Housing Government-Sponsored Enterprises: A New Oversight	 
Structure Is Needed (21-APR-05, GAO-05-576T).			 
                                                                 
Serious concerns exist regarding the risk management practices	 
and the federal oversight of the housing government-sponsored	 
enterprises (GSE)--Fannie Mae, Freddie Mac, and the Federal Home 
Loan Bank System (FHLBank System), which had combined obligations
of $4.6 trillion as of year-end 2003. In 2003, Freddie Mac	 
disclosed significant accounting irregularities. In 2004, the	 
Office of Federal Housing Enterprise Oversight (OFHEO) cited	 
Fannie Mae for accounting irregularities and earnings		 
manipulation. Fannie Mae has to restate its financial statements 
for 2001-2004 and OFHEO has required the GSE to develop a capital
restoration plan. Also in 2004, the FHLBanks of Chicago and	 
Seattle entered into written agreements with their regulator, the
Federal Housing Finance Board (FHFB), to implement changes to	 
enhance their risk management. To assist Congress in its housing 
GSE oversight, this testimony provides information on GSEs'	 
missions and risks, the current regulatory structure, and	 
proposed regulatory reforms.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-576T					        
    ACCNO:   A22079						        
  TITLE:     Housing Government-Sponsored Enterprises: A New Oversight
Structure Is Needed						 
     DATE:   04/21/2005 
  SUBJECT:   Accounting standards				 
	     Agency missions					 
	     Government sponsored enterprises			 
	     Housing						 
	     Housing programs					 
	     Lending institutions				 
	     Mortgage programs					 
	     Regulatory agencies				 
	     Reporting requirements				 
	     Risk management					 

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GAO-05-576T

United States Government Accountability Office

GAO Testimony

Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate

For Release on Delivery

Expected at 10:00 a.m. EDT HOUSING GOVERNMENT-

Thursday, April 21, 2005

SPONSORED ENTERPRISES

                      A New Oversight Structure Is Needed

Statement of David M. Walker, Comptroller General of the United States

GAO-05-576T

[IMG]

April 21, 2005

HOUSING GOVERNMENT-SPONSORED ENTERPRISES

A New Oversight Structure Is Needed

  What GAO Found

While the GSEs provide certain public benefits, they also pose potential
risks. Fannie Mae and Freddie Mac's primary activity involves purchasing
mortgages from lenders and issuing mortgage-backed securities that are
either sold to investors or held in the GSEs' retained portfolio. The 12
FHLBanks traditionally made loans to their members and more recently
instituted programs to purchase mortgages from their members and hold such
mortgages in their portfolios. While not obligated to do so, the federal
government could provide financial assistance to the GSEs if one or more
experienced financial difficulties that could result in significant costs
to taxpayers. Due to the GSEs' large size, the potential also exists that
financial problems at one or more of the GSEs could have destabilizing
effects on financial markets.

The current housing GSE regulatory structure is fragmented and not
wellequipped to oversee their financial soundness or mission achievement.
For example, although all the GSEs face increasingly similar risks
(particularly potential losses in their mortgage portfolios resulting from
fluctuations in interest rates), OFHEO is responsible for Fannie Mae and
Freddie Mac's safety and soundness oversight while FHFB is responsible for
the safety and soundness and mission oversight of the FHLBanks. OFHEO also
lacks key regulatory authorities necessary to fulfill its oversight
responsibilities. Moreover, the Department of Housing and Urban
Development (HUD), which has housing mission oversight responsibility for
Fannie Mae and Freddie Mac, faces a number of challenges in carrying out
its responsibilities. In particular, HUD may not have sufficient resources
and technical expertise to review sophisticated financial products and
issues.

Creating a single housing GSE regulator could better ensure consistency of
regulation among the GSEs. With safety and soundness and mission oversight
combined, a single regulator would be better positioned to consider
potential trade-offs between these sometimes competing objectives. To
ensure the independence and prominence of the regulator and allow it to
act independently of the influence of the housing GSEs, this new GSE
regulator should have a structure that consists of a board or a hybrid
board and director model. To be effective, the single regulator must also
have all the regulatory oversight and enforcement powers necessary to
address unsafe and unsound practices, respond to financial emergencies,
monitor corporate governance and compensation practices, assess the extent
to which the GSEs' activities benefit home buyers and mortgage markets,
and otherwise ensure that the GSEs comply with their public missions.

                 United States Government Accountability Office

Mr. Chairman, Mr. Ranking Minority Member, and Members of the Committee:

I appreciate the opportunity to participate in today's hearing to discuss
federal oversight of the housing government-sponsored enterprises (GSE),
namely Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System
(FHLBank System). When I testified before this committee in February 2004
on this same topic, it was shortly after Freddie Mac had disclosed
significant financial problems associated with its accounting practices.1
Freddie Mac's regulator-the Office of Federal Housing Enterprise Oversight
(OFHEO)-did not detect the GSE's accounting irregularities at an early
stage. At that hearing, I discussed the need for the establishment of a
capable, credible, strong, and independent regulatory structure to help
ensure that the housing GSEs operate safely and soundly. To accomplish
this goal, GAO-and others--proposed that Congress replace the current
fragmented regulatory structure for housing GSE oversight with a single
regulator that would be responsible for safety and soundness and mission
activities. Subsequently, this committee took the lead in approving a
strong bill to create a single GSE regulator.

Over the past year, the need for fundamental regulatory reform of the
housing GSEs has become even more clear and compelling. As you well know,
Fannie Mae has been found to have engaged in the misapplication of
accounting standards and earnings manipulation, and company staff even
allegedly falsified signatures on documents. Fannie Mae will have to
restate its financial statements for the past several years and OFHEO has
required the GSE to develop a capital restoration plan. I am encouraged
that OFHEO identified these deficiencies at Fannie Mae and has moved
aggressively to correct them. I also note that the FHLBank System's
regulator-the Federal Housing Finance Board (FHFB)-has identified risk
management deficiencies at the Chicago and Seattle FHLBanks and entered
into written agreements with these institutions to correct identified
deficiencies. Nevertheless, I believe the evidence clearly shows that the
current regulatory structure is not well-equipped to oversee the
operations and effectively monitor the risks of the large and complex

1See GAO, Government Sponsored Enterprises: A Framework for Strengthening
GSE Governance and Oversight, GAO-04-269T (Washington, D.C.: Feb. 10,
2004).

housing GSEs, which had combined financial obligations of about $4.6
trillion at year-end 2003.2

To assist the committee in its oversight of the housing GSEs and their
regulation, my testimony today is divided into two sections. First, I will
provide an overview of the GSEs and their missions, identify the risks
they pose to taxpayers and the financial system, and describe the current
regulatory structure, which is divided among OFHEO, the Department of
Housing and Urban Development (HUD), and FHFB. Second, I will identify
deficiencies in the current regulatory structure and discuss how a single
regulator that is governed by a board and endowed with adequate legal
authorities is, in our view, the best potential means to help ensure that
the GSEs meet their housing-related missions while doing so in a safe and
sound manner.

To prepare for this testimony, we relied heavily on a substantial amount
of work that we had done on the housing GSEs and their regulatory
oversight in the past (see Related GAO Products), but we also reviewed our
historical positions in light of recent events. We conducted our work in
Washington, D.C., in April 2005 in accordance with generally accepted
government auditing standards.

I would like to begin my testimony by briefly describing the missions and
activities of each of the GSEs, and the risks they pose to taxpayers. Then
I will describe the current GSE regulatory structure.

Overview of the

  Housing GSEs, Their Risks, and Regulatory Structure

The Housing GSEs Share Similar Missions

Fannie Mae and Freddie Mac's mission is to enhance the availability of
mortgage credit across the nation during both good and bad economic times
by purchasing mortgages from lenders (banks, thrifts, and mortgage
lenders), which then use the proceeds to make additional mortgages
available to home buyers. Most mortgages purchased by Fannie Mae and
Freddie Mac are conventional mortgages, which have no federal insurance

2The reported housing GSEs' financial data for financial obligations and
retained mortgage portfolios identified in this testimony are subject to
change. Both Fannie Mae and the FHLBank System are currently revising
previous financial statements.

or guarantee. The companies' mortgage purchases are subject to a
conforming loan limit that currently stands at $359,650 for a
single-family home in most states. Although Fannie Mae and Freddie Mac
hold some mortgages in their portfolios that they purchased, most
mortgages are placed in mortgage pools to support mortgage-backed
securities (MBS). MBS issued by Fannie Mae or Freddie Mac are either sold
to investors (offbalance sheet obligations) or held in their retained
portfolios (on-balance sheet obligations). Fannie Mae and Freddie Mac
guarantee the timely payment of principal and interest on MBS that they
issue.

The 12 FHLBanks that constitute the FHLBank System traditionally made
loans-also known as advances-to their members (typically banks or thrifts)
to facilitate housing finance and community and economic development.
FHLBank members are required to collateralize advances with high-quality
assets such as single-family mortgages. More recently, the FHLBanks
initiated programs to purchase mortgages directly from their members and
hold them in their retained portfolios. This process is similar to Fannie
Mae and Freddie Mac's traditional business activities, although the
FHLBanks do not currently have the authority to securitize

3

mortgages.

The housing GSEs' activities have generally been credited with enhancing
the development of the U.S. housing finance market. For example, when
Fannie Mae and the FHLBank System were created during the 1930s, the
housing finance market was fragmented and characterized by regional
shortages of mortgage credit.4 It is widely accepted that the housing
GSEs' activities helped develop a unified and liquid mortgage finance
market in this country.

Housing GSE Activities Involve Significant Risks

While the housing GSEs have generated public benefits, their large size
and activities pose potentially significant risks to taxpayers. As a
result of their activities, the GSEs' outstanding debt and off-balance
sheet financial obligations were about $4.6 trillion as of year-end 2003.
The GSEs face the risk of losses primarily from credit risk, interest rate
risk, and operational

3Securitization is the process of aggregating similar financial
instruments, such as loans or mortgages, into pools and selling investors
securities that are backed by cash flows from these pools.

4Freddie Mac was established in 1970.

risks.5 Although the federal government explicitly does not guarantee the
obligations of GSEs, it is generally assumed on Wall Street that
assistance would be provided in a financial emergency. In fact, during the
1980s, the federal government provided financial assistance to both Fannie
Mae and the Farm Credit System (another GSE) when they experienced
difficulties due to sharply rising interest rates and declining
agricultural land values, respectively. The potential exists that Congress
and the executive branch would determine that such assistance was again
necessary in the event that one or more of the GSEs experienced severe
financial difficulties. Because the markets perceive that there is an
implied federal guarantee on the GSEs' obligations, the GSEs are able to
borrow at interest rates below that of private corporations.

The GSEs also pose potential risks to the stability of the U.S. financial
system. In particular, if Fannie Mae, Freddie Mac, or the FHLBank System
were unable to meet their financial obligations, other financial market
participants depending on payments from these GSEs may in turn become
unable to meet their financial obligations. To the extent that this risk,
called systemic risk, is associated with the housing GSEs, it is primarily
based on the sheer size of their financial obligations. For example, as
discussed in OFHEO's 2003 report on systemic risk, if either Fannie Mae or
Freddie Mac were to become insolvent, financial institutions holding the
enterprise's MBS could be put into a situation where they could no longer
rely on those securities as a ready source of liquidity.6 Depending on the
response of the federal government, the financial health of the banking
segment of the financial services industry could decline rapidly, possibly
leading to a decline in economic activity. As another example, derivatives
counterparties holding contracts with a financially troubled GSE could
realize large losses if the GSE were no longer able to meet its
obligations. If such an event were to occur, widespread defaults could
occur in derivatives markets.

5Credit risk is the possibility of financial loss resulting from default
by homeowners on housing assets that have lost value; interest rate risk
is the risk of loss due to fluctuations in interest rates; and operational
risk includes the possibility of financial loss resulting from inadequate
or failed internal processes, people, and systems or from external events.

6Office of Federal Housing Enterprises Oversight, Systemic Risk: Fannie
Mae, Freddie Mac, and the Role of OFHEO (Washington, D.C.; Feb. 4, 2003).

Housing GSE Regulatory Structure Is Divided among OFHEO, HUD, and

o

FHFB

o

o

  Housing GSE Regulatory Reform Is Necessary to Better Ensure Safety and
  Soundness and Mission Achievement

The current regulatory structure for the housing GSEs is divided among
OFHEO, HUD, and FHFB, as described below:

OFHEO is an independent office within HUD and is responsible for
regulating Fannie Mae and Freddie Mac's safety and soundness. OFHEO
oversees the two GSEs through its authority to examine their operations,
determine capital adequacy, adopt rules, and take enforcement actions.
Although OFHEO's financial plans and forecasts are included in the
President's budget and are subject to the appropriations process, the
agency is not funded with tax dollars. Rather, Fannie Mae and Freddie Mac
pay annual assessments to cover OFHEO's costs.

HUD is responsible for ensuring that Fannie Mae and Freddie Mac are
accomplishing their housing missions. HUD is to accomplish this
responsibility through its authority to set housing goals, and to review
and approve new programs, and through its general regulatory authority.
HUD is funded through appropriations.

FHFB is responsible for regulating the FHLBank System's safety and
soundness as well as its mission activities. The agency has a five-member
board, with the President of the United States appointing four members-
each of whom serves a 7-year term-subject to Senate approval. The fifth
member is the Secretary of HUD. The President also appoints FHFB's chair
subject to Senate approval. Like OFHEO, FHFB carries out its oversight
authorities through examinations, establishing capital standards, rule
making, and taking enforcement actions. FHFB is funded through assessments
of the 12 Federal Home Loan Banks and is not subject to the appropriations
process.

As I stated previously, OFHEO has moved aggressively over the past year to
identify and address risk management and accounting deficiencies at Fannie
Mae and Freddie Mac, and FHFB has entered into written agreements with two
FHLBanks to correct interest rate risk management deficiencies.
Nevertheless, we continue to believe that the current fragmented
regulatory structure for the housing GSEs is inadequate to monitor these
large and complex financial institutions and their mission activities.
Establishing a single housing GSE regulator with a board structure and
equipping the agency with adequate authorities would better ensure that
the GSEs operate in a safe and sound manner and fulfill their housing
missions.

Current GSE Regulatory Structure Is Fragmented, OFHEO Lacks Key
Authorities, and HUD's Mission Oversight Capacity Is Questionable

The current fragmented structure of federal housing GSE regulation does
not provide for a comprehensive and effective approach to safety and
soundness regulation. Although the housing GSEs operate differently, their
business activities and risks are becoming increasingly similar. As I
described previously, the FHLBank System has established mortgage purchase
programs over the past several years and FHLBank System mortgage holdings
were $113 billion at year-end 2003. While still small compared with Fannie
Mae and Freddie Mac's combined retained mortgage portfolios of $1.3
trillion for the same time period, the FHLBank System now operates more
like Fannie Mae and Freddie Mac and is increasingly incurring interest
rate risks. Management of interest rate risk for mortgage holdings
involves the application of sophisticated riskmanagement techniques,
including the use of financial derivatives. Although such strategies are
appropriate for risk management, they require specialized expertise,
sophisticated information systems, and an understanding and application of
sometimes complex accounting rules. In my view, it simply does not make
sense for the federal government to entrust regulation of large and
complex GSEs that are incurring similar risks to two different regulators,
which have different approaches to examinations and setting capital
standards.

Moreover, OFHEO, and FHFB to a lesser degree, lack key authorities to
fulfill their safety and soundness responsibilities, as described below:

o  	Unlike with bank regulators and FHFB, (1) OFHEO's authority to issue
cease and desist orders does not specifically list an unsafe and unsound
practice as grounds for issuance and (2) OFHEO's powers do not include the
same direct removal and prohibition authorities applicable to officers and
directors.

o  	Bank regulators have prompt corrective action authorities that are
arguably more robust and proactive than those of OFHEO and FHFB. These
authorities require that bank regulators take specific supervisory actions
when bank capital levels fall to specific levels or provide the regulators
with the option of taking other actions when other specified unsafe and
unsound actions occur.7 Although OFHEO has statutory

authority to take certain actions when Fannie Mae or Freddie Mac capital
falls to predetermined levels, the authorities are not as proactive or
broad

7Capital can be a lagging indicator of unsafe and unsound conditions at
financial institutions. Declining asset quality is an unsafe and unsound
condition that may be identified months or years before capital declines.

as those of the bank regulators.8 OFHEO has also established regulations
requiring specified supervisory actions when unsafe conditions are
identified that do not include capital, but OFHEO's statute does not
specifically mention these authorities. FHFB's statute does not establish
a prompt corrective action scheme that requires specified actions when
unsafe conditions are identified. Although FHFB officials believe they
have all the authority necessary to carry out their safety and soundness
responsibilities, the agency has significant discretion in resolving
troubled FHLBanks. Consequently, there is limited assurance that FHFB
would act decisively to correct identified problems.

o  	Unlike bank regulators--which can place insolvent banks into
receivership-and FHFB, which can take actions to liquidate an FHLBank,
OFHEO is limited to placing Fannie Mae or Freddie Mac into a
conservatorship.9 Thus, it is not clear that OFHEO has sufficient
authority

to fully resolve a situation in which Fannie Mae or Freddie Mac is unable
to meet its financial obligations.

Finally, we have significant concerns about HUD's capacity as the mission
regulator for Fannie Mae and Freddie Mac. As I stated in my testimony last
year, HUD officials we contacted said the department lacked sufficient
staff and resources necessary to carry out its GSE mission oversight
responsibilities. HUD officials said that although the GSEs' assets had
increased nearly sixfold since 1992, HUD's staffing had declined by 4,200
positions and GSE oversight-which consisted of about 13 full-time
positions-must compete with other department priorities for the limited
resources available. While HUD's ability to ensure adequate resources for
its GSE oversight responsibilities is limited, its mission oversight
responsibilities are increasingly complex. For example, as we have noted
in the past, it is not clear that HUD has the expertise necessary to
review sophisticated financial products and issues, which may be
associated with the department's program review and approval and general
regulatory

8For example, bank regulators are generally required to take specified
regulatory actions at earlier stages of capital depletion than is OFHEO.
Bank regulators are also required to initiate four supervisory actions
against an undercapitalized institution-including restricting asset
growth-while OFHEO is mandated to take only two actions (not including
restricting asset growth).

9According to OFHEO officials, a receivership is empowered to take over
the assets and operate an entity, assuming all of its powers and
conducting all of its business as well as removing officers and directors.
A receiver may place the failed institution into liquidation and sell its
assets. While a conservator may also remove officers and directors of an
entity, a conservator is typically appointed to conserve rather than
dispose of assets.

authorities.10 In addition, without the authority to impose assessments on
Fannie Mae and Freddie Mac to cover the costs associated with their
mission oversight, it would appear that HUD will always be challenged to
fulfill its GSE mission oversight responsibilities.

A Single Housing GSE Regulator with a Board or Hybrid Board/Director
Governance Model and Equipped with Sufficient Authorities Is Critical

To address the deficiencies in the current GSE regulatory structure that I
have just described, we have consistently supported and continue to
believe in the need for the creation of a single regulator to oversee both
safety and soundness and mission of the housing GSEs.11 A single housing
GSE regulator could be more independent, objective, efficient, and
effective than separate regulatory bodies and could be more prominent than
either one alone. We believe that valuable synergies could be achieved,
and expertise in evaluating GSE risk management could be shared more
easily, within one agency. In addition, we believe that a single regulator
would be better positioned to oversee the GSEs' compliance with mission
activities, such as special housing goals and any new programs or
initiatives any of the GSEs might undertake. This single regulator should
be better able to assess these activities' competitive effects on all
three housing GSEs and better able to ensure consistency of regulation for
GSEs that operate in similar markets.

Further, a single regulator would be better positioned to consider
potential trade-offs between mission requirements and safety and soundness
considerations, because such a regulator would develop a fuller
understanding of the operations of these large and complex financial
institutions. Some critics of combining safety and soundness and mission
have voiced concerns that doing so could create regulatory conflict for
the regulator. However, we believe that a healthy tension would be created
that could lead to improved oversight. The trade-offs between safety and
soundness and compliance with mission requirements could be best
understood and accounted for by having a single regulator that has
complete knowledge of the GSEs' financial condition, regulates the mission
goals Congress sets, and assesses efforts to fulfill them.

10See GAO, Government Sponsored Enterprises: Federal Oversight Needed for
Nonmortgage Investments, GAO/GGD-98-48 (Washington, D.C.: Mar. 11, 1998).
HUD's general regulatory authority can be used to limit or disallow
activities that are determined not to support the mission of Fannie Mae or
Freddie Mac.

11See GAO, Government-Sponsored Enterprises: Advantages and Disadvantages
of Creating a Single Housing GSE Regulator, GAO/GGD-97-139 (Washington,
D.C.: July 9, 1997).

New GSE Regulator Should Have a Board or Hybrid Board/Director Governance
Structure

Adequate Regulatory Authorities Are Essential

In determining the appropriate structure for a new GSE regulator, I note
that Congress has authorized two different structures for governing
financial regulatory agencies: a single director and board. Among
financial regulators, single directors head the Office of the Comptroller
of the Currency, the Office of Thrift Supervision and OFHEO, while boards
or commissions run FHFB, the Securities and Exchange Commission, and the
Board of Governors of the Federal Reserve, among others. The single
director model has advantages over a board or commission; for example, the
director can make decisions without the potential hindrance of having to
consult with or obtain the approval of other board members.

In our previous work, however, we have stated that a "stand-alone" agency
with a board of directors would better ensure the independence and
prominence of the regulator and allow it to act independently of the
influence of the housing GSEs, which are large and politically
influential. A governing board may offer the advantage of allowing
different perspectives, providing stability, and bringing prestige to the
regulator. Moreover, including the secretaries of Treasury and HUD or
their designees on the board would help ensure that GSE safety and
soundness and housing mission compliance issues are considered.

I would note that in other regulatory sectors--besides financial
regulation--Congress has established alternative board structures that
could be considered as potential models for the new GSE regulator. One
such alternative structure would be the hybrid board/director governance
model. Under such an approach, there would be a presidentially appointed
and Senate-confirmed agency head who would report to a board of directors
composed of secretaries from key executive branch agencies, such as
Treasury and HUD. Having board members from the same political party could
lessen some of the tensions and conflicts observed at boards purposefully
structured to have a split in membership along party lines. A board
composed of members from the same political party, however, may not
benefit from different perspectives to the same extent as a board with
members from different political parties. Therefore, an advisory committee
to the regulator could be formed to include representatives of financial
markets, housing, and the general public. This advisory committee could be
required to have some reasonable representation from different political
parties.

It is also essential that the new GSE regulator have adequate powers and
authorities to address unsafe and unsound practices, respond to financial
emergencies, and ensure that the GSEs comply with their public missions.
These authorities include (1) cease and desist authority related to
unsound

practices, (2) removal and prohibition authority related to officers and
directors, (3) prompt corrective action authority, and (4) authority to
resolve a critically undercapitalized GSE, which may include placing it
into receivership. Additionally, the new housing GSE regulator should have
the authority to adjust as necessary the housing enterprises' minimum and
risk-based capital requirements to help ensure their continued safety and
soundness.

I would also like to comment on an area of recent debate concerning
discussions of GSE regulatory reform, i.e., restrictions on Fannie Mae's
and Freddie Mac's retained mortgage portfolios, which were approximately
$1.3 trillion as of year-end 2003. In testimony before this committee on
April 6, 2005, Federal Reserve Chairman Greenspan stated that the GSEs'
large retained mortgage portfolios do not necessarily benefit housing
finance, are primarily intended to increase the GSEs' profitability, and
increase the potential for systemic financial risks. To address these
concerns, Chairman Greenspan called for limits on the GSEs' mortgage
portfolios to be phased in over time. Moreover, Treasury Secretary Snow
also expressed concern about the GSEs' mortgage portfolios and called for
limits on their size. We also have commented that the GSEs' housing
portfolios raise potential risks, and their benefits to housing finance
markets are not clear. In my view, providing the new regulator with strong
criteria to evaluate the costs and benefits of the GSEs' mortgage
portfolios and the authority to limit them, if necessary, is essential.
The criteria could include the extent to which the mortgage portfolios
enhance the GSEs' housing mission, increase financial risks, and raise
financial stability concerns.

Further, the new housing GSE regulatory agency should be provided with
explicit authority to oversee the GSEs' corporate governance and
management compensation practices. As I stated in my previous testimony,
while the GSEs should have been leaders with respect to corporate
governance, in many respects they were not. For example, unlike leading
organizations, the chairman of Fannie Mae's board also served as the GSE's
chief executive officer (CEO). I note that both Fannie Mae and Freddie Mac
have formally agreed with OFHEO to separate the positions of chairperson
of the board and CEO, thereby helping to ensure that the GSE boards
independently establish company policies that their CEOs are responsible
for carrying out. OFHEO also found that Fannie Mae's compensation system
provided managers with financial incentives to take actions-such as
accounting irregularities-that increased the GSE's reported short-term
profitability. Without the authority to police

                          Regulatory Funding Structure

such practices, the new regulator would not be able to fully carry out its
oversight responsibilities.

I also believe that the new GSE regulator should be tasked with the
responsibility to conduct research on the extent to which the housing GSEs
are fulfilling their housing and community development missions. As I
described earlier, there are already questions about the extent to which
the housing GSEs' mortgage holdings benefit housing finance markets.
Moreover, federal agencies, academics, and the GSEs have initiated studies
that have estimated the extent to which Fannie Mae's and Freddie Mac's
activities generate savings to home buyers, which have reached differing
conclusions. Additional studies may be needed to more precisely estimate
the extent to which the GSEs' activities benefit home buyers. Further,
there is virtually no empirical information on the extent to which FHLBank
advances lower mortgage costs for home buyers or encourage lenders to
expand their commitment to housing finance. Without better information,
Congress and the public cannot judge the effectiveness of the GSEs in
meeting their missions or whether the benefits provided by the GSEs'
various activities are in the public interest and outweigh their financial
and systemic risks.

Finally, I would now like to comment on issues surrounding the potential
funding arrangements for a new housing GSE regulator. Exempting the new
GSE regulator from the appropriations process would provide the agency
with the financial independence necessary to carry out its
responsibilities. More importantly, without the timing constraints of the
appropriations process, the regulator could more quickly respond to
budgetary needs created by any crisis at the GSEs. However, being outside
the appropriations process can create trade-offs. First, while the
regulator will have more control over its own budget and funding level, it
will lose the checks and balances provided by the federal budget and
appropriations processes or the potential reliance on increased
appropriations during revenue shortfalls. As a result, the regulator would
need to establish a system of budgetary controls to ensure fiscal
restraint. Second, removing the regulator from the appropriations process
could diminish congressional oversight of the agency's operations. This
trade-off could be mitigated through increased oversight by the
regulator's congressional authorizing committees, such as a process of
regular congressional hearings on the new GSE regulator's operations and
activities.

Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions that you or other Members of the Committee may
have.

GAO Contacts and For further information regarding this testimony, please
contact Thomas J.

McCool, Managing Director, at (202) 512-8678 or [email protected]; orStaff
William B. Shear, Director, at (202) 512-4325 or [email protected].
Acknowledgments Individuals making contributions to this testimony include
Allison M.

Abrams, Marianne E. Anderson, Wesley M. Phillips, and Karen C. Tremba.

Related GAO Products

Federal Home Loan Bank System: An Overview of Changes and Current Issues
Affecting the System. GAO-05-489T. Washington, D.C.: April 13, 2005.

Government-Sponsored Enterprises: A Framework for Strengthening GSE
Governance and Oversight. GAO-04-269T. Washington, D.C.: February 10,
2004.

Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ
Significantly. GAO-03-973. Washington, D.C.: September 8, 2003.

Financial Regulation: Review of Selected Operations of the Federal Housing
Finance Board. GAO-03-364. Washington, D.C.: February 28, 2003.

OFHEO's Risk Based Capital Stress Test: Incorporating New Business Is Not
Advisable. GAO-02-521. Washington, D.C.: June 28, 2002.

Federal Home Loan Bank System: Establishment of a New Capital Structure.
GAO-01-873. Washington, D.C.: July 20, 2001.

Comparison of Financial Institution Regulators' Enforcement and Prompt
Corrective Action Authorities. GAO-01-322R. Washington, D.C.: January 31,
2001.

Capital Structure of the Federal Home Loan Bank System. GAO/GGD-99177R.
Washington, D.C.: August 31, 1999.

Federal Housing Finance Board: Actions Needed to Improve Regulatory
Oversight. GAO/GGD-98-203. Washington, D.C.: September 18, 1998.

Federal Housing Enterprises: HUD's Mission Oversight Needs to Be
Strengthened. GAO/GGD-98-173. Washington, D.C.: July 28, 1998.

Risk-Based Capital: Regulatory and Industry Approaches to Capital and
Risk. GAO/GGD-98-153. Washington, D.C.: July 20, 1998.

Government-Sponsored Enterprises: Federal Oversight Needed for Nonmortgage
Investments. GAO/GGD-98-48. Washington, D.C.: March 11, 1998.

Federal Housing Enterprises: OFHEO Faces Challenges in Implementing a
Comprehensive Oversight Program. GAO/GGD-98-6. Washington, D.C.: October
22, 1997.

Government-Sponsored Enterprises: Advantages and Disadvantages of Creating
a Single Housing GSE Regulator. GAO/GGD-97-139. Washington, D.C.: July 9,
1997.

Housing Enterprises: Investment, Authority, Policies, and Practices.
GAO/GGD-91-137R. Washington, D.C.: June 27, 1997.

Comments on "The Enterprise Resource Bank Act of 1996." GAO/GGD-96140R.
Washington, D.C.: June 27, 1996.

Housing Enterprises: Potential Impacts of Severing Government Sponsorship.
GAO/GGD-96-120. Washington, D.C.: May 13, 1996.

Letter from James L. Bothwell, Director, Financial Institutions and
Markets Issues, GAO, to the Honorable James A. Leach, Chairman, Committee
on Banking and Financial Services, U.S. House of Representatives, Re:
GAO's views on the "Federal Home Loan Bank System Modernization Act of
1995." B-260498. Washington, D.C.: October 11, 1995.

FHLBank System: Reforms Needed to Promote Its Safety, Soundness, and
Effectiveness. GAO/T-GGD-95-244. Washington, D.C.: September 27, 1995.

Housing Finance: Improving the Federal Home Loan Bank System's Affordable
Housing Program. GAO/RCED-95-82. Washington, D.C.: June 9, 1995.

Government-Sponsored Enterprises: Development of the Federal Housing
Enterprise Financial Regulator. GAO/GGD-95-123. Washington, D.C.: May 30,
1995.

Federal Home Loan Bank System: Reforms Needed to Promote Its Safety,
Soundness, and Effectiveness. GAO/GGD-94-38. Washington, D.C.: December 8,
1993.

Improved Regulatory Structure and Minimum Capital Standards Are Needed for
Government-Sponsored Enterprises. GAO/T-GGD-91-41. Washington, D.C.: June
11, 1991.

Government-Sponsored Enterprises: A Framework for Limiting the
Government's Exposure to Risks. GAO/GGD-91-90. Washington, D.C.: May 22,
1991.

Government-Sponsored Enterprises: The Government's Exposure to Risks.
GAO/GGD-90-97. Washington, D.C.: August 15, 1990.

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