[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
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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.
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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.
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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.
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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.
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\1\ See 12 U.S.C. Sec. Sec. 1, 250, 1462a(b)(2), (3), and (4).
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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\
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\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.
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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\
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\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.
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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.
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\6\ ``Comparison of Financial Institution Regulators' Enforcement
and Prompt Corrective Action Authorities,'' GAO-01-322R, January 31,
2001.
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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.
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\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.
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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.
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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.
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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.
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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.
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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.
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\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.
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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.
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\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).
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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.
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\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.
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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:
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\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.
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\8\ Federal Home Loan Bank Act, Pub. L. No. 72-304, 47 Stat. 725
(1932)
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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.
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\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.
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\11\ 12 CFR 985.6(b).
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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\
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\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.
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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).
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\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.
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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.
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\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).
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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.''
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\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).
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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.
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\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.
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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\
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\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).
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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\
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\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\
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\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.
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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.
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\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).
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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.
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\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\
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\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.
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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\
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\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.
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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.
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\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.
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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\
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\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.
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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\
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\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.
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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.
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\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\
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\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.
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\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\
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\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.
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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.
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\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.
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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\
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\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.
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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:
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\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\
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\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\
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\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.
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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.
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\8\ See 12 U.S.C. Sec. Sec. 1, 250, 1462a(b)(2), (3), and (4) and
1464(d)(1)(A).
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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.
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\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.
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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\
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\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.
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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\
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\13\ The New Basel Capital Accord, Consultative Document, Basel
Committee on Banking Supervision (January 2001) (the 2001 Basel
Accord).
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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.
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\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.
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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.
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\15\ ``Comparison of Financial Institution Regulators' Enforcement
and Prompt Corrective Action Authorities,'' GAO-01-322R, January 31,
2001.
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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.
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\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.
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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.