[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]





                         ADDITIONAL ACCOUNTING
                        AND MANAGEMENT FAILURES
                             AT FANNIE MAE

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                     CAPITAL MARKETS, INSURANCE AND
                   GOVERNMENT SPONSORED ENTEREPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 6, 2005

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 109-12



                    U.S. GOVERNMENT PRINTING OFFICE
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana          PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, Jr., North          HAROLD E. FORD, Jr., Tennessee
    Carolina                         RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut       WM. LACY CLAY, Missouri
VITO FOSSELLA, New York              STEVE ISRAEL, New York
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TIBERI, Ohio              JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
TOM FEENEY, Florida                  STEPHEN F. LYNCH, Massachusetts
JEB HENSARLING, Texas                BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey            DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida           ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina   AL GREEN, Texas
KATHERINE HARRIS, Florida            EMANUEL CLEAVER, Missouri
RICK RENZI, Arizona                  MELISSA L. BEAN, Illinois
JIM GERLACH, Pennsylvania            DEBBIE WASSERMAN SCHULTZ, Florida
STEVAN PEARCE, New Mexico            GWEN MOORE, Wisconsin,
RANDY NEUGEBAUER, Texas               
TOM PRICE, Georgia                   BERNARD SANDERS, Vermont
MICHAEL G. FITZPATRICK, 
    Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina

                 Robert U. Foster, III, Staff Director
  Subcommittee on Capital Markets, Insurance and Government Sponsored 
                              Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair         PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
PETER T. KING, New York              DENNIS MOORE, Kansas
FRANK D. LUCAS, Oklahoma             MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois         HAROLD E. FORD, Jr., Tennessee
EDWARD R. ROYCE, California          RUBEN HINOJOSA, Texas
SUE W. KELLY, New York               JOSEPH CROWLEY, New York
ROBERT W. NEY, Ohio                  STEVE ISRAEL, New York
VITO FOSSELLA, New York,             WM. LACY CLAY, Missouri
JUDY BIGGERT, Illinois               CAROLYN McCARTHY, New York
GARY G. MILLER, California           JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio              STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina   BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
TOM FEENEY, Florida                  NYDIA M. VELAZQUEZ, New York
JIM GERLACH, Pennsylvania            MELVIN L. WATT, North Carolina
KATHERINE HARRIS, Florida            ARTUR DAVIS, Alabama
JEB HENSARLING, Texas                MELISSA L. BEAN, Illinois
RICK RENZI, Arizona                  DEBBIE WASSERMAN SCHULTZ, Florida
GEOFF DAVIS, Kentucky                BARNEY FRANK, Massachusetts
MICHAEL G. FITZPATRICK, 
    Pennsylvania
MICHAEL G. OXLEY, Ohio


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    April 6, 2005................................................     1
Appendix:
    April 6, 2005................................................    21

                                WITNESS
                        Wednesday, April 6, 2005

Falcon, Hon. Armando Jr., Director, Office of Federal Housing 
  Enterprise Oversight...........................................     3

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    22
    Gillmor, Hon. Paul E.........................................    24
    Hinojosa, Hon. Ruben.........................................    25
    Kanjorski, Hon. Paul E.......................................    26
    Ney, Hon. Robert W...........................................    28
    Falcon, Hon. Armando Jr......................................    30

 
                         ADDITIONAL ACCOUNTING
                        AND MANAGEMENT FAILURES
                             AT FANNIE MAE

                              ----------                              


                        Wednesday, April 6, 2005

             U.S. House of Representatives,
        Subcommittee on Capital Markets, Insurance,
               and Government Sponsored Enterprises
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 10:03 a.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[chairman of the subcommittee] presiding.
    Present: Representatives Baker, Shays, Gillmor, Royce, 
Oxley, Kelly, Ney, Miller of California, Kennedy, Tiberi, 
Feeney, Hensarling, Davis of Kentucky, Kanjorski, Moore, 
Hinojosa, Baca, Lynch, Scott, Watt, Davis of Alabama, and 
Wasserman Schultz.
    Mr. Baker. I would like to call this meeting in the 
Subcommittee on Capital Markets to order.
    Today, the committee meets for the purposes of receipt of 
additional testimony from the Honorable Armando Falcon, 
director, Office of Federal Housing Enterprise Oversight, on 
his interim report relative to accounting and management 
failures at Fannie Mae and the enterprise's observations as to 
the ongoing difficulties with these disclosures and potential 
recommendations for our future actions.
    It, indeed, is disappointing to read press reports 
indicating that, in some cases, signatures that were even 
falsified to documents were not an incidental or irregular act 
of a single individual, but apparently, an ongoing business 
practice. This is deeply troubling in light of the underlying 
financial uncertainties that are already facing the Congress 
with regard to the capital adequacy of Fannie Mae and, to a 
lesser extent, Freddie Mac, and so I look forward with some 
anticipation to the director's information concerning these 
matters.
    Time permitting, I would also bring to the director's 
attention legislation which was introduced yesterday on reform 
of the regulatory oversight process and to seek his insights on 
that legislation, if he so chooses.
    Perhaps more importantly today is, after reading other 
press stories as of yesterday, it is my understanding the 
director has made clear to the White House his intention to 
depart his responsibility as director in the near term, and I 
feel I owe it to him, given our longstanding professional 
working relationship, to make some comment.
    As he would well acknowledge, we have had our moments. 
However, I would say, in the last 18 months of professional 
conduct, he has been more than exonerated and held in high 
esteem by all who have studied this matter. It has been a very 
difficult professional responsibility to be publicly critical 
of either of these enterprises, and you were held up to some 
significant criticism even by members of this committee on 
occasion. I just want to say to you that I think you have done 
an outstanding job and a valuable public service, to you and 
all members of your staff.
    Should legislation be adopted, there is contained in the 
bill, at least as I proposed, significant rules of 
accommodation for transition for those in OFHEO to the new 
regulatory body, and this is, to a great extent, in recognition 
of the difficult work and, I think, the good reports that the 
agency has developed on the activities of the enterprises, and 
it is work that should not be overlooked or soon forgotten.
    So, for those reasons, I commend you and wish you well in 
whatever future endeavors may bring you.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    We meet today to review the most recent developments 
concerning the special examination of Fannie Mae by the Office 
of Federal Housing Enterprise Oversight. As I have regularly 
noted in our past hearings on these matters, it is important 
and appropriate for our panel to conduct comprehensive and 
regular oversight over our housing government-sponsored 
enterprises to ensure that they fulfill their mission and 
operate safely and soundly.
    At our first hearing this year, we heard from the chief 
accountant of the Securities and Exchange Commission about his 
decisions related to Fannie Mae's accounting practices. Today, 
we will follow up on that hearing by receiving testimony from a 
frequent witness before our panel, Armando Falcon, the Director 
of the Office of Federal Housing Enterprise Oversight. As 
always, I appreciate learning of his insights on these issues 
and, again, welcome him here.
    I should also note that, because he will be leaving the 
agency next month, this appearance will likely be the last time 
that Director Falcon testifies before our panel in his current 
capacity. During his tenure, he has steadfastly worked to 
increase the agency's resources and its effectiveness.
    The main focus of today's hearing is the March supplemental 
supervisory agreement between Fannie Mae's board and the Office 
of Federal Housing Enterprise Oversight. This agreement 
addresses additional deficiencies identified by the regulator 
during its ongoing special examination. These failings relate 
to insufficient internal controls, the improper application of 
accounting standards and inadequate corporate governance.
    Like many of my colleagues, I am troubled by these latest 
revelations. As a government-sponsored enterprise with public 
responsibilities and private capital, Fannie Mae has a special 
obligation to operate fairly, safely and soundly. These newest 
disclosures indicate that the company fell short in meeting 
these responsibilities.
    Nevertheless, I am also heartened that Fannie Mae, 
according to its regulator, is cooperating and working to 
address these issues in a responsible manner. I am also pleased 
that, although serious, these problems do not appear to pose a 
systemic risk, according to those most knowledgeable of the 
facts in these matters.
    As we proceed today, I also suspect that some of my 
colleagues will return to the question of how best to modify 
the regulation of government-sponsored enterprise, including 
you, Mr. Chairman. It is in the public's interest that we 
ensure that Fannie Mae and Freddie Mac continue to operate 
safely and soundly. We must further ensure that these public-
private entities achieve their public responsibilities for 
advancing home ownership opportunities.
    As I said at our very first hearing on the oversight of 
government-sponsored enterprises in March of 2000, we need to 
have strong, independent regulators that have the resources 
that they need to get the job done. I can assure everyone that 
I continue to support the strong, world-class and independent 
regulation of Fannie Mae and Freddie Mac.
    A strong and world-class independent regulator will protect 
the continued viability of our capital markets and promote 
confidence in Fannie Mae and Freddie Mac. It will also insure 
taxpayers against systemic risk and expand housing 
opportunities for all Americans.
    In closing, Mr. Chairman, I commend you for your continued 
perseverance in these matters, and I look forward to hearing 
from our distinguished witness.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 26 in the appendix.]
    Mr. Baker. I thank the gentleman.
    By a prior agreement of the chairman and ranking member, 
because of an expected recess of the committee at 11 o'clock 
for the address on the House floor, we have agreed to limit 
opening statements to the chair, ranking member.
    And since neither Mr. Frank or Mr. Oxley are now present, I 
would make all members' statements part of the official record 
and move at this time to recognize Mr. Falcon for whatever 
statement you may choose to make, sir.
    Proceed as you like. Your formal statement, as is the usual 
practice, will be made part of the record.

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

    Mr. Falcon. Thank you, Mr. Chairman.
    I will give a summary of my written testimony.
    First of all, may I say thank you for your comments about 
the agency and my tenure there.
    You, Mr. Chairman, and Mr. Kanjorski have been steadfast 
supporters of strong safety and soundness regulation and the 
agency. I appreciate that very much on behalf of the agency.
    I am pleased to appear before you today to discuss OFHEO's 
supplemental agreement with Fannie Mae and the issues that gave 
rise to the agreement.
    We have two objectives in our ongoing special examination 
of Fannie Mae. First, we must identify all the problems and fix 
them. As my testimony today indicates, that task is not yet 
complete. Second, we must institute a comprehensive reform 
program to prevent problems from recurring. This program will 
include far stronger internal controls and corporate governance 
measures; an adequate investment in systems, processes and 
personnel; and the establishment of a corporate culture fully 
dedicated to compliance with the law, with GAAP and all 
relevant rules and regulations.
    With the continued cooperation of the board and management, 
we expect that Fannie Mae will ultimately emerge from its 
troubles as a healthy, well-managed enterprise properly focused 
on fulfilling its public mission. That is the ultimate goal of 
the supervisory actions we have taken. I believe it is a goal 
now shared by Fannie Mae's board and its interim leadership as 
well.
    As you are aware, last September, we entered into an 
agreement with the board of directors that set forth a series 
of matters requiring immediate attention, particularly in the 
area of accounting. The agreement also outlined longer-term 
remedial steps, such as changes in the company's compensation 
program and corporate structure. In addition, we required that 
the company maintain a 30-percent minimum capital surplus in 
order to address safety and soundness concerns.
    More recently, we entered into a supplemental agreement 
with Fannie's board to address problems found by OFHEO. The 
agreement requires additional remedial steps in accounting 
policy and accounting management and expands on reforms in 
controls and corporate governance.
    Significant among the corporate governance reforms was the 
requirement that Fannie Mae separate the chief executive 
officer and chairman of the board positions. We also required 
that the company report weekly to OFHEO on its efforts to meet 
capital requirements, including any corporate decisions on 
dividend payments or other matters that would affect the 
company's capital position.
    In general, Fannie Mae has moved forward in addressing the 
matters set forth in our agreements. Experts have been engaged, 
studies undertaken, certain personnel changes have been made, 
and the company has formulated preliminary plans for new 
organizational structures and reporting lines.
    OFHEO's special examination of Fannie Mae has revealed a 
significant number of new accounting problems at the 
enterprise. As with previous accounting problems, they reflect 
Fannie Mae's tendency towards overly aggressive interpretation 
of GAAP or, in certain instances, a willful disregard of 
accounting rules. They also reflect situations where Fannie 
Mae's accounting policies actually do comply with GAAP, but 
enterprise personnel have failed to follow those policies.
    I have covered these issues in detail in my written 
statement, so I will not go into them further in my oral 
remarks.
    During our special examination, we have also identified 
several problems involving procedures for preparing, reviewing, 
validating, authorizing and recording journal entries related 
to amortization adjustments. These issues include falsified 
signatures on journal entries; the failure to require that 
journal entry preparers determine the entries were valid and 
appropriate; a failure to require that journal entries include 
supporting documentation, a lack of independent review of 
journal entries, and an absence of written policy guidance 
concerning journal entry procedures.
    My written testimony describes the intent of our review in 
this area and because it is a matter under investigation, I 
cannot go into further detail beyond what is contained in my 
written statement.
    As the scope of the Fannie Mae special examination has 
proceeded well beyond our expectations, we will need additional 
funds this year. Accordingly, we have used our special 
assessment authority to assess Fannie Mae an additional $5 
million. However, while we have collected the funds, OMB has 
opined that due to a technical deficiency in the statute we may 
not spend the funds. While we do not agree with OMB's 
interpretation, we are bound by it.
    I think this provides yet another example of why Congress 
must enact legislation to give the regulator the full authority 
it needs to do its job. Until then, I would ask the committee's 
assistance in resolving this funding matter.
    Finally, Mr. Chairman, I would like to also end on a 
personal note, if I may. As you mentioned, my 5-year term as 
Director of OFHEO expired last October, but I have remained in 
the office to guide the agency through a very challenging 
period. With the most critical and pressing issues at the 
enterprises now addressed, I have decided to step down from my 
position next month.
    I am proud of OFHEO's achievements during my tenure. The 
agency has successfully dealt with very serious problems at two 
of the largest financial institutions in the world, and we have 
done so without disrupting our financial markets, while 
allowing both enterprises to continue fulfilling their vital 
mission of making home ownership more affordable.
    I am particularly proud of the efforts of OFHEO's employees 
and our conduct during the special examinations. Seldom does a 
safety and soundness regulator identify improper actions, with 
potentially billions of dollars of adverse impact, before they 
manifest themselves in a way that does permanent harm to the 
company.
    It has been a privilege to serve the public as the Director 
of OFHEO, and I want to thank this committee for its support 
over the years.
    Thank you, Mr. Baker. I would be happy to answer any 
questions the committee may have.
    [The prepared statement of Hon. Armando Falcon Jr. can be 
found on page 30 in the appendix.]
    Mr. Baker. Thank you very much.
    I do not know that your position would require you to make 
an assessment as to systemic risk potential, but, given the 
knowledge you have now gained pursuant to these inquiries, 
given the time it appears that the management lapse allowed 
practices inconsistent with GAAP to be engaged in, if 
unchecked, would you have had some concern about some potential 
future day when the numbers would not add up, the capital would 
have been inadequate and a systemic risk potential having been 
created?
    Mr. Falcon. I would be concerned that, at some point in 
time, the problems we found in the company would manifest 
themselves some way. Fortunately, we did find them before that 
occurred, but the practices of the company in terms of its 
approach towards compliance with regulations, be they 
accounting or internal controls or best practices in risk 
management, were not healthy.
    Mr. Baker. And had been engaged in on more than just, say, 
a single reporting quarter. This was year-over-year activity, 
not merely an aberrant activity.
    Mr. Falcon. Yes.
    Mr. Baker. Do you have any window yet as to when Fannie 
would be in a position to give us certified or accurate 
financials?
    Mr. Falcon. We cannot say with any degree of certainty 
right now, but I think a useful model might be to look at the 
Freddie Mac situation. There, it did take a couple of years for 
the company to produce financial statements, and it will take a 
couple of years beyond that to get timely. I think that might 
be a useful example of what might be involved here.
    Mr. Baker. There has been no resolution or determination 
yet made, however, with regard to the accounting treatment of 
the special purpose entities.
    Mr. Falcon. Right.
    Mr. Baker. And I am speaking through you to Mr. Pollard 
because he was at a hearing not long ago relative to the First 
Beneficial matter in which he indicated to me at that hearing 
that that examination was still continuing. We do not yet have 
closure on any liabilities that may accrue from the 
transactions with First Beneficial, for example.
    Mr. Falcon. Right. That is still the subject of an 
examination by OFHEO.
    Mr. Baker. My point in asking these series of questions is 
to make clear that, with your departure from the enterprise and 
there having been significant gains made, significant 
disclosures achieved, that there are matters of some 
consequence still pending which will require 18 months to a 
couple of years to get final resolution or closure. Would that 
be a fair statement?
    Mr. Falcon. There is still a great deal of work before the 
agency and Fannie Mae. That is absolutely the case.
    Mr. Baker. I do not know that you would have had time, 
given your preparation for your appearance here today, to be 
familiar at all with the provisions of the bill now introduced 
relative to the creation of an enhanced regulator. Do you have 
any comment to make about the provisions that are included in 
the bill generally, or is there a specific area of concern you 
would like to bring to the committee's attention you do not 
feel is addressed by the bill?
    Mr. Falcon. As you said, I have not had a chance to go 
through much of the details of the bill, but I think the intent 
of the legislation to provide the regulator with authorities on 
par with every other safety and soundness regulator is 
progress. Anything which fills the gaps in the regulator's 
authority to do its job would be a positive step forward. 
Beyond that, the details of any particular provision, I have 
not had a chance to review them.
    Mr. Baker. There has been some discussion primarily led by 
Chairman Greenspan as to the advisability of limiting the 
growth or even further reducing the size of the existing 
investment portfolio, as it is his view, according to press 
reports, that it does not have a correlation to housing 
function. He had suggested even a hard-dollar limit of some 
$200 billion down from the $1.6 trillion currently engaged. Do 
you have any opinion as to whether it is advisable or not to 
have further restrictions on growth at the least or to pursue 
the reductions over time, in your view?
    Mr. Falcon. The company does need to retain a portfolio of 
some amount towards liquidity needs. I think that is very 
evident. What that amount is I could not tell you where any cap 
should stand.
    Mr. Baker. But $1.6 trillion is more than adequate.
    Mr. Falcon. Yes. It is clear, I think, that the current 
levels are more than adequate to provide for their legitimate 
safety and soundness needs for their risk management purposes. 
How much below the current levels would be necessary and then 
how much beyond that simply for other purposes would require 
some study.
    Mr. Baker. And it would be your concern, I presume, that if 
they were precipitously lowered over too short a period of 
time, that could have adverse consequences for the enterprises?
    Mr. Falcon. Yes.
    Mr. Baker. Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    On the insufficient internal controls and improper 
application of accounting standards to meet adequate corporate 
governance, what did your final examination show, how long a 
period that existed--just in the last year, the last 2 years, 
the last 5 years, the last 10 years--or has it been endemic to 
the organization?
    Mr. Falcon. It varies by issue, Congressman. There was one 
lapse in their systems that dated back 21 years, other matters 
may have taken place in the last 1 or 2 years, but, generally, 
I would say that they fall within the last 4 years or so.
    Mr. Kanjorski. I am concerned about, first of all, are 
these lapses. Are they of huge significance where they could 
put at risk the safety and soundness of the organization, or 
are they not that significant?
    Mr. Falcon. I view the weaknesses in internal controls as 
very significant. As you know, there are many examples in 
history where lapses in internal controls have brought down 
large old financial institutions almost overnight. Barings Bank 
is one example of how internal controls can bring down a 
company, even a well-capitalized company. So lapses in internal 
controls, even though we often speak of them after the 
accounting issues, I think, are just as, if not more, serious 
than the accounting problems.
    Mr. Kanjorski. Were these lack of internal controls you 
found really substantial, though, in this particular instance?
    Mr. Falcon. I think they were substantial. I do think they 
were because there were almost no controls in some instances. 
There was one example where one employee was allowed, through 
the lack of internal controls, to make a change in an 
accounting formula on the spreadsheet that resulted in an 
improper reporting of a billion dollars. It is that type of 
lack of internal controls that concern me. With proper internal 
controls, one employee could not go and make those changes 
without a couple of layers of verification before changes like 
that are made.
    Mr. Kanjorski. Well, I guess I do not sufficiently 
understand the nature and focus of the regulator's involvement, 
but what sort of bothers me here is that your testimony says, 
in one instance, this problem existed over 21 years, and then 
substantial internal control failure.
    Why wasn't this picked up by the regulator over the last 
several years or the last 10 years? That is what I do not quite 
understand. Is it because you did not get depthfully involved 
in the books before?
    Under prior testimony before the committee, I understood 
that you were sort of like a meat inspector at a meat plant. 
You are there on a day-to-day basis and you watch the whole 
process as it evolves and you sit at their internal audit exit 
meetings and that you are made aware of everything that the 
corporate governance entity is made aware of.
    Why didn't you pick this up? What is the why?
    Mr. Falcon. I think you are accurate in your reasoning. It 
is the need to do things with adequate depth. When I took over 
the agency, we had 30 examiners, and I had our examination 
staff do a review, a benchmarking study, comparing our program 
to other regulators and how many examiners they would have on 
staff to supervise two companies of this size.
    This benchmarking study showed that on average another 
regulator might have 60 or so examiners per institution. We 
were working with 15 examiners per institution, which is why we 
have moved over the last 5 years to try to increase our 
resources. I wish I had the number of examiners that I have 
today back then. Perhaps we would have had the ability to catch 
many of these problems.
    Mr. Kanjorski. But why didn't we catch some of them? I have 
been under the impression that over the years both Freddie Mac 
and Fannie Mae were fairly well-run organizations, and, every 
time we have had hearings over the last 5 years on this 
subject, that is what we were led to believe by both the 
regulators and by the company.
    Now maybe some of the people that were testifying on behalf 
of the company did not even know these problems--is that your 
testimony--or their absence of knowledge is in itself a 
governance problem?
    Mr. Falcon. I think many of these internal control problems 
revolve around accounting procedures and the recordkeeping 
activities of the company, and this is an area we have not 
looked at traditionally. Safety and soundness regulators rely 
on the outside audit function to do its job properly.
    We have never second-guessed the external auditors to make 
sure that the company's statements are compliant with GAAP. 
That is the role of the external auditor, and only after the 
accounting problems were uncovered did it become very apparent 
that controls around the accounting activities of the company 
and its financial systems were inadequate.
    Mr. Kanjorski. So what you are telling us now is not only 
the internal accounting, it is also their external auditor that 
participated in this misrepresentation, either by omission or 
commission, and I would like you to sort of specify. Do you 
think it was by omission, or were they participants in it?
    Mr. Falcon. Well, it is clear that the external auditor--in 
this case, KPMG--certified financial statements as compliant 
with GAAP that we now know, obviously, were not compliant with 
GAAP. We are examining the question of whether that was just 
the result of inadequate work done by the auditor or was it the 
result of some complicity on the part of the auditor.
    Mr. Kanjorski. You have not determined that?
    Mr. Falcon. No, Congressman.
    Mr. Kanjorski. Under present law, does the regulator have 
authority to not only punish the corporation or extract some 
fine or fee from the corporation but also from the other 
contracted parties, like the auditor, if errors like this are 
made? In other words, can you assess that auditor some penalty?
    Mr. Falcon. We do not have that explicit authority. What we 
could possibly do is limit the company's ability to do business 
with certain counterparties.
    Mr. Kanjorski. What risk does the accounting firm run if 
they do not come forth with accounting principles that are 
according to GAAP? If they miss those either by omission or 
commission, are they at any risk or is that part of the game, 
do it so that you have a client and satisfy the client's needs?
    Mr. Falcon. I think that spreads more to the responsibility 
of the PCAOB to examine whether or not the auditor in this 
instance properly did its job, and they are involved in that 
type of review.
    Mr. Kanjorski. Okay.
    Thank you, Mr. Chairman.
    Mr. Baker. As much as is practicable, given our potential 
11 o'clock recess, I am going to try to stick to the 5-minute 
rule pretty strictly to give as many members as possible a 
chance to be heard.
    Mr. Shays?
    Mr. Shays. Thank you.
    Mr. Falcon, I wish you well in whatever you do in the 
future, and I thank you for your service to your country and in 
this capacity.
    Having said that, I wish you were as good earlier as you 
have been in the last few years.
    I want to understand why OFHEO became more aggressive. I 
felt like--and I will just say this--you basically were almost 
created by Fannie Mae and Freddie Mac in that you were doing 
what they wanted rather than what Congress needed until the 
last year or two. What explains, though, the difference in 
approach that you have had?
    Mr. Falcon. With the resources available to us in more 
recent years, it allowed us more flexibility to cover more 
areas and, certainly, when the problems of Freddie Mac became 
apparent, it did illustrate a particular area where we needed 
to focus more of our attention, as traditionally we had not. So 
really, with the additional resources, it provided us with the 
means to become more thorough in how we went about examining 
the two institutions.
    Mr. Shays. Well, I believe if you had done what you have 
done in the last year, we would not even be talking about a new 
regulator, and that is the sad part of this because we had Mr. 
Raines come before us, challenge your last findings, almost 
arrogantly dismissed it, and I thought you were very forceful 
and, frankly, somewhat courageous, and the SEC backed what you 
all had determined.
    So I think you are going out in a way that is important, 
but it is sad that we never got a handle on Fannie Mae and 
Freddie Mac sooner. That is what is sad.
    I would like to just ask you in regard to the illegal 
entries, the forged entries, what is the significance of it? I 
mean, I know they were illegal. Whose signatures were forged? 
And what is the significance of that? What does it mean? I want 
to understand what it means. I know it was illegal, but what 
does it mean in terms of its impact on the accounting?
    Mr. Falcon. There was a breakdown in the integrity of the 
process by which financial statements are produced. The 
financial statements are produced from the ledgers of the 
company, and the ledgers' data is entered through preparers who 
will----
    Mr. Shays. Well, was it false information besides forged 
signatures?
    Mr. Falcon. This was related to the amortization entries. 
In our September report, we referred to some FAS 91 accounting.
    Mr. Shays. Can you answer the question, though? I mean, 
were the amounts inaccurate?
    Mr. Falcon. Yes, the amounts were improper under accounting 
rules. These were the so-called catch-up amounts that were 
adjustments.
    Mr. Shays. Do we know how high it goes up in the 
organization?
    Mr. Falcon. We do not at this time, but we are looking into 
that.
    Mr. Shays. Yes. Is your statement as comprehensive as your 
knowledge of this, or are you saying less in your statement 
than you know?
    Mr. Falcon. We are doing much more work in this area and, 
because of the sensitivity of it, we have only said what we 
thought might be appropriate to provide the committee with 
information, not do anything which might undermine our efforts.
    Mr. Shays. So there is more to this story that you know 
that you are not really feeling comfortable to disclose.
    Thank you, Mr. Chairman.
    Mr. Baker. I thank the gentleman.
    Mr. Davis?
    Mr. Davis of Kentucky. Thank you, Mr. Chairman.
    Mr. Falcon, I certainly wish you well as you move into 
another phase of your career.
    Let me bring up a subject that, frankly, we have not talked 
about a lot this morning. As you know, there was an inspector 
general's report that I think came out back in December, if I 
am not mistaken. I think it happened while we were in recess. 
It may be that Congress was here for a day on the homeland 
security bill, but it was basically during a recess period, if 
I am not mistaken. I am sure the chair will correct me if I am 
wrong. If I am not mistaken, I do not think that we have had a 
hearing on the inspector general's report.
    Have you reviewed the other contents of the report, Mr. 
Falcon?
    Mr. Falcon. I have.
    Mr. Davis of Kentucky. And respecting my 5-minute 
timeframe, we do not have an opportunity to get into all of it, 
but my recollection of it is that there were some fairly 
stinging criticisms of OFHEO that were contained in that 
report. Do you agree with that?
    Mr. Falcon. Yes.
    Mr. Davis of Kentucky. I recall one observation in the 
report that OFHEO acted not as a disinterested party, but that 
OFHEO may have acted in a fairly aggressive way toward Fannie 
Mae, that it may have overstepped the bounds of being 
disinterested. Was that one of the observations in the report, 
as you recall it? I am not asking if you agree with it. Was 
that one of the observations?
    Mr. Falcon. It has been a while since I have read it. I 
could not tell you all the details of it.
    Mr. Davis of Kentucky. So is that a pretty fair 
characterization, that the report critiqued OFHEO for not being 
a disinterested regulator?
    Mr. Falcon. I think it was, yes.
    Mr. Davis of Kentucky. Well, obviously, OFHEO was still in 
existence, and so we do our task of creating a new regulator, 
which I think there is wide consensus that we will. Obviously, 
I presume that that report has some relevance to you in the 
last weeks of your tenure. I am a little bit concerned about 
the fact that you have not reviewed it in a while.
    More importantly, can you tell me what steps, if any, OFHEO 
has taken to respond to any of the criticisms identified in the 
inspector general's report?
    Mr. Falcon. I am not sure that any response was warranted.
    Mr. Davis of Kentucky. Was there any corrective action?
    Mr. Falcon. The Justice Department, the Department of HUD 
determined that we had done nothing improper, and so that was 
the end of it.
    Mr. Davis of Kentucky. Did you make your own independent 
assessment of the report and its accuracy?
    Mr. Falcon. I did.
    Mr. Davis of Kentucky. And what were your conclusions?
    Mr. Falcon. I disagreed with the criticisms.
    Mr. Davis of Kentucky. I do not mean this pejoratively 
towards you, but I am having a mental picture in my mind that 
when you all came up with your report on Fannie Mae, Mr. Raines 
and Mr. Howard, I think, sat there, and they said fairly 
forcefully that they disagreed with your conclusions.
    What suggestion would you offer us, Mr. Falcon, as to what 
you think this committee or this Congress should be doing to 
look at that report and to learn from it, because, obviously, 
as we create a new regulator, we are going to try to make sure 
they do a better job, frankly, than you all did. I would think 
that it is relevant what is contained in that report. What 
would you suggest Congress do, or do you think it would be 
appropriate, for example, if Congress had a hearing on that 
report?
    Mr. Falcon. I think you should use the report as you would 
like, Congressman, but, as I said, the matters were reviewed by 
agencies outside my own and they determined there were no rules 
or laws broken, and that was the end of it.
    Mr. Davis of Kentucky. What about the portion of the report 
that said that there was contact between OFHEO and between some 
news organizations? Do you recall that part of the report?
    Mr. Falcon. Vaguely.
    Mr. Davis of Kentucky. Well, now you say you recall it 
vaguely. That strikes me as being a fairly serious allegation, 
isn't it?
    Mr. Falcon. I think agencies have contacts with the press 
all the time.
    Mr. Davis of Kentucky. Well, contacts with the press 
regarding a confidential document that was only meant for the 
board of directors of Fannie Mae. Presumably, that does not 
happen all the time, does it?
    Mr. Falcon. I am not sure what you are referring to.
    Mr. Davis of Kentucky. Well, again, speeding along, as my 
time is about to run out, my recollection is there was a 
portion of the IG's report that said that there had been some 
leaking or some dissemination of the confidential report in a 
manner that would have violated OFHEO's internal standards. 
Tell me what steps you took to investigate that allegation that 
there were improper contacts regarding confidential documents.
    Mr. Falcon. The matter was entirely investigated by the 
inspector general's office.
    Mr. Davis of Kentucky. What did you do as the person who 
runs OFHEO? Did you take any steps of your own?
    Mr. Falcon. I do not know. I cannot tell you what the 
source of any leaks on any matter on any given day were.
    Mr. Davis of Kentucky. Did you investigate them?
    Mr. Falcon. I cannot consume my time with trying to pursue 
it.
    Mr. Davis of Kentucky. Did you investigate it?
    Mr. Falcon. I do not recall what it was, specifically what 
the document was. I do not.
    Mr. Davis of Kentucky. Well, I would assume this 
observation, Mr. Falcon, because my time is running out, I hope 
that, as we do construct a new regulator, that, frankly, that 
regulator is a little bit more attentive to the possibility 
that there could be problems in its own house because I am not 
sure that you have been sufficiently so in the last few months, 
but I do wish you well in the private sector.
    Mr. Baker. The gentleman's time has expired.
    Mr. Hensarling?
    Mr. Hensarling. Thank you, Mr. Chairman.
    Well, Mr. Falcon, I want to congratulate you for your 
service to your country, and I believe you are a gentleman who 
was tasked with a very important mission and one for which many 
of us believe you had insufficient resources in which to 
accomplish the mission that you were given.
    Let me ask a few questions about your examination in regard 
to Fannie Mae not applying its own policies with regard to SSAS 
65 as it relates to the booking of loans for sale or 
investment. I think that you have indicated that the problems 
with accounting for these loans were recently discovered, but 
the practice had been ongoing for over 20 years.
    So how can Fannie be unaware that they were in breach for 
over 20 years and, indeed, how was it that, over a 20-year 
period, OFHEO did not discover this breach?
    Mr. Falcon. It was just an error in their systems, which 
was not uncovered until the systems were upgraded in 2004. It 
was such a precise error in, I believe a drill-down type issue 
that was not the type of thing that we caught.
    Mr. Hensarling. It is my understanding that when OFHEO 
discovered accounting problems at Freddie Mac that the 
executives of Fannie stated that they had reviewed all of their 
internal accounting practices and policies and that they had 
found no violations. We have since, obviously, learned, 
according to you, according to the SEC, that there have been a 
number of GAAP violations. So do you believe that OFHEO and 
this committee were purposely misled by executives at Fannie?
    Mr. Falcon. I think that is certainly something that we are 
reviewing in the course of our special examination. While we do 
believe in certain instances there were willful violations of 
accounting principles, whether or not that was hidden from us 
or from the Congress is something we are still determining.
    Mr. Hensarling. Could it be said if de facto Fannie had the 
ability to designate their securities for accounting purposes 
as either held for investment or held for sale that that would 
give them an advantage over their competitors in the 
marketplace?
    Mr. Falcon. It would provide certain accounting benefits if 
they were to classify some assets as held to maturity versus 
available for trading. Then they would not have to recognize 
any loss in market value in those assets. That is certainly the 
case.
    Mr. Hensarling. I think also in your testimony you 
indicated that, although a number of Fannie's policies were not 
GAAP compliant, obviously, a number of them were, but that 
Fannie personnel failed to follow through on these policies. So 
are there particular individuals who are being investigated for 
knowingly violating these GAAP principles?
    Mr. Falcon. We are looking at the role that various 
employees of the company had in both the promulgation of the 
accounting policies as well as the role in the implementation 
of the policies. So you cover both ends. One, how is the 
improper policy formulated and adopted? And, secondly, if it 
was crafted properly; why wasn't it followed? That is the 
subject of further review by us.
    Mr. Hensarling. To speak somewhat prospectively in the 
limited amount time I have left, as you know, our Chairman 
Baker has introduced a comprehensive piece of legislation 
dealing with a new regulator for the GSEs, and I know that you 
have not had an opportunity to examine the particulars of that 
piece of legislation, but, conceptually, do you think that the 
GSE safety and soundness regulator should also have the 
authority of new programs and new activity review from your 
experience? If so, why?
    Mr. Falcon. I think it should. The safety and soundness 
regulator is going to learn about these new activities anyway. 
We have to assign capital to them. We have to make sure that 
the risk of any new activities are properly managed so we will 
be intimately familiar with how those activities will impact 
the company.
    Every other safety and soundness regulator also has a 
responsibility, when it conducts that review, to make sure that 
the activity is consistent with the terms of the charter of the 
entity. Compliance with laws, rules and regulations does also 
rise to a safety and soundness issue, so it is just a natural 
fit that both happen at the same place.
    Mr. Baker. The gentleman's time has expired.
    Mr. Watt?
    Mr. Watt. Thank you, Mr. Chairman.
    Mr. Falcon, thank you for being here.
    I want to change the focus from what we have been talking 
about to something else. I really have no interest in focusing 
on Fannie or Freddie's shortcomings in the past or your or 
OFHEO's shortcomings or successes in the past or on this 
committee's oversight shortcomings or successes in the past.
    Throughout this process, my interest has been in the 
housing function, the housing mission of Fannie and Freddie, 
and on that, on page 11 of your prepared testimony, you come 
closest to addressing that issue.
    You say during your tenure, ``The agency has successfully 
dealt with very serious problems at two of the largest 
financial institutions in the world. We have done so without 
disrupting our financial system,'' which, of course, is true, 
but it has had some financial impact, and then you go on to 
say, ``while allowing both enterprises to continue fulfilling 
their vital mission of making home ownership more affordable,'' 
which also, of course, is true because the mission is going on.
    My concern is that there has, obviously, been some 
disruption of the ability to do the housing mission. Has your 
agency made any assessment of what impact this investigation 
and these financial disclosures have had on the ability of 
Fannie and Freddie to aggressively pursue the housing mission? 
I am not trying to assess whether that investigation went right 
or wrong. Obviously, it turned out to be right.
    But what impact, if any, can you tell us this has had on 
aggressive pursuit of the housing mission and, more 
importantly, how can we more aggressively pursue that housing 
mission either through Fannie and Freddie or otherwise as we go 
forward in the structure of the regulatory institutions we put 
in place?
    Give us whatever suggestions, as you have experienced this, 
both on the staff, in your regulatory position. What 
suggestions do you have for us about how we can more 
aggressively pursue the housing mission?
    Mr. Falcon. I think the guaranteed side of their business 
where they purchase qualifying affordable housing goal type 
mortgages, that does continue, and it is proceeding at a 
healthy pace. Despite the problems the company has with their 
accounting issues and internal control problems, that side of 
the business remains sound.
    So I can give you some comfort there, that while we are 
having to take some supervisory actions with the company to 
make sure that they continue to be as aggressive in fulfilling 
their mission as possible, when we get these other issues 
addressed properly over time, it will not deter them from 
continuing their guarantee side of their business.
    I have always looked at our responsibility at OFHEO as part 
housing mission. A company that is experiencing severe 
financial difficulties is going to constrain the amount of work 
it can do in fulfilling its mission, and so the greater extent 
to which we can make sure that the company does not get into 
any kind of trouble makes sure that there is no interruption in 
their ability to continue to fulfill the mission and innovate.
    With a fully authorized, well-resourced regulator, I think 
there would be a good safeguard to make sure that there are not 
unnecessary interruptions in the company's business as a result 
of safety and soundness problems. The sooner we can get in 
there and identify and fix problems before they manifest 
themselves in the form of larger problems, I think, is only a 
benefit to the company's mission. A strong safety and soundness 
regulator is part of that.
    Mr. Baker. The gentleman's time has expired.
    Just by way of notice to members who have----
    I am sorry, Mr. Watt.
    Mr. Watt. Mr. Chairman, could I have him address the 
prospective suggestions?
    Mr. Baker. Sir, please. That is all right. Okay.
    Mr. Falcon. Prospectively, I think you could look at other 
examples of what has been done at other agencies. The AHP 
program of the federal home loan bank system is one possibility 
where you have some dedicated amount of funds that are used 
towards affordable and low-income housing.
    But I would like to also think about it and possibly get 
back to you, Congressman, if I may.
    Mr. Watt. That would be great. That way, it will not 
disrupt the chairman's schedule. I thank you. I would welcome 
any suggestions you have because I think you have a picture of 
this that probably is unique now, given your years of service 
in a number of different capacities. So I would welcome those 
suggestions.
    Thank you, Mr. Baker.
    Mr. Baker. The gentleman's time has expired.
    By way of prior announcement, we will likely adjourn 
shortly after 11 o'clock. I am told that the full committee 
will have a meeting commencing at 1 o'clock. They need to have 
access to the room by at least 12:30. The matter is on the 
floor. We will probably keep members beyond 12 o'clock. So, as 
members can expedite their comments, otherwise, we will have to 
take every member's comment and put it into the record for 
response. I will forward to the witness, if you so choose.
    The next person here is Mr. Ney. You are up.
    Mr. Ney. Thank you, Mr. Chairman.
    On Monday, April the 4th, OFHEO--I think it was about a 
year in the making--added to their corporate governance rule. 
It takes effect in 60 days. What does that mean for Fannie?
    Mr. Falcon. I think it is an important addition to our 
corporate governance measure that we have taken at the agency. 
It does include more guidance to the company in regards to the 
board of directors, the activity of the board, and it works to 
ensure that there is strong oversight exercised by the board. 
We think it is a good addition to a corporate governance rule 
that we already had out there.
    Mr. Ney. Also, Fannie was given until September of this 
year, and that was to meet the 30 percent capital, and I think 
that was an extension. It was a 90 more days' extension.
    Mr. Falcon. Originally, it was the end of June.
    Mr. Ney. Do you believe they will be able to reach that 
goal?
    Mr. Falcon. We monitor it very closely, and the plan that 
they have submitted to us does indicate that if everything 
happens as planned that they will meet the goal. If at any 
point between now and the end of September it looks like there 
are problems, then we will work with the company to make 
adjustments in the plan so that they can meet it by the end of 
September.
    Mr. Ney. If they do not meet it, what happens?
    Mr. Falcon. If they do not meet it, we will have to 
determine what additional remedial steps might be necessary in 
order to make sure that they can come into compliance with it 
as soon as possible.
    Mr. Ney. People have raised today the issue with whether it 
was 20 years gone undetected or 5, you know, and that has been 
raised several times, and Fannie had brought this out to the 
attention of OFHEO actually about this problem that had been 
over a 20-year period.
    I guess the question I have is: How did they not know and 
how did OFHEO, though, not know or, you know, over a certain 
period of time, you know, that they were operating in a faulty 
and inaccurate way?:
    Mr. Falcon. This was a very technical problem in their 
accounting systems. Assets that were being classified as either 
available for sale or held to maturity were properly designated 
by the company at the time of purchase. However, the system 
itself categorized everything as held to maturity, and that was 
just not uncovered until 21 years later.
    Mr. Ney. So it was more of a technical problem than 
something that was conspired to do this and not be found for 20 
years.
    Mr. Falcon. Yes. That is what we expect by that.
    Mr. Ney. Can we expect another capital assessment of Fannie 
by OFHEO?
    Mr. Falcon. Capital assessment? Yes, Congressman.
    Mr. Ney. Or capital adequacy to report under.
    Mr. Falcon. Yes.
    Mr. Ney. The GSEs, I should say, not just Fannie Mae.
    Mr. Falcon. Yes. We typically classify the enterprises at 
the end of every quarter for the previous quarter and, at the 
end of March, we would typically classify both. We only 
classified Freddie Mac. We are continuing to have discussions 
with Fannie Mae about their capital classification.
    Under the terms of our regulation governing this, they have 
30 days to comment on our proposed classification, and that is 
where this currently stands. When they give us their comments, 
we will take them into consideration and then determine what 
the proper classification will be.
    Mr. Ney. Okay. Good luck with your ventures down the road.
    I want to thank Chairman Baker for having this hearing. 
Thank you.
    Mr. Baker. I thank the gentleman.
    Mr. Baca?
    Mr. Baca. Thank you very much, Mr. Chairman.
    Mr. Falcon, thank you very much for being here today.
    As you know, I support a strong well-funded regulator, and 
I also support the work of Fannie Mae in providing--I say in 
providing--housing to the underserved. Do you believe you have 
the necessary expertise within your agency to regulate GSE in a 
productive manner in an ever-growing complex market?
    Mr. Falcon. I do, Congressman. I am very proud of the 
talented people we have at the agency.
    Mr. Baca. When do you believe this process will be over 
because, in your report, you indicate that you have two 
objectives in an ongoing special examination of Fannie Mae. The 
first was to identify all the problems and fix it. In your 
testimony, you indicate that you have not completed that. There 
is also the second portion: Does the comprehensive reform 
program provide problems with recurring?
    Mr. Falcon. Well, we would like to get it done as soon as 
possible. It is in our interest, the company's interest, and I 
know you would like to see it done as soon as possible.
    I hesitate to give you a specific timeframe because just 
the new re-audit of the company by the new external auditor may 
possibly continue to uncover issues, even if we feel like our 
review is close to being brought to a conclusion. So we really 
need to work closely with them as they do their accounting 
review as well as ours.
    I know that is not a good answer, but it is hard for me to 
pinpoint it. Our goal is to try to get it done as soon as 
possible.
    Mr. Baca. Given the importance of the entity to home 
ownership, how will you know when you have fulfilled your 
obligation as a regulator thoroughly and fairly--and I say 
thoroughly and fairly--so that Fannie Mae can continue to 
further its home ownership in the country in a manner that is 
safe and sound?
    Mr. Falcon. I think when the company has addressed the 
issues related to proper accounting policies, adequate internal 
controls and any additional remedial actions that have taken 
place, when the company is able to submit timely financial 
statements to the SEC, I think when all that comes together, we 
will feel comfortable that the company has put itself back on a 
solid footing, and that is the time that we would begin to 
consider lifting some of these supervisory steps that we have 
taken, like the 30 percent capital surcharge.
    Mr. Baca. Are you providing guidance or assistance or 
training at this point to make sure that there is adequate 
accounting that is done, because that is part of the process 
and part of your auditing report, and that was the problem, I 
believe, that Davis asked originally when it was leaked out to 
the media without allowing them to correct their own particular 
problems before it went out. So are you now then providing the 
guidance, the training to assure that the proper accounting is 
done, the procedures and policies are followed?
    Mr. Falcon. We are, and the board is also very actively 
engaged in this also. The company is working to retain many 
qualified individuals in the accounting field so that the 
company can begin to develop proper accounting policies, but we 
are working with them very closely.
    Mr. Baca. Can you clarify the views of the amount of 
capital that Fannie Mae should have and how you arrive at that 
number? That is question number one.
    And two is: Can you give a sense of under what condition 
you would be satisfied with remediation procedures not required 
to excess capital?
    Mr. Falcon. Well, current capital levels are contained in 
the statute, 2-1/2 percent for on-balance sheet assets and 45 
basis points for off-balance sheet. When we see safety and 
soundness concerns at either company, we exercise our 
discretion to require additional capital, but just for the time 
period where we see problems at each company.
    Whether or not a permanent minimum capital level should be 
higher than 2-1/2 percent, we would have to study that issue a 
little more closely.
    Mr. Baca. Okay. We know that Fannie Mae has taken a number 
of steps to address the problems that are very positive, even 
the change in its leadership right now because of its services. 
My question and final question would be: You indicated in your 
statement that OFHEO became more aggressive as resources became 
available. Who went after the resources, and why did they go 
after the resources to make sure that they were more 
aggressive?
    Mr. Falcon. We have been pursuing additional resources 
since I first got to the agency. As I said earlier, it became 
very evident to me when I assumed my position that we just did 
not have adequate resources to properly fulfill our mission at 
OFHEO and, from the very beginning, I have been seeking to 
increase the agency's budget, and we have had much success in 
that. With the committee's support, our resources have 
increased.
    Mr. Baker. The gentleman's time has expired.
    Mr. Baca. Hopefully, you will apply the same standard to 
other entities to as well have the same standards, same 
policies, same procedures and same aggressiveness in holding 
everybody else accountable as well.
    Thank you.
    Mr. Baker. I thank the gentleman.
    Chairman Oxley?
    Mr. Oxley. Thank you, Mr. Chairman.
    Mr. Falcon, it is good to have you back, and, based on your 
announcement yesterday, I want to wish you Godspeed and success 
in whatever you do. You have led the OFHEO folks at a very 
difficult time and have done remarkable work, and our sincere 
congratulations and best wishes to you.
    Let me ask you. The last time that OFHEO discovered 
accounting problems at Fannie, the SEC was engaged to determine 
whether Fannie needed to restate earnings. Based on your 
testimony and the recent discovery, will that process be 
followed as well, or has the SEC already made a determination 
in terms of whether Fannie Mae was GAAP compliant?
    Mr. Falcon. The process that was followed previously, Mr. 
Chairman--by the way, thank you for your comments--was an 
extraordinary set of circumstances. Typically, the process 
involves the regulator working with the company and the 
company's external auditor on resolving any accounting issues 
that arise and, with the issues related to FAS 133 and 91, 
Fannie Mae decided to seek the input of the SEC on those 
accounting issues. So the SEC did provide guidance on them.
    In this case, that has not happened. We are working with 
the company. We have met with the SEC to review these 
additional issues with them and have kept them fully apprised 
of what we are finding and answering any questions they may 
have, but the SEC is working with us under the standard process 
for these types of matters, and they have not been asked to 
intervene with a formal interpretation or answer like they were 
previously.
    Mr. Oxley. That could happen at some point, but it just 
depends on how the negotiations go with the private entity?
    Mr. Falcon. It could, Mr. Chairman.
    Mr. Oxley. Okay.
    Your testimony raised some concerns about internal controls 
at Fannie Mae, and that has been, obviously, an ongoing issue 
in corporate America for the last 3 or 4 years. I guess my 
question is: What role does OFHEO play in the whole issue of 
internal controls vis-a-vis the SEC and perhaps the Public 
Company Accounting Oversight Board? How does OFHEO's role fit 
into the overall issue of internal controls?
    Mr. Falcon. We do work closely with PCAOB on this, and we 
have. They participate in many of the sessions and meetings 
that we have had, and, obviously, we have worked very closely 
with the SEC.
    As a safety and soundness regulator, we do examine very 
closely for internal control deficiencies. In addition, 
obviously, under Section 404 of Sarbanes-Oxley, companies are 
required to certify the adequacy of their internal controls. So 
we work very closely to make sure that certain minimum, if not 
best practice, standards with regards to internal controls are 
met by the company, and we apply these standards through our 
examination program.
    In addition, because of Sarbanes-Oxley, there are 
certifications that are required on the part of management so 
they have their own strong incentives now to make sure that 
internal controls are adequate. Where we see issues related to 
accounting disclosure matters that require some review by the 
SEC, we will have discussions with the SEC. We have a very good 
working relationship with them.
    Mr. Oxley. Is it fair to say then that the internal 
controls issue as it relates not just to a financial company in 
a general sense, but more particularly to a GSE is treated 
somewhat differently than say a steel company or an oil 
company?
    Mr. Falcon. I would say not just because they are a GSE, 
but because they have a safety and soundness regulator. I think 
that the same levels of internal control review that we apply 
to Fannie Mae and Freddie Mac would also be applied with 
respect to any bank or thrift that is regulated by a safety and 
soundness regulator and that might very well be different from 
the type of internal control review that is applied with 
respect to a steel company.
    Mr. Oxley. Thank you.
    Mr. Chairman, I just want to again compliment Mr. Falcon 
for his leadership and also to recognize Mr. Blumenthal. I know 
Mr. Falcon as an alumnus of this committee in his former 
iteration as the Banking Committee, and Mr. Blumenthal, who 
will be named as interim in your position, was a very able 
staffer over in the committee across the hall that I served on 
for a few years, and we look forward to working with him as 
well.
    Thank you, Mr. Chairman.
    Mr. Falcon. Thank you for your comments, Mr. Chairman.
    Mr. Baker. Thank you, Mr. Chairman.
    I am advised that floor proceedings have now been 
initiated, and, at this time, I would ask members who have 
additional questions to please submit them for the record. We 
will get responses from Mr. Falcon.
    I wish to again extend our appreciation to you for your 
appearance here today and for your good work.
    Our meeting now stands adjourned.
    Mr. Hinojosa. Mr. Chairman, may I ask unanimous consent----
    Mr. Baker. Yes, Mr. Hinojosa.
    Mr. Hinojosa.----that the opening statement be part of the 
record?
    Mr. Baker. Yes, sir. All member statements have been made 
part of the record, and the record will remain open for 5 days 
for any additional correspondence members may choose to 
forward.
    Mr. Hinojosa. Thank you.
    Mr. Baker. The meeting stands adjourned.
    [Whereupon, at 11:07 a.m., the subcommittee was adjourned.]


                            A P P E N D I X



                             April 6, 2005

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