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



 
                        A REVIEW OF THE FEDERAL


                         HOME LOAN BANK SYSTEM

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                    CAPITAL MARKETS, INSURANCE, AND
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 7, 2006

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 109-117



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

                 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
JOHN CAMPBELL, California
MICHAEL G. OXLEY, Ohio
                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    September 7, 2006............................................     1
Appendix:
    September 7, 2006............................................    25

                               WITNESSES
                      Thursday, September 7, 2006

Rosenfeld, Ronald A., Chairman, Federal Housing Finance Board....    12

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    26
    Baca, Hon. Joe...............................................    28
    Clay, Hon. Wm. Lacy..........................................    29
    Hinojosa, Hon. Ruben.........................................    31
    Kanjorski, Hon. Paul E.......................................    32
    Royce, Hon. Ed...............................................    34
    Rosenfeld, Ronald A..........................................    36

              Additional Material Submitted for the Record

Hon. Barney Frank:
    Letter to the Federal Housing Finance Board..................    56
    Standard & Poors study: FHFB Proposed Retained Earnings 
      Regulation Poses Challenges for FHLBs......................    58


                        A REVIEW OF THE FEDERAL



                         HOME LOAN BANK SYSTEM

                              ----------                              


                      Thursday, September 7, 2006

             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 notice, at 10:03 a.m., in 
Rayburn House Office Building, Hon. Richard H. Baker [chairman 
of the subcommittee] presiding.
    Present: Representatives Baker, Castle, Manzullo, Royce, 
Kelly, Biggert, Tiberi, Hensarling, Davis of Kentucky, 
Campbell, Kanjorski, Hooley, Moore of Kansas, Hinojosa, Clay, 
Baca, and Scott.
    Ex officio: Representatives Oxley and Frank.
    Chairman Baker. I would like to call the hearing to order. 
The committee meets today to review the status of the Federal 
Home Loan Banks, and their regulatory regime, and the Federal 
Housing Finance Board, including the latest significant 
developments within the Federal Home Loan Bank system.
    I am pleased that Chairman Ronald Rosenfeld is our single 
witness for today's hearing. The bank system was established in 
1932 to provide liquidity to savings and loan associations 
which were the primary home mortgage lenders in that period. 
The Bank System today encompasses 12 regional Federal Home Loan 
Banks, patterned on the structure of the Federal Reserve 
System. Each is a member-owned cooperative.
    Like the other housing government-sponsored enterprises, 
Fannie Mae and Freddie Mac, Congress granted the Bank System 
special privileges as part of their governmental charter. Those 
privileges include exemption of the Banks' corporate earnings 
from Federal, State, and local taxes, and the status of debt 
issues as government securities for the purpose of compliance 
with securities law.
    The Bank System has enjoyed significant growth, roughly to 
the same size as our competitors, Fannie Mae and Freddie Mac. 
As of June 30, 2006, the System's assets were $1 trillion, of 
which $638 billion were advances to members. The System has 
outstanding debt obligations of $940 billion.
    In recent years, Federal Home Loan Banks have established 
and participated in what is known as a mortgage purchase 
program, whereby credit and interest rate risk are shared 
between member institutions that originate the loan and the 
bank purchasing the loan.
    Accordingly, in light of the growth and programmatic 
changes, review of their regulatory requirements is not only 
appropriate, but necessary. This committee has engaged in 
significant review and oversight of Fannie Mae and Freddie Mac 
throughout the years, but we have not as frequently examined 
the structure or requirements of the Federal Home Loan Bank 
System.
    Today, we shall hear comment, I am certain, from members 
with regard to a rule now pending, as proposed by the chairman, 
some of whom will express concern about the proposal. I want to 
express my appreciation to the chairman for his principled hard 
work, and to his examination staff for the frequency of the 
examinations which they perform.
    I recognize that the purpose of this work is not simply to 
artificially constrain the Bank System, but to ensure that 
there are adequate protections in place for the taxpayer, who 
ultimately would be found responsible for failures of a 
significant nature within the system.
    However, I want to make clear that the pending rule 
revision and the actions taken are really interim steps, in 
that this committee has passed, and the House has passed, H.R. 
1461, which provides for the creation of a unified housing 
regulator for Fannie Mae, Freddie Mac, and the Federal Home 
Loan Banks. I continue to be troubled that there are disparate 
rules governing the practices of each, not only capital 
requirements but business conduct as well.
    Some criticism has been leveled at H.R. 1461 for its 
failure to address the issue of portfolio constraint, and I 
wish to make clear on behalf of the committee one more time 
that the bill makes express provision that the new director 
created by the Act shall examine and report to the Congress on 
the appropriate constraints, and the methodology to impose such 
constraints, in order to effect the leveraging of portfolio for 
shareholder profit, as opposed to the compliance of charter 
requirements.
    Stated another way, when asking Secretary Snow just last 
year whether the portfolio should be constrained to a dollar 
certain, or did he have in mind a particular formula to which 
reduction would be applied, he suggested to the committee that 
there should not be a dollar certain reduction, nor did he have 
in mind a formula by which portfolios should be reduced.
    But rather, that should be the subject of study of 
professional staff, and recommendations to the Congress in 
order to assure that we did not royal the housing markets 
unnecessarily. That's exactly what H.R. 1461 does.
    More importantly, whether there is a difference between 
House and Senate language over the regulatory details of GSE 
governance, I think it extraordinarily important that while we 
still have stability in the housing market, and while we still 
enjoy relatively flat interest rates, that the Senate at least 
act on a GSE proposal.
    Without doubt, there will be a conference committee. We 
have come too far, worked too hard, and have two proposals--
each of which has their own validity--to let this legislative 
opportunity pass us by. And so, I would hope and urge that the 
Senate would act before our final adjournment, perhaps late 
November, early December, with the adoption of some form of GSE 
proposal.
    If we were able to do so, perhaps it would be of assistance 
to the current Federal Home Loan Bank regulators in the matter 
now pending. Knowing that the goals they are trying to reach, 
the patterns that they establish with their regulatory 
construct, would be of great benefit in going forward, with the 
creation of the new consolidated GSE regulator. So, I am 
appreciative of Chairman Rosenfeld's bold leadership, and I 
commend him and his staff for his good work, and look forward 
to his statement at the appropriate time.
    Mr. Kanjorski?
    Mr. Kanjorski. Mr. Chairman, we meet this morning to once 
again examine the Federal Home Loan Bank System. As you already 
know, I share your deep interest in these important financial 
institutions. After all, we worked closely together for several 
years to include language to improve the system during our 
lengthy deliberations over H.R. 10, the landmark law to 
modernize the financial services industry.
    Perhaps most importantly, our joint efforts in 1999 
resulted in a much needed update of the capital structure in 
each of the Federal Home Loan Banks. Until we acted on these 
matters, these financial institutions had operated under 
antiquated subscription capital rules created 67 years earlier, 
in 1932.
    Specifically, the law now requires each Federal Home Loan 
Bank to submit a plan to the Federal Housing Finance Board for 
approval that is best suited for the condition and operation of 
the bank and the interests of its members. Since we completed 
our legislative work, all but one of the Federal Home Loan 
Banks have received approval from the Finance Board to put in 
place a revised capital structure.
    A regulatory proposal put forth earlier this year by the 
Finance Board, however, now threatens to slow the progress 
being made to implement these statutorily required capital 
reforms. Specifically, this proposal would impose inflexible 
minimum retained earnings levels at each bank. This proposal 
has generated an extensive policy debate.
    Ultimately, the Finance Board received 1,066 letters on its 
rulemaking plan. Less than one half of one percent of the 
commentators, as I understand, supported the regulatory change. 
Some of the key arguments raised against the plan include that 
it could result in a decision to engage in higher risk 
activities and that it could undermine the housing mission of 
the system. Standard & Poors has also observed that the 
proposal may ``reduce the financial flexibility'' of a bank to 
manage its capital positions and lessen the attractiveness of 
membership in the system.
    While I share these apprehensions, I am most concerned 
about the failure of the Finance Board to conform this 
regulatory proposal to the specific capital statutory 
requirements outlined in H.R. 10. This plan would impose a 
uniform retained earnings requirement that every bank must 
adopt, regardless of its preferences.
    While the law mentions retained earnings as one source of 
capital, it does not mandate that a bank hold a specific 
minimum level. In fact, as I noted in my remarks on the 
conference report on H.R. 10, our goal was to create ``a 
flexible capital structure.''
    In a recent letter sent to Chairman Oxley and Ranking 
Member Frank, today's witness suggested the Finance Board's 
proposed capital revisions ``satisfies the intent'' of H.R. 10. 
As an author of these provisions, I must take exception to this 
conclusion. Our intent in updating the capital structures used 
at each of the banks was not only to create a more permanent 
capital system, but also to provide maximum flexibility to each 
of the banks to develop their own capital structures to address 
their own special needs.
    Because the retained earnings proposal decreased such 
flexibility, it is inconsistent with the language of the law 
and the legislative history. In my Floor statement on H.R. 10, 
I also noted that I had worked to ensure that we ``would not 
place small financial institutions at a competitive 
disadvantage.'' This regulatory proposal, in my view, would 
undercut our hard work to achieve that important objective.
    A study of the Stanford Washington Research Group found 
that the proposal would disproportionately affect smaller 
publicly traded financial institutions. These entities would 
not only experience decreases in dividend income during the 
transition period, but unlike large financial institutions, 
they would also be unable to tap into our capital markets via 
other financing mechanisms.
    Beyond my strong reservations about this recent rulemaking 
proposal, I continue to be concerned about the failure of the 
Finance Board to follow the clear statutory mandate regarding 
the appointment of public interest directors.
    Section 7 of the Federal Home Loan Bank Act indicates that 
at least six directors on each bank board ``shall be 
appointed'' by the regulator. As you know, Mr. Chairman, I have 
a very strong interest in ensuring that the Federal Home Loan 
Banks benefit from an independent public voice on their boards.
    Inexplicably, at least 70 percent of the public interest 
director positions are currently vacant. If the Finance Board 
fails to act on these matters by the end of the year, there 
will be no public interest directors at any Federal Home Loan 
Bank, and 40 percent of all board positions will be vacant.
    These vacancies occur at a time when the system is 
addressing increasingly complex issues. They also create 
corporate governance problems, in terms of workload of the 
remaining elected directors, institutional memory of the board, 
and ensuring that the Federal Home Loan Bank adheres to the 
system's mission to promote affordable housing and advance 
economic development.
    Before I close, Mr. Chairman, let me make a point to our 
witness. I seem to detect that there must be a signing 
statement written by the President when he signed H.R. 10--not 
this President, but the previous President--that exempted the 
President and this board from this law, because it seems to me 
the Finance Board is acting in direct contradiction of the law 
as enacted by the Congress. And I find that incredible, but 
rather consistent with this President's intent.
    And I think it is very important that the Finance Board 
explain to this committee why you think that the action of 
Congress should be absolutely ignored, and that 40 percent of 
the members of the boards of directors of this huge institution 
involving billions of dollars, and with the support of the 
taxpayers' money behind it, should go improperly governed. So, 
I look forward to hearing that answer.
    In closing, Mr. Chairman, I have deep reservations about 
the retained earnings rulemaking as proposed by the Finance 
Board. I also have great apprehension about the continued 
failure of the Finance Board to appoint public interest 
directors. I, therefore, hope our witness today will 
forthrightly inform us about what he is doing to resolve these 
problems.
    Chairman Baker. I thank the gentleman for his statement. I 
now recognize Chairman Oxley. I don't know with certainty 
whether the committee will meet again in this session on the 
matter of GSE governance. So, accordingly, I want to express my 
appreciation to the chairman for his long-standing work on the 
creation and adoption of H.R. 1461, the House-posed position on 
GSE governance.
    It is clear to me that we wouldn't be where we are today--
although we haven't crossed the goal line--without your hard 
work and commitment to that purpose. So I thank the chairman 
for his good work, and recognize him for such time as he may 
consume.
    The Chairman. I thank Chairman Baker for those words, and 
would certainly echo his remarks regarding GSE reform. The 
package that we passed in this committee, and on the House 
Floor by a large bipartisan vote, is indicative of the hard 
work you have done over a number of years--in many cases, all 
by yourself--and it would be a shame to come this far, and not 
put that across the goal line and get a Presidential signature 
on it, in light of all of the revelations that have come out on 
the GSE's.
    It truly provides an opportunity for the Congress to put 
its imprint on a very important piece of legislation that you 
have worked on for so long. So anything we can do to that end 
would be appreciated.
    Let me welcome Chairman Rosenfeld. It is good to have you 
with us, and thank you for the job that you are doing. We 
thought it was important to have you here to discuss some of 
the issues that were raised in the remarks by the gentleman 
from Pennsylvania, as well as the gentleman from Louisiana.
    The Federal Home Loan Bank System has been critical to the 
country in creating a liquid residential mortgage market. The 
Bank System also plays an important role in small business 
financing and the funding of affordable housing and community 
investment programs.
    From a Congressional standpoint, ensuring the safety and 
soundness and mission performance of the Federal Home Loan 
Banks has never been more important. I want to thank Chairman 
Baker for holding this hearing, and for his continued strong 
oversight of the housing GSE's and their regulators.
    The Finance Board required the Federal Home Loan Banks to 
register their stock with the Securities and Exchange 
Commission, in the belief that greater public disclosures would 
be beneficial. I am interested in the status of that 
registration, the process, and related accounting reviews. 
Sound corporate governance is critical to the function of any 
enterprise, as we found out recently.
    In this regard, I am concerned that the Home Loan Banks do 
not have full boards of directors. I would like to know why 
there has been a delay in appointing public interest directors, 
and what reforms to this process, Chairman Rosenfeld, that you 
might support. Again, I echo the comments of the gentleman from 
Pennsylvania in that regard.
    The Finance Board has issued a proposed rule prescribing a 
minimum amount of retained earnings for each bank, and limiting 
the amount of excess stock that a bank can have. As Mr. Frank 
and I stated in a recent letter to you, Chairman Rosenfeld, the 
potential impact of this proposal is vitally important to the 
banks, to their members, and to the housing finance system.
    We are concerned that the proposed changes may go too far, 
and actually harm the bank system more than protect it. And I 
appreciated your response, that the Finance Board is taking an 
open minded and cautious approach to this rulemaking, and that 
any further actions will take into account the consequences for 
the banks and their members. I look forward to an exchange of 
views today on this important subject. And indeed, this is how 
the process works, in terms of our oversight responsibilities, 
as well as your responsibilities as chairman.
    To that end, clearly the inclusion of the Federal Home Loan 
Banks in the overall GSE legislation was timely and important, 
and I want to say to the Federal Home Loan Banks in general 
thanks for your cooperation in this. I know it wasn't easy, but 
it clearly made eminently good sense to include the Federal 
Home Loan Banks under this legislation.
    Once we were able to work out the difficulties, which are 
always inherent in the legislative process, I think the Home 
Loan Banks are well positioned in this proposal. This is 
another reason, Mr. Chairman, why we need to get this bill 
across the goal line to the President's signature this year, 
before we adjourn. And to that end, we again pledge our best 
efforts. With that, I yield back.
    Chairman Baker. I thank the chairman. And recognizing 
Ranking Member Frank, I also want to express to him my 
appreciation for his courtesies in working with us and moving 
forward on H.R. 1461, and express my hope that we are able to 
continue that good work, and get to conference before the year 
is out. And with that, I recognize the gentleman for such time 
as he may consume.
    Mr. Frank. I appreciate the chairman's good words, and I do 
want to--I think we work well together, and I hope we can 
continue and not give up on this. And I do want to say, in 
particular, I'm not used to being thanked for my courtesy, so 
I'm especially grateful for that.
    [Laughter]
    Chairman Baker. It was particularly notable to me, so I 
wanted to make sure I did it.
    Mr. Frank. That's right. Okay. I think, with whatever 
intentions, Mr. Rosenfeld, you have made a great mistake. And I 
hope that we can hold off on this.
    The chairman and the ranking member of the subcommittee 
mentioned a very serious issue for many of this, the failure to 
appoint public members. Now, when I raised that issue, I was 
told by Assistant Secretary Henry in a letter that the reason 
for not appointing the public members was the pendency of the 
GSE bill. And he said, ``Well, maybe it doesn't make sense, 
given the GSE bill pending.''
    Well, that implies, it seems to me, a--the GSE bill creates 
a new structure for precisely, among other things, the subject 
you are dealing with. And I think a rush to judgement on this 
now, before we get the GSE bill, is a mistake. And when I am 
told that you can't have members appointed by the 
Administration because the GSE bill is pending, but then if you 
were to go ahead with this, the contradiction would have to 
lead me to believe that something else was at stake.
    Now, one of the things I asked to put in the record here, 
Mr. Chairman, is a letter to the Housing Finance Board under 
the public comments section, July 11, 2006, from a very large 
coalition of groups concerned with housing. From advocacy 
groups to builders to public officials, it includes, for 
example: The American Association of Homes and Services for the 
Aging; The National Low Income Housing Coalition; The National 
Association of Local Housing Finance Agencies; Habitat for 
Humanity; and The National Indian Housing Council. And they 
asked the board to shelf this, because of the negative impact 
it would have, as proposed, on housing. And I ask that this be 
put in the record.
    I also ask, Mr. Chairman, that we put in the record your 
quotations from the Standard & Poors study on this in July. A 
heading of one subsection, ``The new regulation poses inherent 
conflicts with the core business of a Federal Home Loan Bank,'' 
that's from Standard & Poors. And Standard & Poors' conclusion 
is, ``Should this proposed regulation be adopted as it is 
currently written, Standard & Poors will have to monitor any 
negative impacts to the liquidity profile of the individual 
bank's core business growth dynamics and membership trends.'' 
It's a very negative analysis of this.
    Obviously, we want to protect safety and soundness. We are, 
in fact, hoping to get a bill passed that will enhance the 
ability of the regulators to do this. But this does not appear 
to be justified by any factual basis for concern. And it is 
very likely to have negative effects on membership, and 
particularly on the affordable housing program.
    Now, the affordable housing program is about 20 years old. 
The affordable housing program is one of the few programs we 
now have that helps build housing. It has been very well run. I 
think it is the model for what we ought to be doing with Fannie 
Mae and Freddie Mac. Everyone concerned about it sees a very 
strong likelihood of a negative impact in the affordable 
housing program from this program.
    Now, I appreciate the fact that you tried to put some more 
flexibility into that, and you were responsive to concerns I 
made, and I thank you for that, for the question of not being 
so geographically bound. I appreciate that. But helping it 
become more flexible, if it is diminished overall, is a 
mistake.
    So, if there is a need for some increased capital here, 
let's have a better justification. And I am afraid this is an 
across-the-board approach that will have negative consequences. 
I think, insufficiently, it reduces the incentive for them to 
differentiate between activities that have different degrees of 
risk. It tends to lump things together, so that is reduced.
    And the overall issue to me is that it is a proposal to 
cure a problem the existence of which hasn't been documented. 
And it's a cure that will damage many of the ongoing activities 
here.
    I know we have had problems with Fannie Mae and Freddie 
Mac, and we are trying to resolve them. And we did agree to 
also include more authority over the Home Loan Banks. But this 
appears to be motivated, in part, by a kind of general 
skepticism of the enterprise, unjustified by any reality that 
we have seen.
    And, yes, we want to be safe. But not to the point where we 
do things not dictated by any, I think, reasonable fear that 
will diminish the very important function. Look, we are in a 
situation now where the last thing this country needs from the 
macro-economic standpoint as well as the micro standpoint, is 
further damage to the housing industry. Everybody now 
acknowledges that the housing industry, which had carried the 
economy to some extent, is now becoming a potential source of 
trouble.
    To promulgate a rule that would cause all kinds of concerns 
about the viability of the housing industry at this time is 
about the last thing we ought to be doing. And I would hope 
that the board would withdraw this. We are certainly available 
to talk. If there is a need for more specifics, let's look at 
it.
    At the very least, the rationale that says we can't appoint 
public board members until the GSE bill's fate is decided 
certainly applies heavily to this. And I would hope we would 
have, accordingly, the Board act that way. Thank you, Mr. 
Chairman.
    Chairman Baker. I thank the gentleman for his statement. 
Mr. Royce?
    Mr. Royce. Thank you, Chairman Baker. I want to thank you 
for holding this hearing, and I would also like to thank 
Chairman Rosenfeld for his appearance, and his testimony here 
before us today.
    Over the past 6 years, under Chairman Mike Oxley's 
leadership, this committee has held a number of very important 
oversight hearings, and this is no exception here today. As one 
of the largest financial institutions in the United States, and 
frankly, as one of the largest borrowers in the world, the 
Federal Home Loan Bank System plays a very significant role in 
the U.S. housing finance market.
    And I have particular questions about some recent 
regulatory actions taken by the Federal Housing Finance Board. 
And more specifically, I am interested in learning more about 
the Finance Board's thinking and its rationale behind the 
recent subordinated debt offering at the Federal Home Loan Bank 
of Chicago, and also the proposed rule to increase retained 
earnings at the 12 banks.
    I am concerned about recent Finance Board action that has 
allowed the Federal Home Loan Bank of Chicago to use 
subordinated debt in determining compliance with its regulatory 
minimum capital requirement. It is my understanding that this 
waiver was granted so that $1 billion in subordinated debt 
offering could enable the Federal Home Loan Bank Chicago to 
redeem stock of withdrawing members, which has the effect of 
substituting equity capital with debt capital.
    I am interested to know if this regulatory forbearance is 
not only unnecessary, but also if perhaps it is inconsistent 
with the statutory minimum capital requirements this committee 
passed in title six of Gramm Leach Bliley.
    Additionally, I think this committee and the public needs 
to learn more about how this subordinated debt offering could 
affect the joint and several obligations of the Federal Home 
Loan Bank System, as a whole.
    As to the retained earnings proposed rule, while I 
understand the intent behind the Finance Board's desire to 
increase the retained earnings at each of the 12 banks, it is 
not evident how the Finance Board arrived at some of the 
proposed rule's specific requirements.
    For example, the rule would require each Home Loan Bank to 
hold retained earnings of at least 1 percent of non-advance 
assets. However, it is not clear to me how or why the Finance 
Board arrived at the 1 percent figure. Perhaps the 1 percent 
number is a good target, but I think it would be helpful for 
the committee to have an understanding as to why the Finance 
Board believes each bank should be required to have that 
specific mix of regulatory capital.
    Mr. Chairman, I would like to thank Chairman Rosenfeld for 
his willingness to engage the committee today. And I yield 
back.
    Chairman Baker. I thank the gentleman. Ms. Hooley?
    Ms. Hooley. Thank you, Mr. Baker, for holding this hearing, 
and for all that you have done on GSE reform. And I thank the 
chairman and Ranking Member Kanjorski for holding the hearing 
today.
    Like my colleagues, I have some concern about the proposed 
retained earnings rule for the Federal Home Loan Bank System, 
both in terms of the rule, and in the process. My primary 
concern is regarding the necessity of the rule. When the board 
just recently approved capital plans for the 12 Federal Home 
Loan Banks, if these capital plans were not sufficient to 
protect the soundness of the Federal Home Loan Bank System, it 
seems to me they should not have been approved by the Finance 
Board.
    As the board stated in its proposal, the system is well 
capitalized, and the risk of insolvency for any Federal Home 
Loan Bank is remote. So my question--is the rule necessary?
    Furthermore, the Finance Board did not use an advance 
notice of proposed rulemaking, and instead, issued the proposed 
rule without feedback from the various stakeholders of the 
Federal Home Loan Bank System. As a result, the Finance Board 
received over 1,000 comments in response to the proposed rule, 
almost all of which were strongly opposed.
    When there are so many concerns about the impact of the 
rule--and it is clear that this is not an immediate pressing 
issue--it seems to me that an advance notice of a proposed 
rulemaking is a better way to address the issue, which would 
allow for an increased dialogue amongst the board, the Federal 
Home Loan Banks, their member institutions, and interested 
members of the public, all of which should have, I think, a 
voice in the process.
    Finally, I have concerns about the possible impact of this 
proposed rule, not only on the Federal Home Loan Banks, but the 
member institutions and the communities they serve. Under this 
rule, the Federal Home Loan Banks will have to increase 
retained earnings by over $3 million over the next 18 to 36 
months, and that is just an average amongst the banks.
    In the case of the Seattle Home Loan Bank, it may take as 
much as 10 years for them to reach the required retained 
earning minimum. Because of the requirement to dividends, when 
a Federal Home Loan Bank does not have the required retained 
earnings, the member institutions will suffer from the loss of 
income.
    Larger member institutions may even seek out alternatives, 
and reduce their use of the Federal Home Loan Bank, all 
together. As the Federal Home Loan Banks face a reduction in 
earnings, it will also lead to reductions in the funds 
available for the affordable housing program.
    In light of the concerns with the proposed rule, both in 
terms of its likely effect on both the Federal Home Loan Banks 
themselves and their member institutions, I think this is an 
issue that certainly merits further consideration. And we 
should ensure that all the concerns of the stakeholders have 
been reasonably addressed before moving forward with the rule, 
so I just want to have more people involved in the process.
    Thank you very much for being here today, and thank you, 
Mr. Chairman.
    Chairman Baker. I thank the gentlelady. Mr. Hensarling? No 
statement? Mr. Castle? Ms. Biggert? In that regard, Mr. Moore? 
Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Mr. Chairman. Chairman Baker and 
Ranking Member Kanjorski, I want to express my sincere 
appreciation for you holding this hearing to review the status 
of the Federal Home Loan Banks, and the activities of the 
Federal Housing Finance Board today.
    I have a long statement, and I would ask unanimous consent 
that it be included in the hearing today.
    Chairman Baker. Without objection. And by earlier request 
of Mr. Frank for inclusion of his additional documents, that is 
also included without objection.
    Mr. Hinojosa. Thank you.
    Chairman Baker. Mr. Tiberi?
    Mr. Tiberi. Thank you, Mr. Chairman. I will submit a 
statement for the record, but just want to thank you for 
holding this hearing today, and express my concern about the 
proposed rule, and the impact it would have across the country 
to the different regions, and hope that this is the first of 
more hearings, Mr. Chairman, on this proposal. Thank you.
    Chairman Baker. I thank the gentleman for his statement. 
Mr. Scott?
    Mr. Scott. Yes, thank you, Mr. Chairman. I appreciate this 
opportunity. I have some very serious concerns about the 
proposed rule. The Federal Home Loan Bank in Atlanta, and all 
the 12 others across this country, are doing a tremendous job, 
particularly in providing affordable housing funds.
    Now, I think it is very important that we understand an 
important aspect that--as background. The members generally own 
capital stock in the banks, in proportion to the amount of 
their business. Bank stock is not publicly traded. Members buy 
and sell it at a fixed par value of $100 per share. And the 
member stock provides the capital needed to operate the banks 
in a safe and sound manner.
    Now, as I understand it, your proposal, Mr. Chairman, 
asserts that banks could incur losses, and that any loss in 
excess of a bank's retained earnings would require members to 
mark down their bank stock below par value. Thus, in order to 
protect the par value of member stock, the board has proposed 
requiring the banks to keep retained earnings equal $50 million 
plus 1 percent of total assets minus advances, correct?
    The banks would have to cut dividend payments in half, 
until they met the new retained earnings requirement. Such a 
rule, Mr. Chairman, would make doing business with banks much 
less attractive to member institutions, and would dramatically 
reduce bank profits and dramatically reduce the affordable 
housing funding, which is vitally, vitally important.
    Now, my concerns are thus; the need for the proposed rule 
definitely has not been established. The premise that the par 
value of bank stock must be protected at all costs is 
incorrect. In accordance with current accounting policy only, 
``other than temporary impairment'' would require a write-down 
of member stock.
    There has never been such an event in the entire history of 
the Federal Home Loan Banking System, and the Board has not 
predicted one. And in proposing to change the capital rules for 
the bank, your Finance Board itself acknowledged that all the 
banks are well capitalized and they face no threat of 
insolvency. And even if additional capital in the form of 
retained earnings is appropriate for some banks, the proposed 
formula is overly simplistic, and does not take into 
consideration the specific risk and risk management policies 
and policies of each bank.
    The proposed formula creates a retained earnings to target 
that seems excessive in relation to the risk to the par value 
of capital stock for most banks. And the proposed retained 
earnings rules formula creates incentives for the banks to take 
on more risk and reduce liquidity.
    This proposed rule has the potential to create instability 
within the system by causing some members to leave the system, 
or at least reduce their use of advances significantly. If that 
happens, as I said, bank profits and the affordable housing 
funding would decline dramatically.
    The proposed rule is not consistent with bank capital 
requirements as established in Gramm-Leach-Bliley. The 
appropriate way to address capital concerns is not this way, 
perhaps to modify bank capital plans. There is no justification 
for this proposed regulation.
    Even if it were demonstrated that there are problems that 
need to be addressed--and you all haven't even demonstrated 
that--but even so, there are far more effective ways to do that 
without driving down the available housing funding.
    This proposed regulation has serious adverse consequences 
for the banks, their members, and the system of their 
respective communities. I would hope we reject this. I hope we 
would withdraw this. I think it is bad policy for our banking 
system, and would hurt the affordable housing funding 
dramatically.
    I look forward to your comments on this, and I have some 
very, very significant questions I would like to address to you 
at that time.
    Chairman Baker. I thank the gentleman. If there are no 
further opening statements at this time, I would like to 
recognize the Honorable Ronald A. Rosenfeld, Chairman of the 
Federal Housing Finance Board, welcome you here to the 
committee, and express my appreciation for your hard work and 
diligence in establishing a new regulatory regime. Please 
proceed as you see fit.

  STATEMENT OF RONALD A. ROSENFELD, CHAIRMAN, FEDERAL HOUSING 
                         FINANCE BOARD

    Mr. Rosenfeld. Thank you, Chairman Baker, Ranking Member 
Kanjorski, and distinguished members of the subcommittee. I 
appreciate the opportunity to testify on the Federal Housing 
Finance Board and the Federal Home Loan Bank System by 
testimony, reports on the condition and performance of the 
banks, the operations of the Finance Board, the status of two 
supervisory actions, and two key regulatory initiatives.
    I want first, however, to stress the need for reform of the 
regulation and supervision of the housing GSE's. Fannie Mae, 
Freddie Mac, and the 12 home loan banks are large, complex 
entities. They are important to the Nation's housing market and 
play a vital role in the financial markets. They should be 
overseen by a single, strong, and independent regulator that 
has a full arsenal of supervisory and enforcement tools.
    The combined assets of the 12 banks exceed $1 trillion. If 
the Federal Home Loan Bank System was a bank holding company, 
it would be the fourth largest bank holding company in the 
country. Advancers are the largest asset class, consisting of 
62 percent of assets. The top 10 holders of advances account 
for 33 percent of the total system advances.
    Mortgage purchases are even more heavily concentrated than 
advances. Mortgage loans purchased from members constitute 10 
percent of assets. Almost 70 percent of the mortgages in the 
system were purchased from 10 members. The total capital of the 
banks is $45.5 billion, or 4.4 percent of assets. Of that 
total, retained earnings are $3 billion.
    In the first 6 months of 2006, the banks' net income was 
$1.25 billion. The banks have grown in size, sophistication, 
and risk in recent years. Many of the banks were not equipped 
to deal with those changes. They did not embrace and implement 
appropriate governance and risk management tools.
    Two examples are the Seattle and Chicago banks. The Seattle 
and Chicago banks continue to operate under written agreements. 
While the particulars of each case are different, both had a 
high level of excess stock, and both were intent on growing 
their mortgage portfolios. The Chicago bank grew its mortgage 
portfolio by relying on excess stock. The Chicago bank's 
mortgage portfolio grew to 60 percent of assets and excess 
stock constituted approximately 60 percent of its capital 
stock.
    When the Chicago bank's earnings declined and dividends 
were reduced, as one might expect, member requests that the 
bank repurchase excess stock accelerated. To conserve its 
capital, the bank halted its repurchase of stock. In response, 
members holding over a quarter of a billion dollars in stock 
elected to withdraw from the bank. That process began a 6-month 
statutory redemption clock. We then had to act decisively and 
quickly.
    There were no easy options. The Chicago bank, unlike 
Seattle and the other 10 banks, had not yet converted to the 
Gramm-Leach-Bliley capital structure. After reviewing a number 
of alternatives, we permitted the Chicago bank to issue 
subordinated debt. The bank issued $1 billion in 10-year 
subordinated debt, which is used to retire a like amount of 
excess stock that was redeemable with 6 months notice.
    That solution provided the Chicago bank's new management 
team time to work through and resolve the bank's financial 
issues. We have learned from our supervisory experiences. We 
have also increased the supervisory staff, and upgraded our 
risk modeling technology. We now have the resources to better 
monitor risk, and the wherewithal to take early and resolute 
action where problems emerge.
    We have also taken a number of important regulatory 
actions. One of these is our rule requiring the banks to 
register with the SEC. All banks are now SEC registrants. 
Investors, other home loan banks, and the public now have a 
full and fair view of the financial condition and performance 
of each of the banks.
    A second regulatory action is our proposed rule on retained 
earnings and excess stock. In April of this year, the Finance 
Board issued for public comment a proposed rule to strengthen 
the capital composition of the banks. We are analyzing the 
1,066 comments we received, and are taking an open minded and 
cautious approach to the final rule.
    We will be guided by some fundamental principles. 
Specifically, we will do nothing to impede the good business 
judgement of the banks. We will not materially alter the value 
of membership in a bank, we will respect the lawful actions 
that banks have previously taken.
    Speaking only for myself, some commentators made valid 
points, and there is room for movement on several important 
issues. I want to be clear. I will never be apologetic about 
capital. While the capital level of the banks exceeds the 4 
percent statutory minimum, the composition of the bank's 
capital needs to be strengthened. That's the purpose of our 
proposed rule.
    Some comments state that that proposed rule is contrary to 
the statutory intent of Gramm-Leach-Bliley, and that we have 
exceeded our regulatory authority. We strongly disagree. The 
intent of Gramm-Leach-Bliley was to stabilize and strengthen 
the capital of the banks. Our proposal does exactly that. The 
rulemaking is fully consistent with our regulatory authority, 
and is an exercise of our regulatory duty. It is our duty to 
ensure the financial safety and soundness of the banks, a duty 
entrusted to us by this Congress.
    Chairman Baker, Ranking Member Kanjorski, and the members 
of the subcommittee, thank you for the opportunity to report on 
the condition of the Bank System and the Federal Housing 
Finance Board. I would be pleased to respond to any questions.
    [The prepared statement of Chairman Rosenfeld can be found 
on page 36 of the appendix.]
    Chairman Baker. Thank you, Mr. Chairman. I appreciate the 
manner in which you have approached this regulatory proposal, 
and certainly can understand how a GSE regulatory concept and 
controversy could be associated with one another.
    You could, in some instances, erase the name, ``Federal 
Home Loan Bank,'' and put the words ``Fannie Mae'' and 
``Freddie Mac'' in, and play back a few years ago, and it would 
not be too dissimilar.
    However, there is one element of the proposal that I found 
particularly interesting, if not troublesome. And that is, with 
regard--if I am understanding it properly--with regard to the 
holding of cash to require reserving, if you had $100, to 
reserve against that $100 in your account, is there a 
particular structural regulatory reason why reserving against 
cash on hand, which I thought would be a bit onerous?
    On the other side of the coin, however, not stated in most 
of the talking points distributed by the opponents of the 
matter, but expressed to me by intermediaries, and just--I find 
on these GSE things, you might as well just get it all out on 
the public domain--that some are suggesting there are other 
reasons, other than just capital adequacy, for the proposal of 
the current rule.
    Some have suggested this is just a first step for some sort 
of consolidation proposal. Others are more direct, in calling 
it just an attack on their profitability through the mortgage 
purchase program.
    If you could, just outline your policy reasons for the 
proposals construct. I think in your opening statement you 
referenced the necessity for adequate capital to hedge against 
any identifiable risk.
    But that ought to--we ought to dismiss these other 
accusations outright, or discuss the legitimizing reasons for 
the manner in which you're approaching this. And please proceed 
as you desire on those.
    Mr. Rosenfeld. Chairman Baker, you have given me a 
smorgasbord of possibilities, in terms of responding to the--to 
elements of the proposal. Let me attempt to deal with them as I 
recall them being raised.
    With regard to the commonality of the same retained 
earnings for all types of assets, other than advances. That is 
an area that we have received a great many comments on, and 
something that we are carefully considering.
    In the course of receiving comments, we have been apprised 
of some things relating to that concept, which is--certainly 
provides the benefit of simplicity. But it also has the 
potential of perhaps adversely affecting prudent business 
judgement. And therefore, it is something that we need to look 
at very carefully, as to whether we ought not apply some degree 
of risk weighting to various types of assets. And that is 
clearly one of the things that has been raised.
    While I am on areas that have been commented upon 
extensively, the other areas, though, one is the area of stock 
dividends. A number of people have said, ``Well, if you're 
going to limit excess stock, why limit how you get there? I 
mean, just stick with one objective, and that ought to be 
enough.'' And besides, some of the banks rely heavily on excess 
stock--pardon me, on stock dividends.
    The third area that has received a great deal of comment 
and has been referenced by a number of your committee members 
is this issue about until they reach a required level of 
retained earnings, dividends can be no more than 50 percent of 
income.
    Again, that is an area that--where the comments have been 
extraordinarily helpful, because a number of commentators have 
suggested that as long as there is no particularly urgent issue 
in the system today, it need not be so difficult, and the banks 
ought to have more time to get there, which raises an 
absolutely remarkable point, and that is there are 12 Home Loan 
Banks in the system. Eight or nine of the banks, in terms of 
the retained earnings requirement, are at or very close--within 
a stone's throw--of being there.
    So, this notion of how Draconian it is, is simply nonsense. 
Eight or nine of the banks are there, or will be there very 
shortly, without doing anything. In addition to which, the 
other Draconian allegation that was made towards this limit on 
excess stock, 8 of the 12 banks are there now. And one or two 
are very much on their way.
    So, the impact--this enormously broad opposition throughout 
the country and all the banks simply doesn't exist. It is 
absolutely nonsense. And let me point out to you that on the 
issue, for example, the issue of excess stock, which is one of 
the pillars of the proposal--we've got 400-some letters, 
comments, on that issue--81 percent of the letters came from 
the Cincinnati Bank.
    And throughout the entire comment period, what has happened 
is that the vast majority in virtually every single category 
has come out of the Cincinnati Bank. That's not to suggest the 
comments from the other banks are not important; they are very 
important. And quite frankly, they are very helpful. I just 
wanted to convey to you the fact that this is--that there is 
not this enormous outpouring of opposition throughout the 
country. It largely emanates from a campaign by the Cincinnati 
Bank. And we respect that, there is nothing wrong with that.
    With regard to the issue that we have in the ulterior 
motives, I have heard a couple of them alleged. Number one, is 
this our way at getting at the mortgage programs? The answer is 
absolutely not. If we decide to take some action with regard to 
the mortgage program, believe me, Mr. Chairman, we will take it 
directly. We will never go through the back door, we don't need 
to. That's not the way to regulate.
    Number two, the issue of consolidation, which has been 
raised frequently. The answer to that is we have stated 
publicly that we have--we are not promoting the consolidation 
of banks. We have said if two or more banks decide they want to 
merge, we will be cooperative and help them do it.
    Quite frankly, in my mind, I don't quite understand why you 
need six banks between Pittsburgh and Topeka. But if that's 
what the members want, and that's what the members are willing 
to pay for, and they run those institutions in a safe and sound 
fashion, that is their prerogative. It is not our call to 
change, and we have no intentions of changing.
    And quite frankly, Mr. Chairman, my memory at my age is--I 
can't remember some of the other issues, but if you could help 
me out--
    Chairman Baker. No, you have done an excellent job. One, 
your intention is to provide safety and soundness, providing a 
capital basis which you believe is justifiable. You don't have 
ulterior motives in mind that you are attempting to achieve. 
You perhaps will consider further adjustments to the pending 
rule, and you will not move and give adequate time for people 
to make further comment as warranted. Is that summarized 
properly?
    Mr. Rosenfeld. Yes, sir.
    Chairman Baker. Thank you very much. Mr. Kanjorski?
    Mr. Kanjorski. Mr. Rosenfeld, in an article this morning, 
in one of the banker's publications, they refer to the fact 
that Washington Mutual is--in regard to the ruling, because of 
the cost to them of the retained earning role, it would cost 
them $210 million. They are going overseas to finance.
    Now in my prior life as an attorney, I represented co-ops, 
and I very often found that members of co-ops are very astute 
in figuring out the effect of the co-ops' policies upon their 
particular earnings. And this is a strong indication that they 
are voting with their feet. They have other alternatives; they 
can go overseas. So I don't know whether it is--for safety and 
soundness--it is smarter to drive a customer, the largest 
customers to the banks of the System, to go overseas and do 
their financing.
    And that is why I think it's important that--and I can 
understand why we want to get safety and soundness, there isn't 
any question of that. But the implementation of these rules, or 
the inflexibilities of the rules, may cause unintended 
consequences of actions just like this.
    I don't want to dwell on that because I think the 
chairman's questions and your response served a lot of those 
purposes.
    I really want to find out about something that is--it's 
sort of offensive, because I was under the impression when we 
have met in the past, that you were going to be a hands-on 
regulator. You were going to get out into the field, and find 
out what is happening. Have you gone and met with the boards of 
directors of the various banks, and--
    Mr. Rosenfeld. I have not gone to the banks. I have met 
with them, met them here in Washington.
    Mr. Kanjorski. Are they telling you something different 
than I am hearing, that they are being literally choked by not 
having adequate membership on--
    Mr. Rosenfeld. Oh, quite the contrary, Mr. Kanjorski. I 
have had very little comment from the banks. As a matter of 
fact, with the exception of some issues with regard--a couple 
of banks have mentioned a problem with staffing committees on 
the bank board. But beyond that, there has been very little--
surprisingly little--commentary from the banks.
    Mr. Kanjorski. Do you know what some of the banks are 
doing, as a result--
    Mr. Rosenfeld. Well, I know what the Pittsburgh bank has 
done, and that is they have gone out and where one might have 
hoped that they had certain talent that was in the form of 
public interest directors with certain skill sets, since they 
don't have that, they have gone out and hired consultants, 
which is an interesting approach.
    Mr. Kanjorski. And they're the same people who would have 
been serving on the Board--
    Mr. Rosenfeld. Not necessarily. The people--the most well 
qualified don't necessarily get on the Board.
    Mr. Kanjorski. Well, then, is your hesitancy in making 
these appointments that you think the Administration is not 
offering competency in the appointment of these directors?
    Mr. Rosenfeld. No, no, no. I am responding to the 
difference between the expertise of a consultant--
    Mr. Kanjorski. I understand. But--
    Mr. Rosenfeld. And--
    Mr. Kanjorski. Mr. Rosenfeld, I have extraordinary contacts 
with all of these banks across the country, and I visit with 
them on a regular basis.
    Now, either they are not talking to you the way they are 
talking to me, but I have to tell you that, internally, for 
governance purposes, they are hurting. And their institutional 
memory is suffering. I think that the majority of the members 
at the end of this year will have less than 3 years' experience 
on the board.
    Mr. Rosenfeld. I respect that, Mr. Kanjorski. I understand 
what you are saying, and I respect it. But please, let me 
comment on one thing you said earlier, with regard to 
Washington Mutual.
    Mr. Kanjorski. Yes.
    Mr. Rosenfeld. Interestingly enough, I would suggest that 
the proper interpretation of their action is just the converse 
of what you are suggesting. And the reason that--well, I am 
sure one of the very significant reasons that WAMU is seeking 
to withdraw, or at least do less business, with the Home Loan 
Bank System is their experience in Seattle.
    Seattle is a terrible situation for WAMU, because they are 
getting--they have a big presence, and they are getting zero 
dividends. The reason they are getting zero dividends is 
because we did not have in place the rules that we are now 
trying to put in place. WAMU would have a totally different 
experience with the Home Loan Bank System, had Seattle not 
succumbed to the problems that they--
    Mr. Kanjorski. Well, aren't they a member of another bank, 
the San Francisco--
    Mr. Rosenfeld. They are a member of the San Francisco--
    Mr. Kanjorski. Why don't they go to the San Francisco bank?
    Mr. Rosenfeld. I think the San Francisco bank, to my 
knowledge, they have not had a bad experience there. And I 
don't think you can contribute--with an organization as big and 
sophisticated as WAMU is, or Wells Fargo, or Bank of America, 
they have all sorts of reasons for how they fund their needs.
    And we certainly can't blame a decision to go overboard or 
go to the private sector, or whatever, on the--
    Mr. Kanjorski. Okay. I accept that, and we will have to 
look at that maybe in a future hearing. We can call Washington 
in to explain why they made these judgements. But I am seeing a 
lot of business here move overseas that could be in the 
American market.
    But getting back to the directors, what does the Congress 
of the United States have to do? The present law says it is 
your responsibility to make these appointments. You have 
refused to do so.
    I have to ask the question, are you an independent 
regulator, as you have defined it, totally at arm's length with 
the industry, and totally independent of all other influence, 
or are you failing to carry out these appointments by some 
statement or conversation with the White House, whose policy is 
not to make these appointments? Are you failing to carry out 
your function as a regulator independently, because of 
something this White House is telling you to do?
    Mr. Rosenfeld. I believe that we are an independent 
regulator. I also believe that it is inappropriate for a 
regulator to appoint the regulated.
    Mr. Kanjorski. Oh, you disagree with the law, then?
    Mr. Rosenfeld. I think a regulator should not appoint the 
regulated. I am aware there is a statute. I believe, however--
    Mr. Kanjorski. Mr. Rosenfeld, you mean the regulator now is 
going to pass and interpret the laws governing these banks, or 
is the Congress--
    Mr. Rosenfeld. I think the statutes are such, the latitude, 
in terms of time, as to when to appoint, while the issue of GSE 
reform--which has been referred to numerous times today--
    Mr. Kanjorski. Mr. Rosenfeld, 2\1/2\ years, not one 
independent director to any of the banks has been appointed by 
your office or your predecessor. Is that correct?
    Mr. Rosenfeld. That is true. I believe the real answer is 
to have GSE reform.
    Mr. Frank. Will the gentleman yield?
    Mr. Kanjorski. I will yield, Mr. Frank.
    Mr. Frank. Again, Mr. Rosenfeld, it is--first of all, the 
suggestion that consultants can make up for boards of 
directors, and that it is somewhat interchangeable--
    Mr. Rosenfeld. I'm sorry?
    Mr. Frank. I hope you don't really think, really mean to 
say, that you can solve a problem of not having an appropriate 
board of directors by hiring consultants.
    Mr. Rosenfeld. I didn't--
    Mr. Frank. Yes, you said, ``Well, they lost the 
expertise.''
    But secondly, this assertion that you can't appoint 
directors because GSE legislation is pending, but you can 
promulgate the most far reaching change in the capital 
structure when that's also the subject of GSE legislation, 
that's the least logical argument I have ever heard here.
    Chairman Baker. If I might interject here, gentlemen, just 
for the moment--Mr. Kanjorski, we are down to a little over 3 
minutes on the pending vote. We are going to recess and come 
back to continue. So if I may ask the indulgence of the 
chairman, the committee will stand in recess for about 15 
minutes.
    [Recess]
    Chairman Baker. I would like to reconvene our hearing on 
capital markets. When we were last meeting, I believe it was 
Mr. Kanjorski who had been previously recognized. So I would 
now go to the Republican side, and recognize Ms. Kelly for any 
comment or question she may have.
    Mrs. Kelly. Thank you very much, Mr. Chairman. In its 
proposed rule concerning deposit insurance assessments that was 
published on July 24th, the FDIC specifically requested 
comments on whether the Federal Home Loan Bank advances should 
be included in the definition of ``volatile liabilities'' for 
risk differentiation purposes for smaller institutions with 
less than $10 billion in assets.
    Frankly, I don't see a need for charging higher premiums 
for prudently managed and sufficiently capitalized 
institutions, simply because they use the Federal Home Loan 
Bank advances. Advances are not volatile liabilities. Of the 
sources available to community banks, Home Loan Bank advances 
are the only ones which have been around for nearly 75 years, 
and which have been--and which are purchased on a pre-defined 
and predictable term by fully regulated member lenders.
    Obviously, this is a matter that should be on the radar 
screen of the FHFB. And in this regard, I would like to know if 
the FHFB considers advances to be volatile liabilities. You can 
probably just answer that yes or no.
    Mr. Rosenfeld. No.
    Mrs. Kelly. Okay.
    Mr. Rosenfeld. Absolutely not. I think it is a mistake to 
use the term ``advances'' and ``volatility'' in the same 
sentence.
    Mrs. Kelly. Okay. In addition, is FHFB planning to take a 
position on the Federal Home Loan Bank issue raised in the 
FDIC's proposal, and notify the FDIC of its views?
    Mr. Rosenfeld. I am sure that, to the extent that we are an 
involved participant, we will appropriately make our position 
known.
    Mrs. Kelly. All right. Thank you, Mr. Chairman, he has 
answered my question. I yield back.
    Chairman Baker. I thank the gentlelady. Mr. Clay?
    Mr. Clay. Thank you, Mr. Chairman. And thank you for being 
here.
    The affordable housing programs of the FHL Banks has been a 
tremendous success, with over $2 billion in grants for 
affordable housing since 1990. These AHP grants by FHL Banks 
provide capital so that member institutions and community 
sponsors can arrange for the development and construction of 
affordable housing.
    At a time when more families need affordable housing, it is 
troubling that the Finance Board has issued a proposal whose 
effect on FHL Bank System, you acknowledge in your July letter 
to Congressmen Oxley and Frank, is uncertain. Since the AHP 
program depends directly on FHL Bank earnings, this is even 
more troubling.
    What analysis has the Finance Board done on the potential 
impact of the proposal on the AHP program?
    Mr. Rosenfeld. I am delighted you asked that question, 
because a number of commentators and a number of 
congresspersons here have made the statement that somehow or 
another these proposals adversely affect AHP. I would submit to 
you that that's simply wrong.
    First of all, in both the case of the retained earnings 
provisions, as well as the excess earning--excess stock 
provisions, roughly three-quarters of all the banks simply 
aren't affected at all. So I think you can eliminate them from 
the issue of whether anything negative would occur in their AHP 
program.
    I would also suggest that AHP contributions are based upon 
earnings. To the extent that you increase retained earnings, 
that does not affect your income. If it did anything, it would 
increase the income, not decrease the income. I can think of 
perhaps one bank, maybe two, where the excess stock provisions 
would have a bearing in possibly reducing AHP payments.
    But I would point out to you the worst thing that has 
happened to AHP, which is a wonderful program, and we all 
acknowledge it, has been Seattle and Chicago. That's where AHP 
has gotten hurt. I wouldn't want to be the person that called 
on Seattle to get their contribution to AHP. It's not a pretty 
number.
    And what we are trying to do is to make sure that those 
kinds of things that reduce the earnings of banks and adversely 
affect AHP simply don't occur again. That's what this is all 
about.
    Mr. Clay. Let me follow up on that vein. What alternative 
funding source may be available for affordable housing, if FHL 
Bank earnings decline, as a result of the proposal?
    Mr. Rosenfeld. Well, first of all, the answer to increasing 
AHP profitability is to increase the business and increase the 
earnings.
    For example, there are some pending new business activities 
in the area of working with insurance companies, which could be 
the source of additional income. I think Mr. Kanjorski is 
familiar with a proposal to have the FHLB be able to credit 
enhance industrial bonds, which could be a new source of 
revenue appropriately--if it were appropriately underwritten.
    There is--quite frankly, the Home Loan Banks have an 
enormous opportunity. What they need to do, as any good 
business does, is through the use of ingenuity and technology 
working together, create better products, do a better job, in 
terms of growing their businesses.
    I would point out to you that it takes a Des Moines bank--
the Des Moines bank has had a number of problems in their 
mortgage portfolio. They had 90 percent of their mortgages that 
they bought coming from 1 customer. What prudent businessperson 
would ever allow 90 percent of their portfolio of anything--
certainly anything significant--to come from 1 customer?
    Now, I would also point out that Des Moines has 1,190 other 
banks in the system, in their membership. Boy, I will tell you, 
if I ran Des Moines, I would be out trying to figure out what I 
could sell to those other 1,190 banks. That's how you grow 
earnings. It's a business.
    Mr. Clay. So, the banks should be innovative and look at 
new business ventures?
    Mr. Rosenfeld. Absolutely. That is what I am--that's 
American business. That is why we are where we are. Innovation 
is critical.
    Mr. Clay. I thank the witness for his response, and thank 
you, Mr. Chairman. I yield back.
    Chairman Baker. I thank the gentleman. Mr. Campbell, did 
you have--Mr. Scott?
    Mr. Scott. Thank you very much, Mr. Chairman. Let me visit 
this issue of the affordable housing program. And your response 
to Congressman Clay's question somewhat intrigued me, when you 
just cavalierly passed that off. Let me tell you how I 
understand the impact that your ruling will have on drying up 
affordable housing funds.
    First of all, as your rule would do, FHL Banks would be 
forced to retain earnings, no matter what their individual 
business plans or risk profiles look like, over $2 billion will 
be retained. And that $2 billion will be $2 billion that will 
not be distributed through FHL Banks' member institutions to 
the borrowing public.
    And in addition, as the FHL Bank adjusts their business 
operations to take into account that some of their larger 
members will leave because the FHL Bank membership is no longer 
financially attractive--I am not saying you are intentionally 
trying to dry up that fund. This is unintended consequences. If 
your membership leaves, and is no longer financially attractive 
to the Home Loan Banks, then the cost of the FHL Bank advances 
to remaining members will increase, and members will, in turn, 
pass on those increased costs to working class families who are 
seeking home mortgages.
    Now, if the FHL Bank members leave--and, indeed, they will, 
as you have mentioned two or three of them, but there will be 
more than that--another potential adverse effect of the rule 
that would drive affordable housing money is that the earnings 
of the FHL Banks will decrease, thereby decreasing the amount 
of funds available for FHL Banks' affordable housing programs.
    Each year, the FHL Banks contribute 10 percent of their 
earnings as seed capital to the affordable housing program, 
which sponsors the local community groups, and backed 
financially by FHL members.
    Of course, as we pointed out, since 1990 the FHL Banks have 
provided over $2 billion in affordable housing funds. This 
public/private partnership is vital to providing decent housing 
opportunities for working class families. And your rule, the 
Finance Board rule, will--and let's be generous here, and say 
``inadvertently''--but it will, nonetheless, restrict the 
ability of the FHL Banks to meet their affordable housing 
funding responsibilities.
    To show you how serious this is, this is an article in 
today's paper. Here is what it says, ``African Americans not 
closing the gap in home ownership rates.'' The report blames 
two things: discrimination and lack of affordable housing 
funds.
    Now, it is clear, as I have pointed out, how this would 
work. And I don't understand why you all have not taken that 
into consideration, that members will leave, drying up the 
amount of money that is there. And even when you put the 
pressure on, it will be downward pressure with this $2 billion 
that won't be available public monies, anyway. In two ways you 
are taking available funds out of the market place, out of 
play, that would help with the affordable housing fund.
    Mr. Rosenfeld. Mr. Scott, I share your obviously great 
interest in affordable housing. As you know--perhaps you don't 
know--I spent most of my Federal service at HUD, and I really 
do share your concerns and your beliefs in the importance of 
that issue.
    But I would respectfully suggest that you are 
misinterpreting something. The amount of dividends that a bank 
pays to its members has nothing to do with its earnings. The 
contributions to AHP are made at the Federal Home Loan Bank 
level, which is--and that amount of contribution is determined 
by their income. Dividends to the members have nothing to do 
with it.
    And I would point out, as a practical matter--and this is 
not a reason to make the proposal, but as a practice matter--
the more retained earnings you have, which are invested, the 
greater your income is. So the reality is that by having more 
retained earnings, that in and of itself increases income--and 
therefore, AHP contributions--rather than decreases them.
    The one comment--or, I shouldn't say one--you made a 
comment about major banks leaving, and therefore that could 
adversely affect income, and therefore adversely affect AHP 
contributions. Theoretically, that is possible. But both in my 
written statement to the committee, and my oral statement, I 
tried to make it very clear that one of the things we will 
consider in doing the final rule is that we don't materially 
change the value calculation for members, and we are very 
conscious of that.
    Again, I reiterate that 75 percent of the members are 
unaffected. So you are talking about perhaps two banks, two or 
three banks, where we have to be extremely cautious and careful 
that, however the final rule comes out, that we don't 
materially adversely affect the value of membership.
    Mr. Scott. Seventy-five percent of the banks won't be 
affected? One of those 25 percent affected might be my bank, 
the Federal Home Loan Bank of Atlanta.
    Mr. Rosenfeld. I don't think so.
    Mr. Scott. And even if it is not, if one bank is impacted 
by this rule negatively, it should not be in place.
    Mr. Rosenfeld. If we had this rule in place 3 years ago, 
AHP would have substantially more money today than they have.
    Chairman Baker. Mr. Scott--
    Mr. Scott. Yes, I want to ask another question.
    Chairman Baker. If this can be your final, we will wrap up, 
Mr. Scott.
    Mr. Scott. Even if there are some Home Loan Banks with 
inadequate capital, your proposal doesn't appear to adequately 
differentiate such home loan banks from others that have plenty 
of capital. I mean, why not?
    And how do you justify requiring the same capital for cash 
and cash equivalents as you require for mortgages and 
relatively high risk securities? And what analysis have you 
done to justify the proposal?
    And I do understand that you were asked to disclosure your 
analysis before, but you refused. Why?
    Mr. Rosenfeld. Well, I don't recall the specific facts, but 
I can't imagine I refused to disclose an analysis. I can tell 
you that the issue that you are alluding to, in terms of the 
potential risk waiting for different types of assets, I think, 
is an issue that has been raised by many people.
    I think the notion of 1 percent for all kinds of assets 
needs to be seriously revisited. We intend to do so. And I 
think there is a great deal of merit in the--as I mentioned 
with the commentators, I think there is a great deal of merit 
in your question.
    The answer is, I mean, the very simple answer is when 
you're doing this sort of thing we start with a very simple 
principle. What we have come to understand, through the benefit 
of the comments, is that the simple principle may be a better 
principle if it's somewhat more complex. And we are very 
concerned that the principle, as proposed in the rule simply 
might lead to what could be poor business judgement on the part 
of bank management.
    And again, as I said in my testimony, that is something we 
clearly want to avoid. So, we are going to do whatever we can 
to get away from anything that would create poor business 
judgement on the part of management.
    Mr. Scott. Mr. Chairman, I am going to thank you for your 
indulgence on that, and the question, and I certainly want to 
submit this very important article, very timely, about the lack 
of affordable housing and its impact on working class folks, 
for the record.
    Chairman Baker. Without objection, Mr. Scott.
    And we will keep the record open, so if members choose to 
submit additional written inquiries of the chairman, they 
certainly may do so.
    I want to express my appreciation to you, Mr. Chairman, for 
being available, for coming before the committee. It is clear 
that Members have a number of considerable concerns about the 
proposal, but I was pleased to hear your comment indicating 
that the rule is still subject to potential modification, that 
you will move ahead slowly, listening to those legitimate 
concerns that have been raised, and will continue to advise the 
committee as to the intended consequences of this rulemaking 
process. And for that, I am appreciative.
    And thank you for your courtesy in appearing here today. 
Our meeting stands adjourned.
    [Whereupon, at 11:40 a.m., the hearing was adjourned.]


                            A P P E N D I X



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