the bank context, as
    you know, and the banks have fiercely resisted having any
    capital set aside for operational risk. We are big operations.
        Senator Corzine. But should that be tied to the size of the
    balance sheet, ultimately, the size of the book of risk that
    you have played into the market?
        Mr. Raines. It probably does not correlate very well with
    the size of the balance sheet. It may well correlate better
    with the capital requirement or it may correlate better with
    number of loans or number of debt issuances because our
    operational risk comes in moving $12 trillion through the
    company every year, and that is more a function of the number
    of loans than it is of the size of the balance sheet because if
    the 18 million loans I think that we have are pooled into 1
    million mortgage-backed securities, you do not have 18 million
    transactions, instead you have 1 million transactions that you
    are paying out on.
        Senator Corzine. As you also well know, that the hedging
    risk that you speak about, it is not just callable securities.
    There is a whole book of derivatives and other kinds of
    elements that are extraordinarily volatile in and of their own
    context, and so I think that we all need to do a lot of
    scrubbing on that operational risk. And the bigger the book,
    the greater the danger. I am not sure it is a straight-lined
    element that needs to be examined.
        Mr. Raines. As well, our regulator's version of our risk-
    based capital standard has in it a counterparty risk element,
    and so it matters as to who your counterparties are, and it
    matters as to what your exposure is to them. So we have a big
    incentive, for example, to have collateral behind these
    obligations. So if they do not perform, we do not absorb all of
    the risk. There is still some residual risk, but it is
    mitigated by having cash collateral available.
        Senator Corzine. Those two issues are the ones that I am
    most interested in. I would like to see a real scrubbing. I
    hear a lot of complaints about the Federal Reserve study, that
    it is assertive, not empirical. We need to have open debate
    about where the subsidy or the amount of benefit that exists in
    the marketplace, and I think we all would be debating from a
    much clearer view if we actually had objective evidence about
    how we worked on this. I think it would be worthwhile. I would
    suggest that it would be worthwhile for all of us to see that
    all at one time, with different people having different points
    of view, to bring challenge to that.
        But it is really a remarkable thing that I have heard many
    of my colleagues say about where our marketplace is, and by the
    way we do have adjustable rates, even in the fixed rate. I
    guess that is called the refinancing market people.
        [Laughter.]
        Chairman Shelby. What is the market capitalization? What is
    the value today roughly of Fannie Mae?
        Mr. Raines. You want to know what the stock price is?
        Chairman Shelby. The market.
        Mr. Raines. I can tell you when I left the office, it was
    about $75 billion, but I am not so sure where it is now.
        [Laughter.]
        Chairman Shelby. Mr. Syron, what was Freddie Mac's
    capitalization?
        Mr. Syron. Forty-two billion dollars, sir.
        Chairman Shelby. Twenty-two billion dollars.
        Mr. Syron. Forty-two.
        Chairman Shelby. What?
        Mr. Syron. Forty-two.
        Chairman Shelby. Oh, so over $100 billion, $120 billion.
        What role would Congress play if we had a conservatorship?
    Would Congress be deciding whether to provide financial
    assistance once the GSE was in a conservatorship? In other
    words, taxpayers' money would be needed to keep it going
    possibly?
        Mr. Syron. Excuse me, Senator, may I try answering that?
    Because I think the point is absolutely correct about the
    difference between receivership and conservatorship between the
    GSE's and an ordinary depository institution, where you have
    the deposit insurance funds.
        I mean, actually, if we think that there is this implied
    guarantee, leaving that aside, but if we were to assume
    arguendo, as they say, and we thought that there was this
    implied guarantee----
        Chairman Shelby. Do you think there is? I mean, do you
    think there is a benefit of subsidy that comes to Freddie Mac
    because people think there is an implied guarantee?
        Senator Sarbanes. I believe that the marketplace, to some
    degree--not 100-percent--but to some degree thinks that these
    institutions are so large, just as they would think with
    Citicorp, just as they would with JP Morgan, just as they would
    with a variety of other investment banks in the United States,
    thinks that special steps would be taken if they were to get
    into difficulty, to answer your question directly.
        Chairman Shelby. You think that is factored in, in the
    marketplace, don't you.
        Mr. Syron. I do, sir. But having said that, it comes back
    to this issue of conservatorship versus receivership. Because
    if that was the case, and the Congress at some point--and I am
    not saying it would. It might well decide not to--if the
    Congress were to decide in this one, and actually it is a Nobel
    Laureate that estimated that the chance of a cataclysmic
    meltdown in these institutions was less than 1 in 500,000. I
    can get you the exact citation, but it was about the same as an
    asteroid hitting the United States.
        Chairman Shelby. I hope they do not hit at the same time.
        [Laughter.]
        Mr. Syron. Well, I do not know. It might not be all bad if
    you owe us.
        [Laughter.]
        Chairman Shelby. You might not distinguish one from the
    other.
        Mr. Syron. Yes, that is right.
        If you were to think in that 1 in 500,000 case or whatever
    probability you were to assign on it, that the Congress would
    have to do something, then, in that regard, it would be, you
    know it really would not make a difference if you were in
    receivership. There would be no advantage to being in
    receivership because the assets of the Enterprises would have
    to go to the debtholders. There would be no insurance fund or
    anything else. The question would be then, after the assets of
    the Enterprise were fully liquidated were they sufficient to
    address all of the claims of the debtholders.
        Chairman Shelby. Would there be anything left?
        Mr. Syron. Exactly.
        Mr. Raines. Senator, I think, with regard to the
    conservator, what would happen is that what a conservator would
    do is we would all be fired. A conservator would be running the
    company, and the goal of the conservator would be to pay off
    the liabilities of the company, and the conservator would wind
    down the company and pay off as many of the liabilities as the
    conservator could. At the end of the day if there were fewer
    assets than there were liabilities, he would announce simply
    that there was not enough money to pay everybody and that the
    company is no longer functioning.
        Undoubtedly, our regulator would report to the Congress
    that the Enterprise had failed or was in the course of having
    failed. Now, would Congress at that point say this is so
    important that we need to do something? I have no idea. I think
    it depends entirely on what the circumstances are.
        Chairman Shelby. Senator Sarbanes and I sat on this
    Committee during the thrift debacle. We understand.
        Mr. Raines. There has been the thrift debacle, there has
    been the airline debacle, there has been Chrysler. There have
    been many occasions where the Congress, no one had ever uttered
    the word that there might be some implied guarantee, where
    Congress, for public policy reasons, decided it wanted to
    intervene but there is no obligation on the Congress of the
    United States to appropriate any funds to any conservator. The
    conservator only has the assets of the company to work with.
        Chairman Shelby. But if you had a receivership, and if you
    had language in there to what the receiver could do or not do
    or the steps within certain things, wouldn't that work? Because
    all receiverships, they do not go straight to liquidation in
    all receiverships, do they?
        Mr. Raines. No, but if the receiver has the authority to
    displace the senior debtholders, then that will be a huge
    problem because our debtholders would wonder for what reason do
    they have their authority?
        In the bank's situation, it has been made clear that the
    receivers there cannot avoid certain contracts in order to
    protect those obligations. But in the discussions that I have
    heard, I have seen no such protection being suggested for the
    debtholders of Fannie Mae, and I think it just adds an element
    of confusion, particularly since it is not clear to me that you
    could apply a new receiver provision to the outstanding debt
    because those debtholders put their money forward under an
    entirely different regime. They have a contract, and it is not
    clear to me that that contract can be abrogated after the fact
    without having given them notice before they bought the
    securities.
        Chairman Shelby. I know in a private company, if a company
    goes bankrupt, the bondholders stand in a high-priority
    relationship. Stockholders' equity----
        Mr. Raines. Right, gone.
        Chairman Shelby. --they are really at risk.
        Mr. Syron. Senator, I think the question is what is the
    advantage of receivership versus conservatorship, and as far as
    I can see, from the public FISC point of view, there is no
    advantage of receivership over conservatorship, but it comes
    with this cost of casting a shadow, particularly in
    international capital markets, over the claims about
    debtholders. So that is the way I would be inclined to look at
    it.
        Senator Sarbanes. When you say your ``debtholders,'' who
    are you referring to?
        Mr. Syron. I am referring, sir, to the debtholders not of
    mortgage--I am not referring to the holders of mortgage-backed
    securities. I am referring to the people that hold the
    debentures of the corporation, both domestically and overseas.
        Senator Sarbanes. Well, what would happen to the holders of
    the mortgage-backed securities?
        Mr. Syron. The holders of the mortgage-backed securities
    would have, I mean, we are responsible for the payment of the
    faith and credit, but the holders of the mortgage-backed
    securities would have ultimately to fall back on the assets,
    the mortgages that secure them and ultimately, if necessary, on
    the properties that were held. And given the history of these
    things, they would be in a quite favorable position.
        Senator Sarbanes. Who would get paid first?
        Mr. Syron. Who would get paid first? Boy, this is
    speculative, to some extent on my part, you would have two sets
    of creditors, if you will--the debtholders and the holders of
    the mortgage-backed securities, and I would assume that they
    would go on a pari passu basis, but I am not an attorney, and
    we should get back to--
        Chairman Shelby. The priorities are debtholders, in the
    scheme of things, in the corporate world, is it not?
        Mr. Raines. It depends on what the contracts say.
        Chairman Shelby. Absolutely.
        Mr. Raines. It depends on what the contracts say, and so
    you really have to go back to each contract, and the contracts
    that Freddie Mac have may be different than contracts we have.
    I do not want to answer as an absolute, but overall they stand
    pari passu. They stand in line together. The mortgage-backed
    securities holders have an advantage in that they also have the
    collateral of the mortgages which the debtholders do not. Our
    debtholders have no security interest in the mortgages in our
    portfolio, whereas, our mortgage-backed securities holders do
    have a security interest in the mortgage-backed security.
        Chairman Shelby. In the package that they buy.
        Mr. Raines. In the packages that they finance. But on the
    whole, they stand pari passu. The issue is that for some 60, 70
    years we have been successfully selling debt on this basis.
    What I am concerned with is someone is going to put a provision
    in a statute that raises the question: Have you changed
    something? And, if so, what?
        And I do not look forward to going around the world, as I
    am about to leave on Saturday for a week in Europe to go visit
    investors, and I am sure I am going to be asked a lot of
    questions about the last couple of days, I do not look forward
    to going out and explaining--
        Senator Sarbanes. You are going off to Europe for a week
    while the Congress is in session?
        [Laughter.]
        Mr. Raines. Senator, I have such undying faith in the U.S.
    Congress that I would even dare to go off and visit investors
    and raise a little money for homeowners while Congress is in
    session.
        Chairman Shelby. Mr. Raines, let me pose this question to
    you. If the receiver had FDIC-like protections for debtholders,
    would that be acceptable?
        Mr. Raines. I would have to look at----
        Chairman Shelby. You want to look at it.
        Mr. Raines. We have to look at what is meant by----
        Chairman Shelby. Mr. Syron, you come out of the Federal
    Reserve, go ahead.
        Mr. Syron. Yes, excuse me, sir. I think that is a very good
    question. But, then, to be honest with you, we start to change
    the whole character of the receiver.
        Chairman Shelby. I know.
        Mr. Syron. But it does reduce----
        Chairman Shelby. Let us assume that we change the whole
    character of the receiver.
        Mr. Syron. I do not know the right or the exact answer, but
    it does remove some of the problem that you would have with
    debtholders.
        Mr. Raines. As I said, I can agree with the suggestion made
    by Chairman Greenspan----
        Chairman Shelby. It could alleviate some of the problems,
    possibly.
        Senator Sarbanes. Or you could call it ``Bob.'' Did you not
    suggest earlier just calling it Bob?
        [Laughter.]
        You take these categories and try to press something into
    it, but these are special institutions or enterprises, and you
    may have to work out special arrangements to deal with them,
    and you need a different name.
        Mr. Raines. I agree with you totally, Senator, and that is
    why I agreed earlier with the suggestion by Chairman Greenspan.
    I am not adverse to spelling out in statute what happens. I
    just don't want to leave it ambiguous, and that is my concern.
    And I think putting the word ``receiver'' in makes it
    ambiguous. But if there is a concern that the statute is not
    clear, I am in favor of making it clear.
        Chairman Shelby. Now, the word ``receiver'' could be very
    definite and unambiguous. It depends on what you set out, could
    it not? A conservatorship could be ambiguous.
        Mr. Raines. It could be. And if there is a doubt as to what
    is meant in the statute today, even though we do not believe
    there is a doubt, but if there is a doubt, we have no problem
    with making it clear. But what I fear is that we will not be
    clear. It will be ambiguous, and what we will have is lawyers
    all over the world trying to figure out, what did Congress mean
    when they did that? They must have meant something. They could
    not have meant just to leave it the way it was.
        Chairman Shelby. That would not be the first time lawyers
    tried to find out what Congress meant--ambiguities.
        [Laughter.]
        Mr. Raines. But trying to sell trillions of dollars of
    securities in that environment is not always the best.
        Senator Sarbanes. It is hard to persuade them that we did
    not mean anything, even though that may be the case.
        [Laughter.]
        Chairman Shelby. I hope it means something, but you never
    know.
        Mr. Raines, you note in your testimony that, ``Enacting a
    receivership provision unfairly imposes new risk on holders of
    existing obligations that they could not have anticipated at
    the time they purchased the obligation.''
        What is the new risk you are referring to?
        Mr. Raines. It is the risk that there is a meaning in the
    receiver that is contrary to their interests.
        Chairman Shelby. Supersede the risk.
        Mr. Raines. They now have 60 years of history as to what
    this means. If the language changes, everyone is going to want
    to know what is the import of the change. That is why lawyers
    are so reluctant to change documents that have existed for many
    years.
        Chairman Shelby. That is why we have so many lawyers in
    Washington.
        Mr. Rice. Mr. Chairman, one of the things I will say, as
    you look at the structure, that is one of the reasons why we
    think that it is necessary to have two divisions under them
    because we are not the same in the way we are laid out.
        Chairman Shelby. I know you are not, and I also know you
    are not publicly traded.
        Mr. Rice. Right.
        Chairman Shelby. I want to follow up on this. I know that
    the evening is moving on. Wouldn't the GSE investors--I will
    pose it to these two--and debtholders be better served by a
    clearer specification of the resolution process; in other
    words, remove some ambiguity, Mr. Rice? In other words, if the
    GSE investors and debtholders knew what was in the resolution
    process.
        Mr. Rice. Mr. Chairman, we have successfully sold trillions
    of dollars the way it is. Any change will be viewed introducing
    risk.
        Chairman Shelby. But a lot people are questioning the way
    it is now.
        Mr. Rice. Not our investors.
        Chairman Shelby. I know that.
        Mr. Rice. Our investors are not questioning it, and it is
    their money that is at risk.
        Chairman Shelby. But there is taxpayers' money possibly at
    risk, too, and that is what concerns a lot of people.
        Mr. Rice. That is the problem.
        Chairman Shelby. That is right.
        Mr. Rice. If the Congress is saying that there is no
    guarantee, but just in case we are going to do one, we are
    going to put in provisions that push you to the back of the
    line, there are a lot of people that are going to say that is
    not the deal I signed up for, that if you are going to
    guarantee it, guarantee it. If you are not going to guarantee
    it, do not guarantee it. But do not say I might change my mind
    later on and want to step to the front of the line.
        Chairman Shelby. I believe, in your words, you want to
    remove any ambiguity that we can. In other words, make the
    language clear. Clarity is important. I think that is what we
    are going to try to do. I do not know.
        Mr. Syron, you note, and these are your words, that ``many
    market participants might view a change to receivership as a
    first step to privatization of the GSE's.'' Given that GSE
    equity and debt is held by private investors, should these
    investors not bear the full risk? In other words, they bear the
    rewards.
        Mr. Syron. Well, I think that the situation is, I mean,
    Congress has before it, and Congress has the ability to totally
    privatize these entities. I think with that, you would take
    away some of the special responsibilities we have, for example,
    in the low-income housing area, where I think that we do have
    responsibilities. It is not clear to me what all of the gains
    to that would be.
        What my real concern comes down to is that in this country,
    and we do not have anyplace in the world--I sound like Johnny
    One Note--we have this 30-year prepayable instrument, and I
    think if you were to totally privatize these institutions, that
    would go away because it does not exist anyplace else, even
    with the same set of players, and the more that we move in the
    direction of someone saying, well, we are moving closer to
    privatization, that the advantages that exist now in rates,
    differentials would diminish.
        Chairman Shelby. Your definition of privatization here,
    where there would be clear and unmistakable language that there
    would be no implied guarantee.
        Mr. Syron. No.
        Chairman Shelby. Is that what you are saying?
        Mr. Syron. No, I am going even beyond that. I am going
    beyond that and saying that these things are not creatures of
    Congress, that they have no tie to Government policy, in a
    sense.
        Chairman Shelby. They are creatures of the marketplace.
        Mr. Syron. Exactly.
        Chairman Shelby. And they are subject to the marketplace
    and the rules.
        Mr. Syron. And subject only to the marketplace.
        Chairman Shelby. Only.
        Mr. Raines, in your opening statement I believe you
    indicated that the GSE funding advantage was not a result of an
    implied guarantee, but because of business focus and expertise.
    If this were the case, does it not follow logically that
    receivership authority will not impact GSE's funding advantage,
    if you accept that premise?
        Mr. Raines. No, it does not imply that.
        Chairman Shelby. It does not?
        Mr. Raines. It implies the Government is going to step into
    what had been previously a private enterprise and make
    decisions, and that is the issue. It is that somebody who is a
    stranger to the transaction is going to step in at some point
    and start saying here is the way it is going to go from now on.
    That is the danger. That is a risk. And I have been in the
    financial services business, now for 25 years. I have had to
    deal with this situation when I represented State and local
    Governments. I have had to deal with it in representing
    companies. I have had to deal with it even when I was in OMB,
    when we were privatizing the Government's ownership of the
    production of uranium.
        As much as those of us who have been in public service like
    to believe that we can be helpful----
        Chairman Shelby. Sure.
        Mr. Raines. --when people are investing their money, they
    would just as soon rely on the deal they cut with the business
    entity and not think someone else is going to come in to be
    helpful at a later date.
        Chairman Shelby. Mr. Rice, Mayor, I am going to leave this
    last question to you. Currently, the Federal Home Loan Bank
    System issues its debt, as I understand it, by way of the
    Finance Board's Office of Finance. You are very aware that this
    is an entity that is legally under your System's current
    regulator, yet issues debt on behalf of the System. In other
    words, a regulator is issuing the debt.
        Do you believe this authority should be transferred to the
    bank themselves to issue the debt, you know, as we create a
    future regulator? And, if so, do you have any thoughts on how a
    new Office of Finance owned by the banks would be organized.
    You see my question here.
        Mr. Rice. No, I do. I think, in my opening remarks, I said
    I felt that the Office of Finance should move to the
    independent regulatory structure.
        I do not think you can make that quantum leap in this
    legislation. So, I would elect or offer the suggestion that it
    stay with the regulator, and I think it operates well then.
        Chairman Shelby. To be the regulator and the issuer of
    debt.
        Senator Carper, you have been very patient.
        Senator Carper. Just one question in closing, and again our
    thanks to each of you for joining us for this extended period
    of time and for your very thoughtful answers hopefully to our
    thoughtful questions.
        I have a question really for you, Mr. Syron, and this is
    more I suppose of a personal nature than anything else.
        I understand, in an earlier part of your life, you served
    the Boston Fed.
        Mr. Syron. Yes, sir.
        Senator Carper. And as I recall, you ran the show there for
    a while.
        Mr. Syron. Yes, sir.
        Chairman Shelby. I might add he ran it well.
        Mr. Syron. Thank you.
        Senator Carper. Yes, it got good reviews from as far away
    as Alabama.
        [Laughter.]
        Chairman Shelby. You know, money travels, and so does a
    good reputation.
        Mr. Syron. Thank you, sir.
        Senator Carper. I would like for you just to take a moment
    in closing here and reflect, if you will, on your earlier
    service in that capacity some of the lessons that you learned
    and really some of the values that you brought from that
    service to your new responsibilities.
        Mr. Syron. Thank you for the question, Senator.
        I would say, if there is one thing I learned, that it is be
    wary of unintended consequences; that often in solving the
    problems of today, we create the problems of tomorrow. You will
    remember that 8 or 9 years ago, everyone said that management
    in the United States was not sufficiently aligned with
    shareholders. So what we are going to do is load them up with
    options, and we have seen some of the undesirable outcomes that
    came from that.
        I, also, think if my service had any searing impact on me,
    it was that you have to look at the system as a whole rather
    than just the parts, and particularly when we got into this
    credit crunch in New England in the 1990's, that there was a
    problem of looking at just, on an institution-by-institution
    basis or a piece-by-piece basis and not seeing what we were
    doing to the economy as a whole.
        Sir, I would respectfully say that that is something I hope
    I can bring to this because it is like everything else in life.
    It is a balloon. You press in here, and it pops out someplace
    else. I will finish on this. What this is all about is none of
    us can eliminate risk. We are all about trying to repackage and
    reduce risk and have it go to the part of the system where we--
    --
        Chairman Shelby. Minimize it.
        Mr. Syron. Yes, sir.
        Mr. Rice. I just wanted to make a clarification, Mr.
    Chairman. I really believe the new regulator, when I was
    speaking about OFHEO's oversight, the bank still would be
    responsible for issuing the debt, but the oversight would still
    go with the new regulatory body.
        Chairman Shelby. Mr. Syron, you mentioned options in the
    times a few years back. A lot of people believe it was not the
    issuance of options, it is the way the options were treated,
    and that is of course still subject to debate, on the balance
    sheets, because options do have a place, I believe, in
    corporate America.
        Mr. Syron. Senator, I totally agree with you. My concern
    was that the way they were treated, from a tax perspective as
    compared to the way that----
        Chairman Shelby. That is right.
        Mr. Syron. --and restricted stock was treated created
    unfortunate incentives.
        Chairman Shelby. Absolutely. I totally agree.
        Gentlemen, thank you for your insights today. We appreciate
    it.
        The hearing is adjourned.
        [Whereupon, at 5:08 p.m., the hearing was adjourned.]
        [Prepared statements, response to written questions, and
    additional material supplied for the record follow:]

                     PREPARED STATEMENT OF RICHARD F. SYRON
               Chairman and Chief Executive Officer, Freddie Mac
                               February 25, 2004
        Thank you, Chairman Shelby, Ranking Member Sarbanes, and Members of
    the Committee. Good afternoon. I appreciate the opportunity to appear
    before you today. My name is Richard F. Syron. I am the Chairman and
    Chief Executive Officer of Freddie Mac, a position I took at the end of
    December 2003.
        Prior to joining Freddie Mac, I was Executive Chairman of Thermo
    Electron Corporation, an S&P 500 firm with 11,000 employees. Prior to
    that, I held a number of positions, including the Chairman and
    Executive Officer of the American Stock Exchange, President and Chief
    Executive Officer of the Federal Reserve Bank of Boston, and President
    and Chief Executive Officer of the Federal Home Loan Bank of Boston. I
    also served as assistant to then-Federal Reserve Chairman Paul Volcker,
    and earlier as Deputy Assistant Secretary for Economic Policy of the
    U.S. Department of the Treasury.
        It is a great privilege to lead Freddie Mac, which plays such a
    critical role in financing homes for America's families--and providing
    strength and resiliency to America's economy. I could aspire to no
    greater legacy than to restore public trust in an institution chartered
    by Congress to ensure the stability and liquidity and accessibility of
    the Nation's mortgage markets.
        The issue of regulatory oversight reform of the housing Government
    Sponsored Enterprises (GSE's) is vitally important to our Nation's
    economy and to homeowners. My views on this important topic have been
    profoundly shaped by my experiences as a former regulator. My firm
    belief that capital should be tied to risk stems directly from my
    tenure at the Boston Federal Reserve, where I was deeply involved in
    restructuring New England's banking system following the credit strains
    of the late 1980's and early 1990's. My views on homeownership,
    however, have more personal roots. I grew up in Boston in a two-family
    home financed by a VA loan that my father was able to obtain when he
    returned from World War II.
        Today, in my comments to this Committee, I will focus on three
    areas:

     Why GSE's exist--and what they have accomplished;
     The imperative of regulatory oversight reform; and
     My top priorities for Freddie Mac, particularly how we are
        remedying our past accounting errors.
    Why GSE's Exist and What They Have Accomplished
        One advantage of being a newcomer is the ability to ask provocative
    questions--and there is no more provocative issue in the housing world
    than the role of the GSE's and the benefits they bring. Since arriving
    at Freddie Mac just 8 weeks ago, this question has been vigorously
    discussed in the halls of Government, by national think tanks, in
    newspapers--and just yesterday in this chamber by Alan Greenspan.
        I approach this question from the perspective from what we know--
    that is, the current system of housing finance and its known benefits--
    and weigh it against what we do not know, that is, what housing finance
    would look like without the GSE's.
        What we know is based on 70 years of mortgage history. In the
    aftermath of the Great Depression, Congress chose to provide explicit
    Government insurance to both the housing and banking industries to
    entice investors back to housing. While the plan worked, it also put
    the government directly on the hook for the risks associated with
    loaning individual homebuyers large sums of money for long periods of
    time. Mortgages carried significant credit risk because of the
    differences in the ability of borrowers to repay their loans. However,
    interest-rate risk was more vexing. Even if a borrower did not default
    over the course of 30 years, money would be tied up in a fixed-rate
    asset whose value was subject to the vagaries of interest-rate
    movements over prolonged periods.\1\
    ---------------------------------------------------------------------------
        \1\ These risks are real: Recall the huge credit losses that
    resulted from the ``oil-bust'' in the early 1980's, and the taxpayer
    bailout of the S&L's, which were in the untenable position of holding 6
    percent mortgages in an 18 percent interest-rate environment.
    ---------------------------------------------------------------------------
        To address this issue, Congress found an ingenious way to stimulate
    long-term investment in housing without exposing the public fisc to the
    risk of substantial loss: Create financial institutions with a limited
    nexus to the Government and give them the singular job of making
    markets stable and liquid, at all points along the business cycle.
        The GSE model of housing finance has been a Congressional success
    story. By providing attractive returns on capital, the GSE's have
    proven to be effective managers of the credit risk of the mortgages
    they buy. Further, by maintaining exclusive focus on the residential
    mortgage markets, as required by law, the GSE's have developed
    extraordinary expertise in understanding the credit characteristics of
    borrowers. This has resulted in a steady lowering of downpayment
    requirements within the conventional market to the point at which the
    GSE's, with no explicit subsidy, are able to provide nearly the same
    benefit to borrowers as the Government provides through its on-budget
    FHA and VA mortgage programs.
        Management of interest-rate risk also has been a notable success.
    Through the creation of mortgage-backed securities, the issuance of
    callable debt and the use of derivatives, the GSE's routinely and
    efficiently transfer interest-rate risk from individual households to
    global capital markets. Not only do the GSE's make it possible for
    originators to lend money to individual homeowners for long periods of
    time at better rates than many corporations can borrow, but they also
    permit borrowers to ``put'' the mortgages back whenever they desire to
    do so and at no penalty. This extremely valuable option makes the 30-
    year, fixed-rate mortgage the product of choice among U.S. homeowners;
    in 2003, 82 percent of all conforming purchase-money originations were
    fixed-rate mortgages. Homeowners were able to profit from falling
    interest rates by refinancing into lower-cost loans, adding billions of
    dollars to our economy. Prepayable mortgages also help diminish
    friction in our economy by facilitating the mobility of the Nation's
    labor markets.
        These innovations in mortgage financing made possible by the GSE's
    produce valuable benefits. Low-cost mortgage money is readily
    available. Families can get their loans approved in minutes. (In fact,
    during this hearing, Freddie Mac likely will have financed mortgages
    for about 2,000 families.) Today, more people own homes--and higher
    quality homes--than at any time in our Nation's history and than in
    virtually any other part of the world.\2\ And wealth created through
    homeownership will help bear us into old age, taking some of the burden
    off Social Security and allowing us to pass something along to the next
    generation. Not a bad track record for Congressional inspired
    institutions that need no budget authority, pay significant Federal
    taxes, and employ thousands of people.
    ---------------------------------------------------------------------------
        \2\ ``As a result of the very favorable conditions in the housing
    sector, the U.S. homeownership rate climbed to 68.2 percent in the
    third quarter of 2003--equal to its highest level on record,'' 2004
    Economic Report of the President, p. 89.
    ---------------------------------------------------------------------------
        In United States, we tend to take these benefits for granted.
    However, very few countries can boast of such an efficient and
    effective mortgage delivery system.\3\ Despite the integration of world
    capital markets, the United States is still the only place where a
    long-term callable mortgage product is broadly available. Countries
    that want to provide long-term prepayable mortgages to their own
    citizens are considering creating GSE's. The European Union is
    currently considering the creation of a GSE-type agency to ``enable
    lenders to provide their existing mortgage products at better prices
    and introduce long-term, fixed-rate mortgages without redemption
    penalties.'' \4\
    ---------------------------------------------------------------------------
        \3\ Marsha J. Courchane and Judith A. Giles, ``A Comparison of U.S.
    and Canadian Residential Mortgage Markets,'' March 2002.
        \4\ Richard Adams, ``Banks Back Cheaper Mortgage Plan,'' The
    Guardian, November 17, 2003.
    ---------------------------------------------------------------------------
        Let us now consider U.S. housing finance without the GSE's. There
    are three key arguments I would like to address.
        First is the view that Government sponsorship is no longer needed
    to attract capital to housing or to provide an abundant supply of 30-
    year, fixed-rate mortgages. This optimistic view contradicts the
    experience in other developed countries. That is, if homeowners in
    Northern New York or Washington State lived a few miles to the north in
    Canada, they would typically be restricted to a 7-year, fixed-rate
    mortgages, they would be locked into higher interest rates or have to
    pay heavy penalties if they wanted to prepay, and they would have to
    put 25 percent down.
        This sanguine view of markets also reflects our collective amnesia
    about where we are in the credit cycle. History reveals that certain
    industries will slump, that certain regions will experience economic
    downturn, which, in turn, causes house values to fall and defaults to
    rise. We also know that with interest-rates at historic lows, the
    mortgages put on the books today, in all likelihood, will require
    financing for decades to come. In short, it is easy to dismiss the
    risks of mortgage lending when times are good.
        GSE's were created precisely for those times when things are not
    going so well, however. GSE's absorbed significant losses during the
    oil bust in the 1980's and during the weakening of the economy in
    Northeast in the early 1990's. They also stabilized residential
    mortgage rates during the international financial crisis of 1998--and
    again after-September 11--by continuing to provide liquidity to the
    secondary market for conforming home loans. Their actions ensured that
    mortgage credit remained available and affordable.
        A second argument concerns the allocation of capital to housing.
    The housing market has an enormous impact on the economy, directly
    accounting for more than one-third of the nominal growth in GDP over
    the past 3 years.\5\ And this does not begin to account for all the
    indirect support for consumption generated by record levels of
    refinancing in the past few years. Housing played an important
    countercyclical role in supporting the recent weak economy, as noted in
    the President's 2004 Economic Report:
    ---------------------------------------------------------------------------
        \5\ These percentages are based on data published by the Bureau of
    Economic Analysis, U.S. Department of Commerce for 1996 through 2003
    and data for the same years available upon request from Freddie Mac.

            Despite the similarities between the recent business cycle and
            previous ones, this most recent cycle was distinctive in
            important and instructive ways. One noteworthy difference is
            that real GDP fell much less in this recession than has been
            typical . . . This relatively mild decline in output can be
            attributed to unusually resilient household spending. Consumer
            spending on goods and services held up well throughout the
            slowdown, and investment in housing increased at a fairly
            steady pace rather than declining as has been typical in past
            recessions.\6\
    ---------------------------------------------------------------------------
        \6\ 2004 Economic Report of the President, pages 30, 32.

        Finally, there are arguments about size and systemic risk.
    Residential mortgage debt outstanding grew at an annualized rate of 8.6
    percent over the past decade. Not surprisingly, the GSE's also have
    experienced significant growth. But GSE size is not an accurate proxy
    for risk. On average, there is approximately 40 percent collateral in
    homeowner equity behind the loans Freddie Mac has guaranteed. Interest-
    rate risk also is well-managed. Freddie Mac strives to maintain an
    extremely closely match between the duration of our assets and
    liabilities. Throughout 2003, for example, a period of extreme
    turbulence in financial markets, Freddie Mac's duration gap never
    exceeded 1 month.
        Finally, there is no way that mortgage debt and the risks of
    investing in it would disappear by downsizing the GSE's or making other
    changes to the GSE charter. Rather, the burden of managing mortgage
    credit risk would shift from these institutions to those with explicit
    Government support, while interest-rate risk would shift onto
    individual households. Another likely outcome is that higher costs of
    conventional mortgage financing could cause borrowers to shift into the
    FHA market, thereby actually increasing Government subsidization of
    housing. For homeowners, restrictions on GSE growth likely would result
    in reduced availability of 30-year, fixed-year, prepayable mortgages
    and higher costs.
        These uncertain benefits must be coupled with the potential risks
    of dismantling a highly efficient and successful housing finance
    system. We can get a glimpse of a world without GSE's by looking at the
    jumbo market. On any given day, it is possible to look in a newspaper
    and find that mortgage rates on conforming loans are regularly one-
    quarter of a percentage point lower than those in the higher-balance
    jumbo market. Borrowers in the jumbo market not only pay higher rates,
    but they are also more likely to have to settle for an adjustable-rate
    mortgage (ARM's).
        ARM's have the obvious advantage of lowering monthly mortgage
    payments in the first few years of homeowning, but they require
    borrowers to bear the interest-rate risk on the loan--rather than the
    capital markets bearing this risk. This results in higher borrower
    defaults over the long-term. Jumbo borrowers also typically make larger
    average downpayments than conforming borrowers. Higher mortgage-
    interest rates and larger downpayments make it significantly harder for
    low- and moderate-income families to become homeowners.\7\
    ---------------------------------------------------------------------------
        \7\ Roberto Quercia, George McCarthy, and Susan Wachter, ``The
    Impacts of Affordable Lending Efforts on Homeownership Rates,'' Journal
    of Housing Economics (Vol. 12, 2003), pp. 29-59.
    ---------------------------------------------------------------------------
        In summary, we are a Nation of homeowners--and from all I can tell,
    we want to keep it that way. While discussions of the optimal
    allocation of the Nation's capital have their place, I believe this
    Nation made the right decision 70 years ago to lend housing a helping
    hand. (You will have to excuse my passion on this subject, but
    homeownership was part of my Ph.D. dissertation 30 years ago.) Bi-
    partisan support for Federal housing policy has paid enormous
    dividends. Families build wealth. Kids do better in school.
    Neighborhoods are safer. And, in recent years, housing has been the
    backbone of our Nation's economy. Support for homeownership--whether
    explicit or implicit--clearly has been good for this country.
        But the task is not finished. There are millions of families still
    waiting to participate in the American Dream, and the homeownership gap
    between white families and families of color is unacceptable. This is
    not the time to begin dismantling the world's finest housing finance
    system, or placing artificial limits on the GSE growth. The potential
    benefits of doing so are uncertain, and the risks are great.
    Imperative for Regulatory Reform
        Continued support for the GSE model of housing finance does not
    imply that improvements to the GSE regulatory oversight structure are
    not needed. They are. As a former regulator, I will be the first to say
    that world-class regulatory oversight is absolutely critical to the
    achievement of Freddie Mac's mission and to maintaining the confidence
    of the Congress, the public and financial markets. Freddie Mac strongly
    supports the enactment of legislation that provides strong, credible
    regulatory oversight. These enhancements are needed--even overdue.
        I am sadly aware that Freddie Mac's accounting issues are the
    source of much of the current controversy regarding the role of the
    GSE's. However, as with any episode such as this, it is critical to get
    the ship back on course without overreacting at the wheel. Given the
    enormous benefits of the conforming mortgage market, which has proven
    its resiliency in all interest-rate and credit environments, zeal to
    improve this system must be tempered with an abundance of care.
    Borrowing a phrase from our friends at the Homebuilders, I urge the
    Committee to ``measure twice and cut once.''
        To guard against potential negative unintended consequences, I
    would like to offer a set of principles, based on my experience as a
    former regulator. The new GSE regulatory structure must:

     Engender public confidence through world-class supervision and
        independence;
     Ensure continued safety and soundness of the GSE's;
     Respond flexibly to mortgage market innovation; and
     Strengthen GSE market discipline through robust and timely
        disclosure.

        With these principles in mind, today, I will comment briefly on key
    aspects of the regulatory structure under consideration in this
    Committee.
    Structure and Independence
        Freddie Mac would strongly support an independent board regulatory
    structure modeled on independent Federal agencies such as the
    Securities and Exchange Commission. Our preference would be for a
    three-member board, comprised of a Chair and two additional members.
    The President would appoint Board members, by and with the advice and
    consent of the Senate, subject to statutory criteria relating to
    qualifications of the nominees. For instance, we believe that at least
    one member of the Board should have significant housing industry
    experience. It would also be important to ensure that members have
    significant experience with complex financial transactions. As is
    typical with independent boards, we would suggest that not more than
    two of the Board members be members of the same political party.
        Notwithstanding the importance of housing and financial expertise,
    we would have some concern if the Board were to include representatives
    of cabinet departments such as the Department of Housing and Urban
    Development, the Department of the Treasury or other executive branch
    departments. The purpose of establishing an independent board is just
    that, independence. Inclusion of executive branch representatives on
    the GSE regulatory board could compromise this important component of
    world-class regulation.
        Freddie Mac would have similar concerns should the Congress decide
    to locate the new regulatory office within the Department of the
    Treasury. To ensure independence, we would support applying the same
    operational controls as apply to the relationships between the
    Secretary of the Treasury and the Office of the Comptroller of the
    Currency and the Office of Thrift Supervision.\8\ Adequate firewalls
    are needed to avoid the politicization of the GSE mission and the
    critical role we play in the Nation's economy and global financial
    markets.
    ---------------------------------------------------------------------------
        \8\ See 12 U.S.C. Sec. Sec. 1, 250, 1462a(b)(2), (3), and (4) and
    1464(d)(1)(A).
    ---------------------------------------------------------------------------
    Funding of New Oversight Offices
        Freddie Mac supports providing both the new regulator and the
    Secretary of HUD authority to assess Freddie Mac outside the annual
    appropriations process to pay for the costs and expenses of carrying
    out their respective responsibilities vis-a-vis the GSE's. However, we
    would suggest that the General Accounting Office regularly report to
    the Congress on the efficacy of the new regulatory structure and the
    reasonableness of the costs relative to other world-class financial
    regulators so that neither unnecessarily raise the cost of meeting our
    mission.
    GSE Capital Requirements
        Second to questions of GSE role and benefits, I have quickly
    learned that questions about GSE capital adequacy are highly
    contentious and can serve as ``stalking horses'' for other issues.
    There is no question these issues are of paramount importance. Capital
    adequacy is the touchstone of investor confidence and is key to our
    ability to attract low-cost mortgage funds. On that score, Freddie Mac
    consistently has exceeded both its minimum capital and risk-based
    capital standards.
        However, from the perspective of a former regulator, I believe
    there are many difficult and sometimes confusing aspects about the
    direction of the debate on GSE regulatory oversight. The first is the
    view that the GSE's should be held to the same capital standard as for
    banks. Let me begin by stating the obvious: GSE's are not banks.

     There are nearly 10,000 banks and savings institutions in this
        country. There are two GSE's focused exclusively on housing.
     Banks are largely funded by deposits. GSE's must rely
        exclusively on the capital markets for their funding.
     Banks can (and do) invest in a wide range of higher-risk
        assets, ranging from unsecured loans, to commercial loans and loans
        to foreign countries. In contrast, GSE's are restricted to one line
        of business: Residential mortgages finance. We invest almost
        exclusively in conventional conforming mortgages, among the safest
        investment vehicles around.

        Given these important distinctions, it is entirely appropriate that
    the GSE capital regime be distinct from the bank capital model. GSE
    capital requirements reflect the confinements of its GSE charter, such
    as the conforming loan limit and credit enhancement requirements for
    high loan-to-value mortgages. These charter limitations necessarily
    result in a lower GSE risk profile.
        Since 1994, charge-off losses at the five largest banks have been,
    on average, 17 times larger each year than charge-offs at Freddie Mac.
    Even in these banks' best year, charge-offs were more than five times
    higher than Freddie Mac's worst year.\9\ Limiting the comparison to
    mortgage assets, the residential mortgages found in bank portfolios
    typically entail greater risk than those in Freddie Mac's portfolio. In
    2002, FDIC-insured institutions had an average charge-off rate of 11
    basis points on their mortgage portfolios, compared to 1 basis point
    for Freddie Mac.\10\ Given this lower risk exposure relative to banks,
    we believe that the GSE minimum capital requirement is adequate and
    need not be changed.
    ---------------------------------------------------------------------------
        \9\ Federal Financial Institutions Examination Council,
    Consolidated Reports of Condition and Income and Freddie Mac annual
    reports for 1994 to 2001. For 2002 Freddie Mac credit information, see
    http://www.freddiemac.com/news/archives/investors/2003/4qer02.html.
        \10\ Federal Financial Institutions Examination Council,
    Consolidated Reports of Condition and Income and Freddie Mac. See
    http://www.freddiemac.com/news/archives/investors/2003/4qer02.html.
    ---------------------------------------------------------------------------
        The second troubling aspect of the current debate is the fixation
    on the GSE minimum capital ratio, when the risk-based capital standard
    is a far more effective regulatory tool. Leverage ratios are last
    year's capital ``model.'' They have significant limitations--and,
    depending on how they are enforced, can do more harm than good.
        I observed first-hand the problems with overzealous enforcement of
    simple leverage ratios during my tenure at the Federal Reserve Bank of
    Boston in the early 1990's. While many financial institutions in the
    Northeast were adequately capitalized on a risk-adjusted basis, the
    strict enforcement of simple leverage ratios required them to liquidate
    a substantial portion of their assets. This resulted in a drying up of
    commercial credit that greatly exacerbated the economic downturn. The
    infamous ``credit crunch'' had profound effects on small and mid-size
    businesses and employment in the Northeast. It turned a 2-year
    recession into a 5- to 6-year slump.\11\ I discuss these issues in two
    articles I wrote on this subject.\12\
    ---------------------------------------------------------------------------
        \11\ History of the Eighties, Lessons for the Future: An
    Examination of the Banking Crises of the 1980's and Early 1990's, vol.
    1, part 2, Sectors and Regional Crises, Ch. 10, Banking Problems in the
    Northeast, Federal Deposit Insurance Corporation, 1997.
        \12\ See Richard F. Syron, statement before the Subcommittee on
    Domestic Monetary Policy of the Committee on Banking, Finance, and
    Urban Affairs, U.S. House of Representatives, May 8, 1991, reprinted in
    ``Are We Experiencing a Credit Crunch?,'' New England Economic Review
    (July/August 1991), pp. 3-10; and Richard F. Syron, ``The New England
    Credit Crunch,'' Credit Markets in Transition: Proceedings of the 28th
    Annual Conference on Bank Structure and Competition, Federal Reserve
    Bank of Chicago (1992), pp.483-9.
    ---------------------------------------------------------------------------
        My experiences are consistent with leading international trends in
    capital management. Drawing from recent statements by the Basel
    Committee on Banking Supervision, risk-based capital regimes are
    preferable to the use of simple ratios to set capital standards. In its
    1999 Basel Consultative Paper and the 2001 New Basel Capital Accord,
    the Committee proposed a capital adequacy framework to replace the 1988
    Capital Accord for U.S. bank capital standards, which relied heavily on
    simple ratios to set capital standards. The new framework, which is
    currently under consideration in this country, more accurately aligns
    capital requirements to the actual risks incurred by regulated
    institutions.\13\
    ---------------------------------------------------------------------------
        \13\ The New Basel Capital Accord, Consultative Document, Basel
    Committee on Banking Supervision (January 2001) (the 2001 Basel
    Accord).
    ---------------------------------------------------------------------------
        Notwithstanding my philosophic differences regarding the efficacy
    of leverage ratios, I can understand the need for regulator discretion
    to increase the leverage ratio in the event of a finding of an unsafe
    and unsound practice. We believe parameters should be put in place in
    statute that define the circumstances under which such an increase
    could be undertaken, as well as parameters for resetting the ratio to
    the statutory minimum once the unsafe and unsound practice has been
    satisfactorily addressed.
    Discretion on Risk-Based Capital
        In my view, greater discretion with regard to the GSE risk-based
    capital rule is the best way to avoid potential negative unintended
    consequences associated with strict enforcement of leverage ratios. Ten
    years in the making, the GSE risk-based standard is unique among
    financial services regulation. It requires Freddie Mac to hold capital
    sufficient to survive 10 years of severe economic conditions; under the
    risk-based test, both the credit and interest-rate risk of the GSE's
    mortgage holdings are stressed to historic proportions. Without a
    doubt, this rule is at the cutting edge of financial services
    regulation.\14\ It ties capital to the specific risks of an
    institution--ensuring safety and soundness without raising costs
    unnecessarily or crippling the smooth flow of mortgage capital. It is
    the standard-bearer in capital regulation.
    ---------------------------------------------------------------------------
        \14\ According to an analysis prepared by L. William Seidman,
    former Chairman of the FDIC, the stringent risk-based capital standard
    applicable to Freddie Mac could be extremely challenging if applied to
    most other financial institutions. L. William Seidman, et al.,
    Memorandum to Freddie Mac, March 29, 2000. More recently, the
    CapAnalysis Group, LLC, concluded that the risk-based capital stress
    test is ``a much more stringent test for judging the safety and
    soundness of a financial institution than is a traditional capital-
    requirements test.'' The CapAnalysis Group, LLC, OFHEO Risk-Based
    Capital Stress Test Applied to U.S. Thrift Industry (March 17, 2003),
    p.1.
    ---------------------------------------------------------------------------
        To ensure that the GSE capital standard remains at the forefront of
    capital regulation, the new regulator must have adequate discretion to
    keep pace with developments. Although the basic parameters of the risk-
    based capital stress test are set in law, our present regulator has
    significant discretion in adjusting the risk-based capital
    requirements. Additional discretion, such as provided to Federal
    banking agencies, could help ensure the GSE risk-based capital standard
    remains at the forefront of financial sophistication, while continuing
    to tie capital to risk.
        Discretion must be balanced with continuity, however. Unnecessarily
    changing the risk-based capital standard harms those who made
    investment decisions based on a particular set of rules, only to find
    later that the rules were changed. This ``regulatory risk'' increases
    costs that are ultimately borne by mortgage borrowers. Therefore, until
    such time as an overhaul of the risk-based capital stress test appears
    warranted, the regulator should be encouraged to continue to apply the
    existing risk-based capital rule. The rule has been in effect for only
    1 year and has yet to show signs of need for reform.
        We also believe the new regulator should be encouraged to gather
    information over the entire business cycle before making changes. This
    could be accomplished by requiring that the current rule remain in
    place for a period of time and expressing Congressional intent to this
    effect. When a new rule appears warranted, policymakers should ensure
    that certain fundamental principles remain firmly intact. It would be
    our strong suggestion that any future capital standard must continue to
    tie capital levels to risk; be based on an analysis of historical
    mortgage market data; remain operationally workable and as transparent
    as possible; and accommodate innovation so the GSE's can carry out
    their missions.
        Further, we would expect that any changes to the rule be
    accomplished through notice-and-comment rulemaking, with an adequate
    comment period for all interested parties to express their views,
    followed by an adequate transition period for the GSE's to make any
    necessary adjustments to comply with new requirements.
        In summary, Freddie Mac supports improvements to the GSE capital
    regime that reflect the unique role of the GSE's, while ensuring public
    trust in our financial strength. Based on my experience as a regulator,
    I fully support granting the regulator greater discretion to set risk-
    based capital levels that accurately reflect the risks we undertake.
    Discretion on risk-based capital greatly mitigates the need to provide
    unfettered regulator discretion on minimum capital. Changing capital
    standards unnecessarily, capriciously or frequently will reduce the
    amount of mortgage business the GSE's can do, resulting in higher costs
    for homeowners and renters.
    Supervisory and Enforcement Parity
        The current legislative structure provides our safety and soundness
    regulator an array of supervisory and enforcement authorities to ensure
    that Freddie Mac is adequately capitalized and operating safely.\15\ If
    Congress were to deem it appropriate, we would support providing the
    GSE safety and soundness regulator authorities similar to those
    accorded to the Federal banking agencies. These enhanced powers would
    include broadening the individuals against whom the regulator could
    initiate cease-and-desist proceedings, new authority to initiate
    administrative enforcement proceedings for engaging in unsafe and
    unsound practices, new removal and suspension authority and authority
    to impose industry-wide prohibitions, and new authority to assess civil
    money and criminal penalties.
    ---------------------------------------------------------------------------
        \15\ ``Comparison of Financial Institution Regulators' Enforcement
    and Prompt Corrective Action Authorities,'' GAO-01-322R, January 31,
    2001.
    ---------------------------------------------------------------------------
    Conservatorship v. Receivership
        While it may be appropriate to draw on certain banking provisions
    to improve the GSE regulatory oversight structure, we strongly believe
    the mechanism for dealing with extreme financial distress is not one of
    them. Receivership is an efficient disposition mechanism for thousands
    of Federally insured depository institutions, whose failure would not
    threaten the stability of and public confidence in the financial
    system, particularly in the Federal deposit insurance system. However,
    it is not a credible option for dealing with two GSE's. In contrast to
    the situation for most insured institutions, the decision to liquidate
    a GSE would have substantial economic, market, and public policy
    consequences. It would threaten the public policy mission of the GSE's
    and could potentially disrupt the legal obligations and expectations of
    market participants.
        Recognizing the unique role of the GSE's, and our mission to expand
    homeownership, Congress chose a different disposition mechanism when it
    established the current GSE regulatory oversight structure. To address
    the unlikely event of extreme financial distress, Congress gave the
    safety and soundness regulator the right to appoint a conservator,
    which would rehabilitate an ailing GSE. However, Congress reserved to
    itself the right to appoint a receiver.
        Although Freddie Mac believes that current law provides ample
    convervatorship powers, we would be willing to consider whether
    additional authorities could enhance Congress' and the public's
    confidence in our safe and sound operation. Such enhancements to
    existing GSE conservatorship powers would achieve the important policy
    objective of strengthening the GSE regulatory oversight structure
    without the potential unintended consequences that could result from
    receivership. Many market participants might view a change to
    receivership as a first step to privatization of the GSE's. This could
    have significant implications on our ability to support the market for
    30-year, fixed-rate mortgages.
    Mission Oversight and New Program Approval
        We believe that the HUD Secretary should retain all existing GSE
    mission-related authority consistent with HUD's mission to expand
    homeownership and increase access to affordable housing. Specifically,
    HUD should retain authority to ensure that the purposes of the GSEs'
    charters are accomplished and continue to have regulatory, reporting,
    and enforcement responsibility for the affordable housing goals, just
    as under current law. Additionally, HUD should retain existing fair
    housing authority.
        We also believe that, in keeping with its housing mission, HUD
    should retain its authority to approve any new programs of Freddie Mac
    and Fannie Mac. HUD alone has the expertise to determine whether new
    mortgage programs are in keeping with our charter and statutory
    purposes. In this vein, we also urge the Committee to maintain a new
    program standard--not a new activity standard. Requiring the regulator
    to provide advance approval of each and every new activity
    significantly exceeds the standard required of banks and would chill
    innovation in mortgage lending. Our ability to lower housing costs for
    homeowners and renters is directly linked to our expertise in managing
    mortgage credit risk and our distinguished record of bringing
    innovative products and services to market.
    Affordable Housing Goals
        Meeting the annual affordable housing goals is a key aspect of our
    meeting our mission. Established in 1993 and increased in 1995 and
    2000, the affordable housing goals specify that significant shares of
    Freddie Mac's business finance homes for low- and moderate-income
    families and families living in underserved areas. In 2000, HUD
    specified that 50 percent of Freddie Mac's mortgage purchases must
    qualify for the low- and moderate-income goal,\16\ 31 percent must be
    of mortgages to borrowers in underserved areas,\17\ and 20 percent must
    be of mortgages to very-low income borrowers or low-income borrowers
    living in low-income areas.\18\ Freddie Mac has successfully met all
    the permanent housing goals, which are the highest and toughest of any
    financial institution.
    ---------------------------------------------------------------------------
        \16\ Low- and moderate-income families have incomes at or below 100
    percent of the area median income.
        \17\ Underserved areas are defined as (1) for OMB-defined
    metropolitan areas, census tracts having a median income at or below
    120 percent of the median income of the metropolitan areas and a
    minority population of 30 percent or greater; or a median income at or
    below 90 percent of median income of the metropolitan area; and (2) for
    nonmetropolitan areas, counties having a median income at or below 120
    percent of the state nonmetropolitan median income and minority
    population of 30 percent or greater; or a median income at or below 95
    percent of the greater of the state nonmetropolitan median income or
    the nationwide nonmetropolitan median income.
        \18\ Low-income areas refer to census tracts in which the median
    income is at or below 80 percent of the area median income. Low-income
    families have incomes at or below 80 percent of area median income,
    while very-low income families have incomes at or below 60 percent of
    the area median income.
    ---------------------------------------------------------------------------
        The existing statutory and regulatory structure provides great
    discretion to our mission regulator to determine the goals--and creates
    strong incentives for us to achieve them. The HUD Secretary currently
    has the regulatory authority to establish and adjust the housing goals.
    In the event a GSE fails to meet one or more of the goals--or there is
    a substantial probability that a GSE will fail one or more of the
    goals--the Secretary is authorized to require the submission of a
    housing plan. Further, the Secretary may initiate a cease-and-desist
    proceeding and impose civil money penalties for failing to fulfill the
    housing plan. By contrast, bank regulators do not have authority to
    bring enforcement proceedings against an institution that is not
    meeting its CRA obligations. These are strong incentives for the GSE's
    to strive to meet the goals year after year--to say nothing of the
    reputational ``penalty'' for failing to meet a goal.
        Considering that we have consistently met the permanent affordable
    housing goals, and that existing powers already are the industry's
    toughest, additional enforcement authority seems completely
    unnecessary. Additional enforcement authority would add little to the
    legislative and regulatory incentives that Congress and HUD have put in
    place. Therefore, we respectfully suggest that no additional authority
    is needed.
    Market Discipline Commitments
        In October 2000, Freddie Mac and Fannie Mae announced a set of six
    public commitments to ensure the GSE's adhere to a high standard of
    financial risk management. These commitments continue to represent a
    very high ``bar'' among financial institutions. Excluding the
    commitment to adhere to an interim risk-based capital standard (which
    was rendered obsolete with the completion of the current risk-based
    capital stress test) the commitments are as follows:

     Periodic issuance of publicly traded and externally rated
        subordinated debt on a semiannual basis and in an amount such that
        the sum of core capital and outstanding subordinated debt will
        equal or exceed approximately 4 percent of on-balance-sheet assets.
        Because subordinated debt is unsecured and paid to the holders only
        after all other debt instruments are paid, the yield at which our
        subordinated debt trades provides a direct and quantitative market-
        based indication of our financial strength.
     Maintenance of at least 5 percent of on-balance sheet assets
        in liquid, marketable, nonmortgage securities and compliance with
        the Basel Committee on Banking Supervision Principles of Sound
        Liquidity Management, which requires at least 3 months' worth of
        liquidity, assuming no access to new issue public debt markets.
     Public disclosure of interest-rate risk sensitivity results on
        a monthly basis. The test assumes both a 50 basis-point shift in
        interest rates and a 25 basis-point shift in the slope of the yield
        curve--representing an abrupt change in our exposure to interest-
        rate risk.
     Public disclosure of credit risk sensitivity results on a
        quarterly basis. The disclosure shows the expected loss in the net
        fair value of Freddie Mac's assets and liabilities from an
        immediate nationwide decline in property values of 5 percent.
     Public disclosure of an annual independent rating from a
        nationally recognized statistical rating organization.

        In July 2002, the GSE's made an additional commitment to
    voluntarily register their common stock with the Securities and
    Exchange Commission under the Securities Exchange Act of 1934 so that
    both companies will become reporting companies under that law. Freddie
    Mac remains irrevocably committed to completing this process as soon as
    possible after the company's return to timely reporting.
        Freddie Mac would support giving the regulator authority to ensure
    we carry out these important public commitments. Taken together, they
    significantly enhance the degree of market discipline under which the
    GSE's operate. Robust and frequent credit and interest-rate risk
    disclosures, combined with the release of annual independent ratings
    and the issuance of subordinated debt, constitute an important ``early
    warning system'' for investors.
    Top Priorities for Freddie Mac
        Finally, I would like to say a few words about Freddie Mac--and my
    top priorities for strengthening this vital company and restoring the
    trust of the Congress, the public, and investors.
    Commitment to Exemplary Accounting
        Clearly, my most pressing priority is to get Freddie Mac's
    financials done--and done right. On November 21, 2003, the Freddie Mac
    Board of Directors and our management team announced the release of the
    company's restated and revised financial results for the years 2000
    through 2002. The restatement was a significant step in Freddie Mac's
    progress toward achieving accurate and timely financial reporting. The
    company will issue its annual report for 2002 on Friday, February 27,
    2004 and hold the related annual stockholders' meeting on March 31,
    2004.
        As for 2003 and beyond, we are currently working around the clock
    with the objective of releasing quarterly and full-year 2003 results by
    June 30, 2004 and to provide the 2003 annual report and hold the
    related stockholders' meeting as soon as possible thereafter.
        I am also focused on ensuring that these problems do not happen
    again. I am pleased to report that, under the guidance of our Board of
    Directors, Freddie Mac is building an environment that will allow us to
    provide comprehensive and understandable information about our company,
    incorporating the highest level of financial transparency, accounting
    controls, compliance, and professional standards. Our aim is not simply
    to meet what is required but to become a model of financial excellence.
        We have added over 100 professionals in the accounting, reporting,
    and control areas, including a significant number of new officers and
    senior managers. We have also retained leading experts in the areas of
    public disclosures and corporate governance to assist the company in
    designing and implementing processes and practices in these areas. In
    October 2003, we hired a Senior Vice President--Chief Compliance
    Officer who is responsible for overseeing Freddie Mac's compliance with
    policies, procedures and practices, including compliance with laws and
    regulations. Additionally, in October 2003, we created the position of
    Chief Enterprise Risk Officer. Both of these positions currently report
    directly to me.
        We are also working to create and implement new infrastructure and
    systems to ensure the quality, integrity, transparency, and timeliness
    of our financial reporting.
        Finally, we have taken steps to ensure that Freddie Mac's corporate
    culture promotes integrity, high ethical standards, and the importance
    of compliance. Virtually all of our employees have completed a
    corporate-wide training program on the company's Code of Conduct and
    the provisions of the Act sponsored by Senator Sarbanes and Chairman
    Oxley.
        The scope of these activities is wide and deep. I was deeply
    involved in the transformation of a Fortune 500 company before, and I
    am committed to doing it again. Freddie Mac is on the path to becoming
    a new and better company.
    Enhanced Commitment to Mission
        My second priority is to renew and expand the company's commitment
    to mission. It is a great honor to be the leader of a company that has
    an explicit mission to do good things for society. There are very few
    publicly owned companies that have such a ``higher calling''--and, as a
    Nation, we should work to make them better, as is the Committee's
    intent.
        The special privileges that flow from the GSE charter entail
    special responsibility. While the annual affordable housing goals are
    an important component of our mission to expand mortgage market
    accessibility, I view the goals more as a threshold than a ceiling. I
    am particularly focused on the housing finance needs of minority
    consumers. The homeownership rate for African-Americans is 48 percent
    and 47 percent for Hispanics. We must do better--and we will.
        When I was at the Federal Reserve Bank of Boston, I oversaw one of
    the first major research projects looking at discrimination in mortgage
    lending. That research led to calls for greater objectivity in mortgage
    underwriting--and eventually to the birth of automated underwriting.
    Automated underwriting systems, such as Freddie Mac's Loan
    Prospector', have played a critical role in expanding
    minority borrower access to mortgage markets. Now Freddie Mac is
    looking at ways to integrate nontraditional credit variables into
    automated underwriting. It won't be easy--but neither was creating the
    first mortgage-backed security, which is now widely traded around the
    world.
        We are also studying the best way to extend the efficiencies of the
    conforming mortgage market to the subprime market. This market serves a
    needed function, but many borrowers--particularly minority borrowers--
    could qualify for lower-cost conforming mortgages if they had the
    chance. Further, abusive lending practices make this market ripe for
    the standardization and accountability that the GSE's provide. It is
    time to transform that market so that is serves borrowers better.
        These and other initiatives to enhance Freddie Mac's commitment to
    mission are currently under active consideration. I would be happy to
    return to the Committee at some future point to describe specific new
    commitments Freddie Mac will make to further expand access to low-cost
    mortgage money for more families.
    Maintaining Safety and Soundness
        A final priority is to maintain Freddie Mac's rock-solid commitment
    to safety and soundness. Despite last year's accounting travails,
    Freddie Mac's franchise was safe and strong. Our safety and soundness
    regulator, the Office of Housing Enterprises Oversight (OFHEO),
    continually assessed us as ``adequately capitalized,'' the highest
    rating. And we are in full agreement with OFHEO's directive of [date]
    to hold excess capital until our financials are complete.
        I have been particularly impressed by the company's assiduous
    management of interest-rate risk. Each day at 5 p.m., I receive a set
    of measures of Freddie Mac's exposure to interest-rate risk for that
    day. And each month, investors around the world see what I see when the
    company discloses our average monthly duration gap and other
    statistics. Only the housing GSE's provide such frequent and
    transparent measures of risk exposure. Freddie Mac is clearly a company
    that is serious about managing risk--and good at it, too. This will not
    change. If anything, I will see that our risk management practices and
    disclosures are strengthened.
    Conclusion
        Freddie Mac strongly supports the enactment of legislation that
    provides strong, credible regulatory oversight. These enhancements are
    needed--even overdue. They are critical to the achievement of our
    mission and to maintaining the confidence of the Congress and the
    public.
        As a former regulator, I strongly support significant enhancements
    that will make our regulatory structure stronger, in many cases, than
    the bank regulatory model. Building these new enhancements into
    existing law would give the new GSE regulator comparable supervisory
    and enforcement powers as bank regulators. In addition, these
    enhancements would impose tougher regulatory requirements in many
    areas. Our mission regulator would continue to oversee the most
    challenging, quantitative affordable housing goals in the industry--
    with tremendous powers to enforce them.
        These enhancements will ensure that we improve on the greatest
    housing finance system in the world--without damaging it. A measured
    approach to reform is critical to keeping the door of homeownership to
    a new generation of homebuyers.
        Thank you for the opportunity to appear today. I look forward to
    working with Chairman Shelby, Ranking Member Sarbanes, and the Members
    of this Committee to secure the future of our housing finance system
    and, with it, the dreams of millions of families.
                                   ----------
                      PREPARED STATEMENT OF NORMAN B. RICE
                     President and Chief Executive Officer
                       Federal Home Loan Bank of Seattle
                               February 25, 2004
        Good afternoon Chairman Shelby, Ranking Member Sarbanes, and
    Members of the committee. I am Norman B. Rice, President and Chief
    Executive Officer of the Federal Home Loan Bank of Seattle.
        I would like to start today by underscoring the critical importance
    of this Committee's work--and that of Congress and the Administration--
    in supporting a world-class regulatory structure that ensures and
    enhances the safety, soundness and economic viability of the housing
    Government Sponsored Enterprises (GSE's).
        In my role representing the Council of Federal Home Loan Banks
    before this Committee, I wanted to very clearly state our support of
    this effort. The Bank System should--and must--at all times lead by
    example in terms of pursuing the highest levels of oversight and public
    accountability.
        This Committee is to be commended for the thoroughness of the
    process and efforts regarding the creation of a new regulatory
    structure for the housing GSE's. We believe the strong, independent
    structure being discussed can serve the Bank System--and the more than
    8,000 community financial institutions we serve--appropriately, and we
    stand committed to working with you in this effort.
        The Federal Home Loan Banks are also acutely aware of how much is
    at stake in this process for those who struggle to make ends meet and
    find safe, affordable housing in communities across our country every
    day, for American residents and taxpayers, and for our member
    shareholders.
        We understand that this Committee is considering the creation of a
    new agency. If so, it is imperative that the agency you create improves
    the oversight, the mission delivery, and the effectiveness of the
    business activities of the housing GSE's--not hinder them.
        When I testified before this Committee in October 2003, I outlined
    a set of four principles that framed the Bank System's bottom-line
    needs regarding a new regulatory structure for the housing GSE's. These
    continue to be the key elements we believe must be included in
    legislation in order to create a world-class regulator.
        What I put forth, in essence, were the pillars on which the Bank
    System cooperative rests--the elements that allow our 12 Banks to
    provide more than a half trillion dollars each year in advances to our
    member shareholders; that allow us to issue more than $150 million in
    Affordable Housing Program grants to communities across America; that
    allow us to provide more than $9 billion annually in reduced-rate loans
    for the purpose of community and economic development that benefit low-
    to moderate-income families and neighborhoods.
        Critical to what must be contained in a regulatory structure? Yes.
        Critical to the economic health of the communities our member
    shareholders serve? Yes.
        Those Bank System principles include the following:
    Preserve and Reaffirm the Bank System's Mission
        Mission is everything to us. We strongly believe that any
    legislation should accomplish the following:

     Provide cost-effective funding to members for use in housing
        finance and community development.
     Preserve our regional affordable housing programs, which
        create housing opportunities for low- and moderate-income families.
        Since the inception of our Affordable Housing Programs in 1991, the
        Bank System has contributed more than $1.7 billion in grants to
        communities across America.
     Support housing finance through advances and mortgage
        programs.
     Preserve the Bank System's ability to bring to market
        innovative new business activities that advance our mission without
        creating a cumbersome process that prevents us from responding in a
        timely way to the needs of our member financial institutions.
    A Strong and Independent Regulator
        Safety and soundness of the Bank System is our No. 1 concern. This
    is absolutely consistent with the role of other bank regulatory
    agencies, in which the regulator responsible for safety and soundness
    has free and unfettered authority to determine policy, rulemaking,
    application, adjudicative, and budget matters. It is essential that
    this regulator have the independent authority to promulgate rules and
    perform its safety and soundness role without undue outside agency
    interference.
    Preserve Bank System Funding
        It is critical that we ensure that nothing is done that increases
    the Bank System's cost of funds and, correspondingly, increases costs
    for consumers and financial institutions.
        Therefore, any legislation must:

     Preserve the role and function of the Office of Finance and
        clearly establish it as an entity of the Federal Home Loan Bank
        System, regulated and examined by the System's regulator.
     Ensure that neither the U.S. Treasury, nor the independent GSE
        regulatory unit, has the ability to impede or limit our access to
        the capital markets without cause.
     Not limit the financial management tools available to
        prudently manage the financial risks inherent in our funding and
        business activities.
    Preserve the Unique Nature of the Bank System
        While all three GSE's have much in common, we believe it is
    important to both recognize and preserve the unique nature of the
    FHLBanks.
        Therefore, any legislation must:

     Preserve the cooperative ownership of the Bank System and the
        joint and several liability that is the underpinning of the Bank
        System.
     Preserve the unique regional structure of the 12 Banks that
        assures we are locally controlled and responsive to the financial
        and economic development needs of our communities.

        I also would like to speak more specifically to the regulatory
    structure we understand is under discussion--that of an independent
    agency that operates outside of a cabinet-level department.
        I will present to you this afternoon the Bank System's view on the
    following aspects of this proposed structure:

     Ensuring regulatory independence.
     Agency oversight responsibilities.
     Creating separate divisions for the Federal Home Loan Banks
        and the publicly traded housing GSE's.
    Ensuring Regulatory Independence
        A regulator lacking true independence is often subject to a wide
    range of demands and influences that we believe would be detrimental to
    the supervision, business activities, and mission fulfillment of the
    housing GSE's. The regulator of this new, proposed agency must have a
    laser focus on following the will of Congress in assuring fulfillment
    of the mission and the safety and soundness of the housing GSE's, not
    the agendas of outside agencies and other political influences.
        We know that some have discussed the possibility of an advisory
    body in addition to or as a part of this regulator. The Bank System
    understands the potential value of a board or advisory committee, and
    the regulatory role other cabinet-level departments have played in the
    past. However, it is important that the new ``world class'' regulator
    not be hamstrung by a cumbersome board structure, and not be dominated
    or controlled by any single agency represented on the board. This new
    regulatory body must have the authority to govern--promulgate rules and
    perform its safety and soundness role.
    Agency Oversight Responsibilities
        The Bank System believes this independent regulator should have the
    following authorities:

     Ensuring the safety and soundness of the housing GSE's.
     Overseeing all mission-based goals and programs.
      There are obvious differences in the mission-based goals and programs
        for the two housing GSE's and the Federal Home Loan Banks.
      We are required to annually contribute 10 percent of our net income
        for affordable housing grants, while Fannie Mae and Freddie Mac
        have affordable housing goals.
      However, we believe a proposed new regulator should have the
        authority to review, approve, and monitor all mission-based goals
        and programs.
      Though we appreciate the goals the other housing GSE's maintain, we
        believe that in addition to greater consumer access to credit, one
        of the best ways of passing along our subsidy is through our
        Affordable Housing Program and the direct 10 percent contribution
        made by each of the 12 Federal Home Loan Banks annually.
      In addition, our current regulator has that mission-oversight
        authority, and we believe it has served the Bank System, its
        members and their communities very well.

     Setting capital standards.
      Along with independence, any world-class regulator must have the
        authority to set both leverage- and risk-based capital standards.
        As you know, Congress conducted an extensive review and revision of
        our capital structure in the Gramm-Leach-Bliley legislation, and
        the Federal Housing Finance Board was given this broad authority in
        the Act. We believe any new regulatory agency should have the
        authority to raise and lower capital requirements as deemed
        appropriate and necessary. Anything less, in our opinion, would be
        a significant step backward.

     Approving new business activities and programs.
      Having the capacity to innovate and keep pace with an evolving
        financial services industry is critical to all 12 Federal Home Loan
        Banks. We believe a world-class regulator should preserve the Bank
        System's ability to innovate around existing products and services.
        In turn, the regulator should be diligent in examining and
        approving these innovations and exploring areas that represent new
        risk to the GSE.
      Speaking on behalf of the Seattle Bank, I believe our Mortgage
        Purchase Program (MPP) is a good example of where a regulator
        insisted on close oversight and then approved a new business line.
        This new activity was and remains fully consistent with our mission
        and the statutory authority Congress conferred, but prior review
        was appropriate because it entailed substantial new risks.
      Likewise, going forward, the new regulator should enjoy and exercise
        the same authority to approve innovation. In turn, a Federal Home
        Loan Bank should be expected to demonstrate, first, that it has the
        capacity to manage the business before it is allowed to incur
        substantial new risk. Since nothing is static in financial services
        generally--and housing finance in particular--it is incumbent upon
        the regulator and regulated alike to remain vigilant. To that end,
        we continue to strengthen our internal infrastructure in an effort
        to better manage the risks of this new business, which has proven
        to drive significant value back to our member shareholders and
        lower housing costs for consumers.
    Creating Separate Divisions for the Bank System and the Publicly
    Traded Housing GSE's
        While Fannie Mae, Freddie Mac, and the Federal Home Loan Banks all
    share GSE status, we are, fundamentally, very different entities.
        The Federal Home Loan Banks are cooperatively owned and capitalized
    by our members, most of whom are community banks occupying and
    delivering benefits to Main Streets across the country, while the other
    two housing GSE's must meet the quarterly earnings expectations of Wall
    Street investors.
        To that end, the Bank System believes that creating separate
    divisions within a regulatory structure would add efficiencies in the
    provision of appropriate oversight and supervision. Our assumption is
    that staffing from previous regulatory agencies--such as the Finance
    Board and OFHEO--could be retained to provide a baseline of expertise
    for the two divisions.
        In concluding this afternoon, I want to emphasize to the Committee
    that the onus for strengthening our system lies not only with Congress
    and regulators, but also with the housing GSE's themselves.
        We must be willing to take the steps necessary to efficiently
    manage our financial institutions in a safe and sound manner, and
    provide world-class financial transparency and disclosure regarding our
    business operations. The Federal Home Loan Banks unanimously support
    providing enhanced, comprehensive, and fully transparent securities
    disclosure. On that point, there is no debate.
        Where there is a difference of opinion among the Banks--and where
    there has been much discussion with our regulator, the Federal Housing
    Finance Board, and others--is concerning who should have authority over
    financial disclosures and transparency: The Securities Exchange
    Commission (SEC) or the housing GSE regulator. From the Bank System's
    perspective, we believe that a world-class regulator with the
    experience and expertise to oversee the housing GSE's would,
    potentially, be better able to set the framework and supervision for
    the level of financial disclosure now being demanded of our system.
        If Congress' intent is to create a new, independent regulatory
    structure for the housing GSE's, why not invest the agency with the
    authority to oversee financial disclosure? Why not accommodate in this
    new framework the resources and expertise to supervise financial
    disclosure that conforms to SEC standards, yet fits appropriately
    within the Congressionally mandated scope of the housing GSE charter
    and mission?
        We would respectfully request that this Committee consider this as
    an option as you continue your regulatory restructuring discussions for
    the housing GSE's.
        However, if Congress were to choose the SEC to regulate these
    financial disclosures, the Bank System believes some very specific
    accommodations would be necessary.
        The Banks have identified financial, operational, and legal
    considerations that could lead to uncertainties and risks to the system
    and adversely affect their ability to carry out their Congressionally
    mandated housing finance mission.
        As just one example--issuer stock-repurchase requirements.
        The purpose of this requirement is to provide adequate information
    to the SEC, the holder of an issuer's equity securities, and the
    marketplace of a potential change in control when an issuer repurchases
    its own shares.
        The Federal Home Loan Banks routinely repurchase the excess stock
    of their members. All repurchases must be made at par value. Repurchase
    transactions often occur on a monthly basis, although they may occur
    more frequently than that, at the initiation of the FHLBank or at the
    request of a member shareholder.
        The ability to repurchase excess stock of members enables our banks
    to manage their capital position in view of prevailing market and
    business conditions, consistent with Federal Housing Finance Board
    requirements.
        Repurchases of excess stock cannot result in the change of control
    of a Federal Home Loan Bank, nor can they benefit one member at the
    expense of another, because all transactions must occur at par value.
        Accordingly, no investor protection purpose would be served by
    requiring the Bank System to comply with the issuer-repurchase
    requirements of the Federal securities laws. Moreover, the application
    of such requirements would result in costly and unnecessary filings, in
    view of the volume and frequency of bank repurchase transactions.
        Again, this is just one example--of several--illustrating the
    unique nature of the Bank System and the significant financial,
    operational, and legal challenges created when considering SEC
    registration for our 12 Banks.
        However, it is important to note that the Bank System's ongoing
    questions and discussions have not prevented our institutions from
    working with SEC staff over the last year on the process of registering
    under the 1934 Act--a process driven, in large part, by proposed
    rulemaking through the Federal Housing Finance Board.
        A Task Force of the Bank Presidents' Conference, as well as some
    individual Banks, have had a number of meetings with SEC officials to
    discuss the resolution of outstanding accounting and reporting issues.
        In addition, the Seattle Bank Board of Directors, at our September
    2003 meeting, adopted a resolution calling for SEC registration,
    pending resolution of all reporting and accounting issues. Our
    individual banks are also investing significantly in staff and
    resources in order to conform to SEC and Sarbanes-Oxley disclosure
    requirements.
        If it is the will of Congress for the Federal Home Loan Banks to
    complete SEC registration, we believe we are moving in the right
    direction to make that happen in an appropriate timeframe--and in a way
    that maintains our ability to carry out the Bank System's
    Congressionally mandated housing finance mission.
        After all, that is why the Federal Home Loan Banks exist--to
    provide flexible, long-term financing that helps our member
    shareholders fund the hopes, dreams, and critical needs of their
    communities.
        As you move quickly forward in this legislative process, I would
    ask that you keep top of mind that we are a cooperative system owned by
    more than 8,000 banks, thrifts, credit unions, and insurance companies.
    That means every dollar of value we create is passed through to our
    members and their communities. That is why the Bank System exists.
        We look forward to working with you in strengthening our
    cooperative and the oversight and supervision of the housing GSE's--for
    the good of the American public, our communities, and our members.
        Thank you for your time this afternoon. I would be happy to answer
    any questions you may have regarding my testimony.

            RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGEL
                         FROM RICHARD F. SYRON

    Q.1. In a June 25, 2003 press release, Freddie Mac stated it
    would start to provide disclosure on its fair value balance
    sheet on a quarterly basis. Does Freddie Mac still plan to
    disclose this information? If so, then when?

    A.1. Yes, Freddie Mac's objective continues to be to provide
    quarterly estimates of fair value balance sheet net assets for
    quarterly 2004 financial results subject to meeting our
    objective to return to timely financial reporting. We intend to
    return to timely financial reporting as soon as possible.
    However, we currently are not able to predict when we will do
    so.

    Q.2. How would fair value balance sheets enhance transparency?

    A.2. Our fair value of net assets represents management's
    estimation of the fair value of our existing net assets.
    Although it does not represent the value of the company as an
    ongoing concern, we believe it (along with our GAAP results and
    the interest rate risk sensitivity and other disclosures we
    publish) provides a useful perspective on our financial
    condition. This is because fair value of net assets takes a
    consistent approach to the measurement of all financial assets
    and liabilities, rather than an approach mixing historical cost
    and fair value techniques, as is the case with Freddie Mac's
    GAAP-based consolidated financial statements.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                         FROM RICHARD F. SYRON

    Q.1. In Chairman Greenspan's testimony before this Committee on
    February 24, 2004, in response to a question I posed about
    whether it is appropriate for Congress to recapture some of the
    implicit Federal benefits that are not passed onto homeowners
    in the form of lowered mortgage interest rates, Chairman
    Greenspan agreed that it was a ``legitimate judgment for
    Congress'' to recapture some of these ``lost'' benefits. Why
    shouldn't Congress demand more of Fannie, Freddie, and the
    FHLB's in light of the implied Federal benefits that have been
    documented by several studies?

    A.1. As we said in our testimony on February 25, Freddie Mac
    can and will do more to support homeownership and affordable
    housing. That said, we respectfully disagree with the premises
    of the question. Although Freddie Mac undeniably lowers
    interest rates--by an average of 25-30 basis points--this is
    not why Congress created Freddie Mac. More important, lowering
    interest rates is only one of the many indispensable benefits
    that Freddie Mac brings to America's families and the mortgage
    markets generally.
        Congress created Freddie Mac to provide liquidity, support,
    and stability to the residential housing finance market and to
    support affordable housing. By fulfilling our mission purposes,
    we create value for homeowners, the housing finance system, and
    the overall economy that substantially exceeds the value of the
    benefits we receive from our charter:

     We have created a national mortgage market where funds
        are available at virtually the same rate throughout the
        country, regardless of economic or market conditions. We
        achieved this by attracting capital from a broad base of
        investors worldwide, which enables us to purchase mortgages
        at all times.
     We make 30-year, fixed-rate, prepayable mortgages
        widely available because we are much better able to manage
        the risk of such mortgages than other financial
        institutions. Only in the United States are these mortgages
        widely available.
     Our ability to buy mortgages at all times made the
        refinance boom of the past few years possible. Homeowners
        took advantage of low rates to reduce their mortgage
        interest costs by some $200 billion dollars in 2001-2002
        alone. And as Chairman Greenspan has observed, the ability
        of homeowners to reduce their mortgage costs and liquefy
        their home equity has provided crucial support to the
        economy during the past several years.
     We provide critical stability in the mortgage market
        during periods of economic instability, such as during the
        Asian debt crisis of 1998 and the business and bank
        recession of 1990-1992. At these times, conforming mortgage
        rates would have increased dramatically except for our
        ability to continue buying mortgages and mortgage-backed
        securities. It is precisely during such periods of stress
        that the stabilizing role of the GSE's is most apparent.
     We pioneered innovations such as automated
        underwriting that have substantially lowered downpayment
        requirements, lowered costs, and reduced time in
        originating and closing mortgages. Equally important,
        through automated underwriting, we have helped make
        mortgage underwriting fairer and more objective.
     We have led the Nation in protecting consumers against
        predatory mortgage lending practices, and we are bringing
        the benefits of standardization to the subprime market.
        This leadership has especially benefited elderly, low-
        income, and minority families.

        Many of these benefits are difficult to quantify
    specifically, but they have led to a housing finance system
    that is envied throughout the world. We believe the evidence
    clearly demonstrates that we fulfill the mission purposes for
    which we are created and create substantial benefits for
    homeowners, the housing finance system, and the economy. These
    benefits far outweigh any benefits we receive from our charter.

    Q.2. Do you think that your Affordable Housing Goals are an
    ``inefficient'' way of passing your implied Federal benefits to
    homeowners? How might your implied Federal benefits be passed
    more efficiently on to homebuyers? Please elaborate.

    A.2. As we stated in our answer to question 1, we create value
    for homeowners, the housing finance system, and the economy
    that substantially exceeds the value of the benefits we receive
    from our charter. The Affordable Housing Goals, though
    extremely important, are only one measure of the benefits we
    create.
        Nonetheless, Freddie Mac provides a tremendous amount of
    support to affordable housing. We have met each of the three
    affordable housing goals for eight consecutive years--every
    year since HUD established permanent goals in 1995. Since the
    establishment of the goals in the 1992 Act, we have
    substantially increased our level of service to low- and
    moderate-income families and families in underserved areas. In
    2003, we financed homes for almost 2.5 million low- and
    moderate-income families, a fourfold increase over our
    purchases of such mortgages in 1993. In fact, we financed more
    homes for low- and moderate-income families in 2003 than we did
    for all borrowers in 1993. In 2003, we bought more than $106
    billion of mortgages made to minority families--again, an all-
    time record for us. By any standard, the goals should be
    considered a major public policy success.

        In light of the GSEs' stellar financial performance and in
    the context of GSE regulatory reform, the Administration has
    suggested creating new affordable housing goals and subgoals.
    Q.3.a. Do you believe that these more rigorous goals and
    subgoals are obtainable and appropriate, in light of your
    recent financial performance and the implicit Federal benefits
    you receive? Why or why not?

    A.3.a. We do not know exactly what the Department of Housing
    and Urban Development (HUD) will propose when it publishes
    revised affordable housing goal rules for comment later this
    spring. Until HUD issues its proposal, it is difficult to
    evaluate whether any revisions to the current goals will be
    obtainable or appropriate. Our own discussions with HUD suggest
    that the revised regulations will seek to promote the
    Administration's overall goal--which we enthusiastically
    support--of increasing homeownership rates, particularly among
    minority families.
        We believe that the goals, which have risen dramatically
    over the last decade, are already quite rigorous. Since 1993,
    the first year that HUD set the goal levels, the low- and
    moderate-income goal has risen from 28 to 50 percent, a 79
    percent increase. In that same time, the underserved area goal
    has risen from 26 to 31 percent, a 19 percent increase. The
    special affordable goal has risen from 14 to 20 percent, a 43
    percent increase, since HUD shifted the goal from a dollar
    amount to a percentage of purchases in 1996. As we said in our
    answer to question 2, we have responded by dramatically
    increasing our purchases of mortgages supporting affordable
    housing, and we have met all of the goals for eight consecutive
    years.
        Moreover, we believe that HUD should be very cautious in
    considering new subgoals. For example, some have suggested
    creating a home purchase goal. This could reduce liquidity in
    the housing finance market by creating a disincentive for the
    GSE's to purchase refinance loans. The low mortgage rates of
    the last few years have allowed millions of American families
    to lower their housing costs and thus helped sustain the
    economy through a difficult period. A goal that discourages us
    from fully supporting the entire conforming market would not be
    in the best interests of homeowners or the national economy,
    and would be inconsistent with our mission. Moreover, Freddie
    Mac already provides strong support to home purchase needs. In
    each of the past 4 years (2000-2003), we have purchased more
    than $100 billion of home purchase mortgages each year. In
    2003, we purchased nearly $150 billion of home purchase
    mortgages.
        This is not to suggest that we can rest on our laurels. To
    the contrary, we can build on this record of success and
    continue working hard toward providing an even higher level of
    service to affordable housing needs. The homeownership rates
    for African-American and Hispanic-American families are
    unacceptably low. Freddie Mac and its employees are committed
    to doing more. We are reexamining our business practices and
    policies top-to-bottom to come up with ways we can expand
    homeownership opportunities further and make mortgage finance
    as affordable as possible for all of America's families.

    Q.3.b. What more can Freddie Mac do to promote affordable
    multifamily housing? Please elaborate.

    A.3.b. Apartment homes constitute a major share of the Nation's
    affordable housing. Last year, we purchased a record $22
    billion in multifamily mortgages, representing nearly 600,000
    apartments, more than 90 percent of which were affordable to
    low- and-moderate income families under the HUD goals. We will
    continue to be extremely active in the multifamily mortgage
    market.
        We agree, however, that there is more that Freddie Mac can
    and must do. According to the Joint Center for Housing Studies
    at Harvard University, households with one full-time minimum
    wage earner cannot afford to rent even a modest one-bedroom
    apartment anywhere in the country. The Joint Center also
    reports that as of 2001 there was a shortage of affordable
    market-rate apartments (the type we typically finance) of about
    2 million units; We are also entering a critical period in
    which properties originally financed through low-income housing
    tax credits will need rehabilitation if they are to be
    maintained as decent housing for low-income families. Even
    conventionally financed multifamily properties built in the
    1970's and 1980's will soon need funding if they are to remain
    viable sources of housing for renters. There needs to be
    greater and more diversified support for rural multifamily
    properties.
        One of the most important ways to meet these needs are
    ``targeted'' affordable multifamily mortgages, in which public/
    private partnerships create apartments that the owner commits
    to maintain as affordable to specific income groups on a long-
    term basis. Most private primary market lenders, however, lack
    the specialized staff to process these loans and thus find them
    uneconomic to originate. In the short-term, Freddie Mac is
    working hard to find lenders who are willing to make the effort
    to originate these mortgages. To this end, we recently
    designated four companies as nationwide targeted affordable
    lenders. We chose these particular companies because they have
    invested in personnel dedicated to this type of lending and
    they are affiliated with construction lenders and tax credit
    equity investors, which enables them to provide a full range of
    funding options to affordable housing developers.
        To aid us in the pursuit of more enduring solutions, we
    have created a Targeted Affordable Advisory Council. The
    Council, which met for the first time in January, consists of a
    variety of prestigious affordable housing market participants
    who have agreed to help us streamline our internal processes
    for this type of product, enhance our existing targeted
    affordable products and develop new ones. During March, Freddie
    Mac held a Tax Credit Symposium in which we called on industry
    experts to help us better understand tax credit investment risk
    so that we can increase both our debt and equity investments in
    tax-credited properties.
        We are also increasing our presence in the rural
    multifamily market. This area of the multifamily market has
    traditionally been the province of Federally sponsored
    programs, because most primary market lenders find it
    unprofitable to originate conventional mortgages on small,
    rural multifamily properties, but Federal budget cuts have
    diminished the amount of credit available to these properties.
    We have recently committed that this year we will buy loans to
    fund preservation and rehabilitation of properties financed in
    the past with loans made by the Rural Housing Services, while
    leaving the low-cost RHS loans in place. We are working with
    RHS to expand our activities in this underserved sector.
        Another area in which we have been increasingly active is
    the market for small (5-50 unit) apartment loans, an area of
    the multifamily market that is important source of affordable
    housing and which HUD has previously identified as underserved
    by the secondary market. Last year alone, we financed about
    180,000 units in about 12,500 small multifamily properties.
    Like other small properties, 5-50 unit mortgages are expensive
    to underwrite, and as a result most of our purchases came
    through portfolio transactions with large lenders specializing
    in these properties. We are using the knowledge gained from
    these purchases to help us better understand their special
    characteristics, with the aim of bringing efficiencies and
    liquidity to this sector and increasing sources of credit for
    these properties.

        As many witnesses have stated before this Committee during
    the last several months, Mr. Greenspan testified on February
    24, 2004 that it is crucial to have an appropriate and
    thoughtful process for GSE liquidation in the case that a GSE
    fails. He not only argued that it was important on safety and
    soundness grounds, but also that it was one of the few credible
    ways that Congress could combat the impression in the
    investment community that the Federal Government will bail out
    the GSE's in the event of a crisis. Chairman Greenspan
    emphasized the current conservatorship authority of OFHEO as
    evidence that Congress will bail out the GSE's with taxpayer
    funds if one of them fails.

    Q.4.a. Do you believe that the current OFHEO conservatorship
    authority helps reinforce the impression that the Federal
    Government will bail out the GSE's in a crisis? Why or why not?

    A.4.a. We believe that the conservatorship provisions of the
    Federal Housing Enterprises Financial Safety and Soundness Act
    of 1992 (the 1992 Act) help reinforce the impression that the
    Congress has reserved for itself the full range of resolution
    options in the event a GSE were to experience significant
    financial difficulties.
        The conservatorship provisions of the 1992 Act are designed
    to allow the conservator to operate a GSE that is experiencing
    extreme financial distress as a going concern. These provisions
    contain no mechanism for the use of taxpayer funds to resolve
    an
    insolvent GSE; rather, the conservator must use funds generated
    by such a GSE's business operations to pay the GSEs' creditors.
        The Congress carefully constructed the conservatorship
    provisions of the 1992 Act in recognition of the unique role of
    the GSE's in expanding, and lowering the cost of,
    homeownership. In passing the legislation that created the
    current regulatory oversight structure for the GSE's, the
    Senate Banking Committee stated,

            This judgment takes account of the important role that
            the Enterprises play in our Nation's economy and their
            central role in the functioning of the residential
            housing finance sector of the economy. The Enterprises
            are clearly distinguishable from even the largest
            insured depository institutions, each of which may
            cease to be able to compete as a provider of financial
            services with varying degrees of economic impact. If
            the appointment of a conservator for an Enterprise were
            ever to become imminent, the Congress would have the
            opportunity to consider the reasons for the
            Enterprise's condition and the options then available
            to address that condition. S. Rep. No. 282, 102d Cong.,
            2d Sess. 26 (1992).

        While we cannot represent what an individual investor or
    investors as a group might think, the current conservatorship
    provisions together with the legislative history contemplate
    that the Congress would decide how best to resolve an insolvent
    GSE in the unlikely event of extreme financial distress.
        In addition, as required by law, all of the Freddie Mac's
    obligations and securities state clearly and conspicuously in
    bold type that they are obligations of Freddie Mac only, and
    are not guaranteed by, or debts or obligations of, the United
    States or any agency or instrumentality of the United States.

    Q.4.b. If it does, how can the liquidation authority for the
    housing GSE's be clarified in order to combat the investor
    impression that the GSE's will be bailed out with taxpayer
    funds in a crisis, while at the same time, ensuring that the
    housing mission of the GSE's is not unduly harmed in the
    process of liquidation? If it does not, do you think it is
    appropriate for Congress to make any changes to the current
    OFHEO conservatorship authority? Why or why not?

    A.4.b. We believe that current law provides ample
    conservatorship powers for restoring an insolvent GSE to sound
    financial condition. A conservator appointed for such a GSE has
    all the powers the shareholders, directors, and officers of the
    GSE have to operate the GSE as a going concern. For example, a
    conservator may pay a GSE's creditors to the extent that funds
    may safely be made available for this purpose.
        It is imperative that the GSEs' regulatory structure
    provides rigorous oversight and ensures the continued safety
    and soundness of the GSE's. Strong, credible regulatory
    oversight is key to preventing financial difficulties that
    could lead to the need to appoint a conservator.
        Although we believe that current law contains sufficient
    conservatorship powers, we would be willing to consider whether
    these powers could be enhanced to make sure the Congress, the
    public, and investors are confident in our safe and sound
    operation.

    Q.5. In his testimony, Chairman Greenspan reiterated his
    opinion, albeit admittedly minority opinion, that Fannie and
    Freddie should be privatized. Do you think that the GSE's
    should be privatized? Why or why not? How do you think it would
    affect the housing market and the Nation's housing finance
    system if Fannie and Freddie were privatized. Please elaborate.

    A.5. We do not support privatizing the housing GSE's. To do so
    would effectively dismantle a proven housing finance system in
    exchange for uncertain benefits. Advocates of privatization set
    forth several arguments, none of which make a convincing case.
        First, privatization advocates believe Government
    sponsorship is no longer needed to attract capital to housing
    or to provide an abundant supply of 30-year, fixed-rate,
    prepayable mortgages. This optimistic view contradicts the
    experience in other developed countries. In Canada, for
    example, homebuyers typically are restricted to a 7-year fixed-
    rate mortgage, must make a 25 percent downpayment, and are
    locked into higher interest rates or have to pay heavy
    penalties if they wanted to prepay.
        This view also ignores our own jumbo market, which is not
    served by the GSE's. On any given day, it is possible to look
    in a newspaper and find that mortgage rates on conforming loans
    are regularly one-quarter of a percentage point lower than
    those in the higher-balance jumbo market. Borrowers in the
    jumbo market not only pay higher rates, but they are also more
    likely to have to settle for an adjustable-rate mortgage (ARM).
    ARM's have the obvious advantage of lowering monthly mortgage
    payments in the first few years of homeowning, but they require
    borrowers to bear the interest-rate risk on the loan--rather
    than the capital markets bearing this risk. This results in
    higher borrower defaults over the long-term. Jumbo borrowers
    also typically make larger average downpayments than conforming
    borrowers. Higher mortgage-interest rates and larger
    downpayments make it significantly harder for low- and
    moderate-income families to become homeowners.
        This sanguine view of markets also ignores where we are in
    the credit cycle. History reveals that certain industries will
    slump, that certain regions will experience economic downturn,
    which, in turn, causes house values to fall and defaults to
    rise. We also know that with interest rates at historic lows,
    the mortgages put on the books today, in all likelihood, will
    require financing for decades to come. In short, it is easy to
    dismiss the risks of mortgage lending when times are good.
    GSE's were created precisely for those times when things are
    not going so well, however. GSE's absorbed significant losses
    during the oil bust in the 1980's and during the weakening of
    the economy in Northeast in the early 1990's. They also
    stabilized residential mortgage rates during the international
    financial crisis of 1998--and again after September 11--by
    continuing to provide liquidity to the secondary market for
    conforming home loans. Their actions ensured that mortgage
    credit remained available and affordable.
        A second argument concerns the allocation of capital to
    housing. The housing market has an enormous impact on the
    economy, directly accounting for more than one-third of the
    nominal growth in GDP over the past 3 years. And this does not
    begin to account for all the indirect support for consumption
    generated by record levels of refinancing in the past few
    years. Housing played an important countercyclical role in
    supporting the recent weak economy, as noted in the'
    President's 2004 Economic Report:

            Despite the similarities between the recent business
            cycle and previous ones, this most recent cycle was
            distinctive in important and instructive ways. One
            noteworthy difference is that real GDP fell much less
            in this recession than has been typical . . . This
            relatively mild decline in output can be attributed to
            unusually resilient household spending. Consumer
            spending on goods and services held up well throughout
            the slowdown, and investment in housing increased at a
            fairly steady pace rather than declining as has been
            typical in past recessions.

        The ability of the GSE's to purchase record amounts of
    mortgages during the past several years is a principal reason
    why the housing market remained strong in an otherwise weak
    economy. Privatization advocates have yet to demonstrate who
    other than the GSE's would be able to provide such high amounts
    of liquidity regardless of economic or market conditions.
        Third, privatization advocates raise concerns about size
    and systemic risk. Residential mortgage debt outstanding grew
    at an annualized rate of 8.6 percent over the past decade. Not
    surprisingly, the GSE's also have experienced significant
    growth. But GSE size is not an accurate proxy for risk. For
    every mortgage Freddie Mac guarantees, whether it is
    securitized or held in the retained portfolio, there is
    approximately 40 percent collateral behind the loan in the form
    of homeowner equity. We actively manage interest-rate risk and
    other related market risks and take a disciplined approach to
    risk management. Freddie Mac strives to substantially match the
    duration of our assets and liabilities. Throughout 2003, for
    example, a period of extreme turbulence in financial markets,
    Freddie Mac's duration gap remained low. Moreover, mortgage
    debt and the risks of investing in it would not disappear by
    downsizing the GSE's or making other changes to the GSE
    charter. Rather, the burden of managing mortgage credit risk
    would shift from these institutions to those with explicit
    Government support (such as Federally insured depositories),
    while interest-rate risk would shift onto individual
    households. Another likely outcome is that higher costs of
    conventional mortgage financing could cause borrowers to shift
    into the FHA market, thereby actually increasing Government
    subsidization of housing.
        In other words, we believe that those who call for
    privatization have not begun to demonstrate how this would be
    better for homeowners, the housing finance system, or the
    economy.

    Q.6. It is my understanding that Freddie's compliance with the
    Securities and Exchange Act of 1934 is being delayed due to its
    ongoing revisions of its financial statements. Freddie is
    expected to release its revised earnings sometime soon. Have
    you communicated with the SEC regarding when you expect to come
    into compliance with the Securities and Exchange Act of 1934?
    When
    specifically do you believe that you will be able to do so?

    A.6. Our most pressing priority is to bring Freddie Mac's
    financial statements current. On November 21, 2003, the Freddie
    Mac Board of Directors and management team announced the
    release of the company's restated and revised financial results
    for the years 2000 through 2002. The restatement was a
    significant step in Freddie Mac's progress toward achieving
    accurate and timely reporting. In addition, we issued our
    annual report for 2002 on February 27, 2004 and will hold the
    related annual stockholders' meeting on March 31, 2004.
        We intend to return to timely financial reporting as soon
    as possible. However, we currently are not able to predict when
    we will do so. Significant revisions to our accounting systems
    are necessary to implement the revised accounting policies
    adopted in connection with the restatement, as well as new
    accounting guidance applicable for 2003, so that those
    accounting systems can fully support the preparation of
    consolidated financial statements in accordance with GAAP. As a
    result, the public release of our 2003 financial results has
    been delayed. Our objective is to release combined quarterly
    and full-year 2003 results by June 30, 2004 and to provide our
    2003 annual report and hold our related stockholders' meeting
    as soon as practicable thereafter. However, there can be no
    assurance that we will meet this objective.
        We have been in ongoing discussions with the Securities and
    Exchange Commission (SEC) on various issues since our initial
    announcement that we would register our common stock with the
    SEC under the Securities Exchange Act of 1934. SEC rules
    require us to bring our financial statements ``current'' before
    we can finish the process of becoming an SEC registrant. We
    will complete our voluntary registration with the SEC after we
    return to timely financial reporting.

    Q.7. Some witnesses before the Banking Committee have
    recommended placing your new regulator in the Department of the
    Treasury and letting it have oversight over the GSEs' housing
    mission, as well as their safety and soundness. However, are
    you aware that in an October 1, 2003 letter, Treasury gave
    notice to the National Cooperative Bank, a private nonprofit
    corporation originally created by Congress that has been and
    still is extensively involved in financing affordable housing
    that it was intending to increase the interest rates of its
    long-term loan by 700 basis points? If enacted, that interest
    rate would have been devastating to the affordable housing
    mission of the National Cooperative Bank. Doesn't this letter,
    at a minimum, demonstrate a desire by Treasury to promote
    safety and soundness to the determent of the National
    Cooperative Bank's housing mission? Why or why not?

    A.7. We have not seen the letter you cite and are not familiar
    with the issue involving the National Cooperative Bank, so we
    cannot knowledgeably comment on it. However, to address the
    general concern you are raising, we would like to reiterate
    points we made in our testimony on establishing an effective
    regulatory oversight structure for the GSE's.
        World-class regulatory oversight is critical to the
    achievement of Freddie Mac's mission and to maintaining the
    confidence of the Congress, the public, and financial markets.
    Freddie Mac strongly supports the enactment of legislation that
    provides strong, credible regulatory oversight. Accordingly,
    the new GSE regulatory structure must:

     Engender public confidence through world-class
        supervision and independence;
     Ensure the continued safety and soundness of the
        GSE's;
     Respond flexibly to mortgage market innovation; and
     Strengthen GSE market discipline through robust and
        timely disclosure.

        We believe these principles will be realized most
    completely under an independent regulatory board modeled on
    independent Federal agencies such as the Securities and
    Exchange Commission. We believe such a board should not include
    representatives of HUD, Treasury, or other executive branch
    departments. The purpose of establishing an independent board
    is just that, independence. Inclusion of executive branch
    representatives on the GSE regulatory board could compromise
    this important component of world-class regulation.
        Freddie Mac would have similar concerns should the Congress
    decide to locate the new regulatory office within the
    Department of the Treasury. To ensure independence, we would
    support applying the same operational controls as apply to the
    relationships between the Secretary of the Treasury and the
    Office of the Comptroller of the Currency and the Office of
    Thrift Supervision. Adequate firewalls are needed to avoid the
    politicization of the GSE mission and the critical role we play
    in the Nation's economy and global financial markets.

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                          FROM NORMAN B. RICE

    Q.1. Your question raises the issue of whether Congress needs
    to ``level the playing field'' among the GSE's. Given the
    fundamental differences in the nature and composition of the
    Federal Home Loan Bank System and Fannie Mae and Freddie Mac, I
    doubt that it is desirable or even possible to establish a
    truly level playing field without a wholesale restructuring of
    the present GSE's.

    A.1. Although the FHLBanks are exempt from all Federal, State,
    and local taxation except for real property taxes, they are
    obligated to make payments to the Resolution Funding
    Corporation (REFCORP) in the amount of 20 percent of net
    earnings after operating expenses and Affordable Housing
    Program (AHP) expense. In addition, annually the FHLBanks must
    set aside for the AHP the greater of an aggregate of $100
    million or 10 percent of their current year's net income before
    charges for AHP (but after expenses for REFCORP). Assessments
    for REFCORP and AHP are the equivalent of a 26.5 percent
    effective income tax rate for the FHLBanks. In addition, all
    FHLBank cash dividends received by members are taxable;
    dividends received by members do not benefit from the corporate
    dividends received exclusion.

    Q.2. Congress has established two very different housing
    obligations for the housing GSE's--the Affordable Housing
    Program (AHP) for the Federal Home Loan Banks, and Affordable
    Housing Goals (AHG's) for Fannie Mae and Freddie Mac. These
    differences make it difficult to attempt a direct comparison of
    the performance of the three GSE's in serving specific
    affordable housing needs. At the present time, the Federal
    Housing Finance Board and the Department of Housing and Urban
    Development are conducting a joint study to determine how the
    Chicago FHLBank's Mortgage Partnership Finance program would
    score under the AHG's for Fannie Mae and Freddie Mac. Once this
    study is complete, it should provide a better understanding of
    the potential application of AHG's to the FHLBanks.

    A.2. Although the AHP and AHG's are intended to achieve similar
    objectives, they operate in very different ways. For Fannie Mae
    and Freddie Mac, Congress has imposed certain requirements on
    their purchases of mortgages to target their efforts to
    specified affordable housing goals. In the case of the
    FHLBanks, Congress has required them to set aside 10 percent of
    their net profits for distribution as grants or below-cost
    loans in support of affordable housing. The AHP program also
    targets incomes lower than those established by the AHG's. AHP
    subsidies must be used to fund the purchase, construction, or
    rehabilitation of owner-occupied housing for very low-income,
    or low- or moderate-income (no greater than 80 percent of area
    median income) households; or rental housing in which at least
    20 percent of the units will be occupied by and affordable for
    very low-income (no greater than 50 percent of area median
    income) households.