Government-Sponsored Enterprises: Development of the Federal Housing
Enterprise Financial Regulator (Letter Report, 05/30/95, GAO/GGD-95-123).

Pursuant to a legislative requirement, GAO reviewed the status of the
Office of Federal Housing Enterprise Oversight's (OFHEO) development,
focusing on OFHEO progress in designing and instituting key management
systems.

GAO found that: (1) OFHEO has made considerable progress toward setting
up its key management systems; (2) as of February 1995, OFHEO had most
of its administrative structure in place with 53 of its 65 authorized
staff, and had prepared for the implementation of its human resource
management system; (3) although OFHEO has defined its financial and
accounting system requirements and has worked with the Department of
Housing and Development (HUD) to meet its immediate accounting and
administrative needs, it is having difficulties using HUD systems; (4)
OFHEO has not decided whether to continue to use HUD systems, create and
maintain its own systems, or contract out its accounting and
administrative functions to another federal agency; (5) OFHEO has begun
its mission-related programs, established the fundamentals of its
examination function, adopted an overall examination framework, and set
a 2-year workplan; (6) OFHEO has completed its first on-site examination
of the Federal National Mortgage Association and the Federal Home Loan
Mortgage Corporation and the design, purchase, and installation of
computer software to support its financial research; (7) OFHEO has not
met its legislative deadline to complete final regulations establishing
the enterprises' risk-based capital stress test, but it has adopted
intermediate milestones and expects to publish the regulations in 1996;
and (8) although OFHEO staff is having difficulties meeting its 2-year
workplan, OFHEO has generally met its legislative reporting
requirements.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-95-123
     TITLE:  Government-Sponsored Enterprises: Development of the 
             Federal Housing Enterprise Financial Regulator
      DATE:  05/30/95
   SUBJECT:  Government sponsored enterprises
             Mortgage loans
             Mortgage programs
             Regulatory agencies
             Financial management systems
             Federal agency accounting systems
             Interagency relations
             Capital
             Risk management
             Personnel management
IDENTIFIER:  OFHEO Performance Evaluation Management System
             Federal Housing Enterprises Regulatory Reform Act of 1992
             
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Cover
================================================================ COVER


Report to the Chairman, Senate Committee on Banking, Housing, and
Urban Affairs, and the Chairman, House Committee on Banking and
Financial Services

May 1995

GOVERNMENT-SPONSORED ENTERPRISES -
DEVELOPMENT OF THE FEDERAL HOUSING
ENTERPRISE FINANCIAL REGULATOR

GAO/GGD-95-123

Federal Housing Enterprise Oversight


Abbreviations
=============================================================== ABBREV

  EDP - Electronic Data Processing
  FIA - Federal Managers' Financial Integrity Act
  GSE - government-sponsored enterprise
  HUD - Department of Housing and Urban Development
  OEO - Office of Examination and Oversight
  OFHEO - Office of Federal Housing Enterprise Oversight
  OPM - Office of Personnel Management
  OTS - Office of Thrift Supervision
  PEMS - Performance Evaluation Management System
  RACS - Research, Analysis and Capital Standards
  RSE - Research System Environment

Letter
=============================================================== LETTER


B-259986

May 30, 1995

The Honorable Alfonse M.  D'Amato
Chairman
The Honorable Paul Sarbanes
Ranking Minority Member
Committee on Banking, Housing,
 and Urban Affairs
United States Senate

The Honorable Jim Leach
Chairman
The Honorable Henry B.  Gonzalez
Ranking Minority Member
Committee on Banking and Financial
 Services
House of Representatives

The Federal Housing Enterprises Financial Safety and Soundness Act of
1992\1 established the Office of Federal Housing Enterprise Oversight
(OFHEO) within the Department of Housing and Urban Development (HUD)
as the independent financial regulator of the nation's two largest
government-sponsored enterprises\2 --the Federal National Mortgage
Association (FannieMae) and the Federal Home Loan Mortgage
Corporation (FreddieMac).  OFHEO's mission is to ensure the safety
and soundness of FannieMae and FreddieMac (the enterprises), the
major participants in the secondary mortgage market.  For reasons
relating to the federal charter and structure of the enterprises,
investors and rating agencies perceive the enterprises' securities as
implicitly guaranteed by the federal government, despite there being
no statutory obligation.  In December 1994, the enterprises held
combined assets and mortgage-backed securities of more than $1.3
trillion. 

The act requires us to audit the operations of OFHEO annually during
the first 2 fiscal years following the date of enactment and as
appropriate after that.  Because the act's requirement is broad, the
objective of this initial report was to review the status of OFHEO's
development, focusing on the progress made in designing and
instituting key management systems.  These include OFHEO's
administrative infrastructure systems--the human resources and
accounting and financial management systems--and the major
mission-related systems--examinations and capital adequacy.  The
report also provides an overview of OFHEO's compliance with other
operational and reporting requirements. 


--------------------
\1 Pub.  L.  102-550, Title XIII, 12 U.S.C.  4501 et.  seq.  (Supp. 
IV 1992). 

\2 As used in this report, government-sponsored enterprises (GSE) are
federally chartered, privately owned corporations designed to provide
a continuing source of credit nationwide to specific economic
sectors.  In addition to FannieMae and FreddieMac, the Federal Home
Loan Banks also promote housing lending, while other GSEs promote
lending for agricultural purposes (e.g., the Farm Credit Banks) or
higher education (e.g., the Student Loan Marketing Association, or
"SallieMae.")


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

OFHEO has made considerable progress toward setting up its key
management systems since its first Director was sworn in on June 1,
1993.  As of the end of February 1995, much of OFHEO's administrative
structure was in place.  OFHEO had hired 53 of its 65 authorized
staff and was preparing for the initial implementation of its human
resource management system.  Additionally, OFHEO defined its
financial and accounting system requirements and worked with HUD to
meet its immediate accounting and administrative needs.  However,
OFHEO had not yet determined whether to continue using HUD systems,
create and maintain its own, or contract those functions out to
another federal agency. 

OFHEO has also initiated its major mission-related programs--
examining the enterprises and assessing their capital adequacy. 
During 1994, OFHEO established the fundamentals of its examination
function, adopting an overall examination framework and setting out a
2-year workplan.  OFHEO completed its first on-site examinations of
the enterprises and initiated other supervisory monitoring
activities.  In addition, OFHEO completed the design, purchase, and
installation of the computer hardware and software to support its
financial modeling and research.  This will allow OFHEO to determine
how much capital the enterprises are required to hold to withstand a
10-year period of economic stress (the risk-based capital stress
test).  However, OFHEO did not complete the final regulations
establishing the enterprises' risk-based capital test, which the act
had called for to be in place by December 1, 1994.  OFHEO has adopted
intermediate milestones and now expects to publish final regulations
in 1996. 

Otherwise, OFHEO has generally met its legislated reporting
requirements.  Perhaps most importantly, it made the required
quarterly reports of the enterprises' capital classifications. 
Applying definitions specified in the act, OFHEO classified the
enterprises as adequately capitalized for the second, third, and
fourth quarters of 1993 and for the first three quarters of 1994. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Responding to the massive and expensive failure of federally insured
savings and loans in the mid-1980s, Congress and the administration
examined government-sponsored enterprises to ensure that they were
operating in a manner that protected the taxpayers' interest and
minimized the risk that these entities would fail.  Prior GAO
reports\3 noted that the enterprises' ties to the government had
weakened private market discipline to the point that creditors
believed the government would likely assist an enterprise through
financial difficulties, even though the government has no legal
obligation to do so.\4 This expectation is not without foundation; in
1987, Congress approved $4 billion to help the ailing Farm Credit
System. 

According to a report from the Senate Committee on Banking, Housing,
and Urban Affairs, this perception is based on the structure and
privileges of the enterprises and the special treatment of their
securities.\5 The enterprises were created by statute, are exempt
from state and local income taxes, and each has a line of credit with
the Treasury of $2.25 billion.  Their securities are issued and paid
through the facilities of the Federal Reserve Banks and are eligible
for purchase by the Federal Reserve, for unlimited investment by
Federal Reserve member banks and federally insured thrifts and as
collateral for public deposits of the U.S.  government and most state
and local governments.  As a result, the enterprises' debt trades at
yields only marginally above those on Treasury debt of comparable
maturity.  This implicit credit enhancement allows the enterprises to
operate with relatively little capital. 

The enterprises' federally established charters set out specific
purposes that they are to address.  They are to provide stability in
the secondary market of residential mortgages, respond appropriately
to the private capital market, and provide ongoing assistance to the
secondary market for residential mortgages.  They are also to promote
access to mortgage credit throughout the nation by increasing the
liquidity of mortgage investments and improving the distribution of
investment capital available for residential mortgage financing. 

For these reasons, the government has an interest in seeing that
these enterprises are managed and operated in a prudent and
financially sound manner.  Both enterprises have been highly
profitable for several years,\6 but Congress recognized that both may
not always remain as profitable and well managed as they are today. 
Consequently, Congress reformed the enterprises' regulatory structure
and established capital requirements by passing the Federal Housing
Enterprises Financial Safety and Soundness Act of 1992.  According to
the Senate report accompanying the bill,\7 the capital provisions are
designed to ensure that the enterprises are financially sound.  The
primary emphasis of these provisions is on a risk-based capital
standard that reflects risks the enterprises assume.  The new
regulatory structure was designed to address concerns over HUD's
inadequate regulation and supervision of the enterprises. 

The act established OFHEO as an independent entity within HUD.  The
act reserved for the Secretary of HUD certain authorities relating to
HUD's responsibility to oversee the enterprises' efforts to meet
housing goals.\8 But the act also clarified that the duty to ensure
that FannieMae and FreddieMac are adequately capitalized and
operate in a safe and sound manner, consistent with the achievement
of their public purposes, belongs to OFHEO.  Consequently, the act
specifically delegated other responsibilities and authorities to the
Director of OFHEO.  OFHEO was intended to operate separately from HUD
and be staffed with experts in financial management or financial
institution oversight. 

OFHEO is under the management of a presidentially appointed and
Senate-confirmed Director.  The act provided the Director with
numerous exclusive authorities (i.e., without the review and approval
of the Secretary of HUD), such as powers to examine the operations of
the enterprises, determine capital levels, assign the enterprises
capital classifications, and take certain enforcement actions.  The
act also gave the Director exclusive authority to manage OFHEO,
including establishing and implementing annual budgets and hiring
personnel.  Thus, the Director leads and directs OFHEO's activities
by setting internal and external policy, managing overall operations,
and serving as the chief spokesperson for the organization.  As of
February 1995, OFHEO's six components reported to the Director and
Deputy Director.  Figure 1 illustrates OFHEO's organizational
structure. 

   Figure 1:  OFHEO Organizational
   Structure

   (See figure in printed
   edition.)

Three line functions are directly responsible for carrying out
OFHEO's mission: 

  The Office of Examination and Oversight (OEO) is responsible for
     designing and conducting annual on-site examinations of
     FannieMae and FreddieMac, as required by law, and performing
     additional examinations as determined by the Director. 

  Research, Analysis and Capital Standards (RACS) is responsible for
     developing and implementing financial "stress tests," which use
     interest rate and credit risk scenarios prescribed in the act to
     determine the enterprises' risk-based capital requirements. 
     This unit is responsible for conducting research and financial
     analysis on issues related to the enterprises' activities, such
     as simulating Treasury yields and associated interest rate
     indices. 

  The General Counsel has responsibility for preparing the
     regulations required by the act and advising the Director on
     legal issues, including financial institution regulatory issues,
     applicable securities and corporate law principles, and
     administrative and general legal matters. 

Three staff functions support OFHEO's mission: 

  Finance and Administration is responsible for ensuring that OFHEO
     has the infrastructure to function independently.  This unit is
     to provide human resources management, budget formulation and
     execution, financial and strategic planning, contracting and
     purchasing, office automation, travel, records and document
     security, and related administrative support services.  Finance
     and Administration is also responsible for developing annual
     budgets and serving as the liaison with the Office of Management
     and Budget. 

  The Office of Chief Economist is responsible for providing and
     coordinating economic and policy advice to the Director on all
     issues related to the regulation and supervision of the
     enterprises.  This office is also to direct and conduct research
     to assess the impact of issues and trends in the housing and
     mortgage markets on OFHEO's regulatory responsibilities. 

  The Office of Congressional and Public Affairs is responsible for
     handling public and press inquiries, briefing Members of
     Congress and staff on matters relating to OFHEO, monitoring
     legislative development, and bringing congressional concerns to
     the attention of the Director. 

OFHEO's staffing has grown slowly but steadily since the Director,
its first employee, was sworn in on June 1, 1993.  At the end of
fiscal year 1993, five other employees were on board.  According to
testimony from the Director in October 1993, recruiting specialized
staff was slowed somewhat by OFHEO's need to first do such
fundamental things as obtain hiring authority, develop procedures,
and obtain office space.  By September 1994, however, OFHEO had 37
staff on board.  And in February 1995, OFHEO's staff had grown to 53. 
OFHEO's budget projects filling 69 positions in fiscal year 1996. 
Table 1 compares the distribution of positions among OFHEO's
different units at the end of fiscal year 1994 with that projected
for fiscal year 1996. 



                           Table 1
           
             Actual and Projected Distribution of
           OFHEO Staff Resources, Fiscal Years 1994
                           and 1996

                                     Staff on      Projected
                                board, end of     positions,
                                  fiscal year    fiscal year
Unit                                     1994           1996
------------------------------  -------------  -------------
Office of the Director\a                    6              7
Office of Chief Economist\a                 3              5
Office of Examination and                   7             19
 Oversight
Research, Analysis and Capital              8             15
 Standards
Office of General Counsel                   3              7
Finance and Administration                  6             11
Office of Congressional and                 4              5
 Public Affairs
============================================================
Total                                      37             69
------------------------------------------------------------
\a A reorganization in early fiscal year 1995 separated the Office of
Chief Economist from the Director's Office and moved two positions
among units. 

Source:  GAO analysis of OFHEO data. 

Relative to other federal financial regulatory agencies, OFHEO is a
small organization.  In testimony before the House Banking Committee
in October 1993, OFHEO's Director spoke about the unique challenge
facing OFHEO in regulating two entities as large, complex, and
sophisticated as FannieMae and FreddieMac.  She compared OFHEO's
regulatory task with that of other federal financial regulatory
agencies.  For example, OFHEO's fiscal year 1994 budget funded 45
positions to oversee the enterprises (1 employee for every $23.1
billion in regulated assets).  As a point of comparison, 2,500 Office
of Thrift Supervision (OTS) employees oversaw institutions with $800
billion in assets (1 employee per $0.3 billion in assets).\9 To
address that challenge, OFHEO's philosophy was to create a lean and
flat organization that would attract and retain a highly qualified,
diverse staff with sophisticated financial, legal, and supervisory
expertise. 

Most OFHEO expenses cover personnel and contractor services.  For
fiscal year 1996, OFHEO estimates that it will spend $7.9 million
(53.3 percent of its $14.9 million total) on personnel services
(i.e., expenses related to personnel compensation and benefits, but
exclusive of contractors).  According to OFHEO, it bases salaries and
benefits on market rates for the required technical expertise
comparably with those of other federal banking regulatory
agencies.\10 The second largest category of expenses ("Other
services") generally covers OFHEO's contractor services.\11 In fiscal
year 1996, OFHEO expects to spend $4.4 million (29.7 percent) on
specialized technical services associated with developing and
maintaining its research capability and computer models, examination
services, and specialized legal services.  All other expenses
constitute a smaller, but growing, proportion of OFHEO's total
obligations.  These expenses cover such fundamental but crucial items
as computer acquisition, travel, and rent, which fluctuate with
changing numbers of staff and contractors on location. 

Table 2 shows actual and estimated OFHEO obligations for fiscal years
1994 through 1996.  Although OFHEO's financial plans and forecasts
are to be included in the budget of the United States and in HUD's
congressional justifications,\12 it is not funded with tax dollars
through the congressional appropriations process.  Rather, the act
requires the enterprises to pay annual assessments to cover OFHEO's
costs.\13 OFHEO's fiscal year 1996 budget estimated that it would
obligate nearly $0.6 million less than was estimated for operations
in fiscal year 1995.  That estimate reflects a diminished reliance on
other contractor services, especially in support areas, partially
offset by increases in rent associated with the need for additional
space and in personnel expenditures associated with four additional
OFHEO positions. 



                           Table 2
           
             OFHEO Obligations, Fiscal Years 1994
                         Through 1996

                    (Dollars in thousands)

                                                       1995-
                        Actual  Estimate  Estimate      1996
                          1994    d 1995    d 1996    Change
--------------------  --------  --------  --------  --------
Personnel services      $2,690    $7,300    $7,944      $644
Other services           2,473     5,875     4,422    -1,453
All other                1,323     2,276     2,529       253
============================================================
Total                    6,486    15,451    14,895      -556
------------------------------------------------------------
Source:  GAO analysis of OFHEO data. 


--------------------
\3 See Government-Sponsored Enterprises:  The Government's Exposure
to Risks (GAO/GGD-90-97, August 15, 1990); and Government-Sponsored
Enterprises:  A Framework for Limiting the Government's Exposure to
Risks (GAO/GGD-91-90, May 22, 1991). 

\4 Section 1302(4) (12 U.S.C.  4501(4)) specifically provides that
"neither the enterprises .  .  .  nor any securities or obligations
issued by the enterprises .  .  .  are backed by the full faith and
credit of the United States .  .  .  ."

\5 S.R.  102-282, Federal Housing Enterprises Regulatory Reform Act
of 1992, May 15, 1992, p.  9. 

\6 FannieMae reported profits for calendar year 1994 of $2.132
billion, an increase of 13.8 percent from the earnings of $1.873
billion for 1993.  FreddieMac reported earnings of $983 million for
calendar year 1994, up 25.1 percent from its 1993 profits of $786
million. 

\7 S.R.  102-282, Federal Housing Enterprise Regulatory Reform Act of
1992, May 15, 1992, p.  19. 

\8 Sections 1331-1334 of the act (12 U.S.C.  4561-4564) required the
Secretary of HUD to establish housing goals for the enterprises in
three areas:  low- and moderate-income housing, "affordable" housing,
and credit to underserved areas, with particular attention being
given to central cities and rural areas. 

\9 This information came from OTS' 1992 annual report. 

\10 Section 1313(b)(9) of the act (12 U.S.C.  4513) authorizes the
Director, without the review or approval of the Secretary of HUD, to
take such actions necessary regarding the hiring of, and compensation
levels for, OFHEO personnel.  Section 1315 (12 U.S.C.  4515) further
provides that OFHEO personnel may be paid without regard to certain
provisions of title 5, United States Code, relating to classification
and General Schedule pay rates, and comparably with the officers and
employees in the Office of the Comptroller of the Currency, the Board
of Governors of the Federal Reserve System, the Federal Deposit
Insurance Corporation, and the Office of Thrift Supervision. 

\11 Section 1315(e) of the act (12 U.S.C.  4515) authorizes the
Director to employ outside experts and consultants as necessary. 

\12 Section 1316(g)(3), 12 U.S.C.  4516. 

\13 Section 1316 of the act (12 U.S.C.  4516) authorizes the Director
to establish and collect annual assessments from the enterprises to
cover "reasonable costs and expenses," including the costs of any
examinations.  The initial assessment was to cover start-up costs and
any anticipated costs and expenses for the next fiscal year.  The
enterprises are to make their payments in proportion to the ratio of
their total assets.  The assessments are to be paid semi- annually
into a Treasury fund known as the Federal Housing Enterprises
Oversight Fund. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

Because OFHEO continues to develop its major management systems, we
limited the scope of our work for this report to the planning and
initial implementation of those systems.  As of February 1995, none
of OFHEO's major management systems had been completely implemented. 
Consequently, we did not evaluate their ultimate implementation or
effectiveness. 

To develop our information, we interviewed OFHEO's senior management
and HUD officials and reviewed OFHEO management systems
documentation, focusing on the policies and procedures relating to
OFHEO's human resource management and accounting and financial
control systems.  We reviewed changes in these plans and systems that
OFHEO made over time.  We also reviewed OFHEO's plans for its
organizational development, particularly its examinations and capital
adequacy functions, along with its completed examinations of the
enterprises and the advance notice of proposed rulemaking on the
risk-based capital regulation. 

OFHEO provided written comments on a draft of this report.  The
comments are summarized on page 22 and reprinted in appendix I. 

We did our work at OFHEO and HUD in Washington, D.C., between
September 1994 and February 1995.  This review was done according to
generally accepted government auditing standards. 


   DEVELOPMENT OF OFHEO'S
   INFRASTRUCTURE GENERALLY ON
   SCHEDULE, BUT CHALLENGE OF
   IMPLEMENTATION REMAINS
------------------------------------------------------------ Letter :4

Before OFHEO's Director was sworn in on June 1, 1993, OFHEO had no
employees, no structure, no physical location, no policies or
procedures, and no plan.  Much has changed since then.  OFHEO has
made steady progress toward establishing administrative and financial
management systems and controls designed to enable it to operate
independently of HUD.  OFHEO has nearly finished designing its human
resource management system, worked with HUD to meet its initial
financial and accounting needs, and begun exploring alternative
arrangements for "cross-servicing," through which OFHEO would
contract with another agency to provide administrative and financial
management services.  According to its September 1994 operational
workplan, OFHEO is basically on schedule developing and installing
its infrastructure.  OFHEO now faces the challenge of implementing
its systems and resolving unforeseen difficulties. 


      HUMAN RESOURCE MANAGEMENT
      SYSTEM NEARING INITIAL
      IMPLEMENTATION
---------------------------------------------------------- Letter :4.1

By February 1995, OFHEO had substantially completed the design of its
human resource management system (called the Performance Evaluation
Management System, or PEMS) and established milestones for pilot
testing the system.  OFHEO anticipates full implementation of PEMS at
the beginning of fiscal year 1996. 

Rather than adopting HUD's or another agency's human resource
management system, OFHEO developed its own.  Based on recommendations
of two consulting firms, OFHEO's performance management system is
intended to enable it to respond to changing regulatory needs and
ease its developmental operations.  PEMS' broad pay band structure
reflects three general design elements:  (1) salaries to help OFHEO
recruit technical expertise, (2) pay ranges to provide management
flexibility to make pay decisions that reflect labor market pay while
providing internal equity, and (3) occupational levels to be
significantly and recognizably different. 

OFHEO classifies personnel by occupation and assigns them to one of
seven pay bands.  Occupations are based in part on the type of work
done relative to OFHEO's mission, the nature and subject matter of
the work, and the fundamental qualifications required.  Pay levels
and ranges are based on comparisons with similar occupations in other
federal financial regulatory agencies.  An individual's pay also
depends on the complexity of the work, scope of responsibility, and
supervisory content of the job.  Changes in pay are to occur once a
year, at the end of the review cycle.  Individuals may receive pay
increases within each pay band, unless they are at the band's
ceiling.  Those staff meeting qualifications for other occupations
and demonstrating the ability to perform the relevant duties and
responsibilities may also be promoted.  In 1994, pay could range from
$15,000 to $135,000. 

In March 1995, OFHEO was preparing to implement PEMS.  Having
obtained official approval of PEMS from the Office of Personnel
Management (OPM) on February 23, 1995, OFHEO planned to implement
PEMS in April 1995.  OFHEO will abbreviate PEMS' initial performance
cycle and begin regular, full-year cycles in fiscal year 1996. 


      EFFORTS TO ESTABLISH OFHEO'S
      ACCOUNTING AND FINANCIAL
      SYSTEMS HAVE PROVEN MORE
      DIFFICULT
---------------------------------------------------------- Letter :4.2

Compared to the progress made with PEMS, OFHEO has experienced
greater difficulty in establishing its accounting and financial
systems and controls.  OFHEO has worked with HUD to meet its
immediate needs, but OFHEO is still uncertain as to whether HUD can
meet its accounting and financial systems requirements.  As of
February 1995, OFHEO was still considering either establishing its
own systems or arranging for cross-servicing with another federal
agency. 

OFHEO has established general requirements for its accounting and
financial management system.  According to OFHEO, the system must
support all personnel and procurement components within an integrated
automated accounting system and accommodate its classification and
compensation system.  In addition, the system must produce auditable
financial statements.  The system must maintain accounting records
that accurately reflect expenses and income; provide monthly budget,
accounting, and exception reports; and pay approved invoices. 

OFHEO has used HUD's accounting and financial systems since its
inception but experienced various difficulties.  In the procurement
area, for example, OFHEO used the services of HUD's Office of
Procurement and Contracts.  According to OFHEO, HUD's office was not
staffed to provide the expedited procurement processing OFHEO's
start-up mode of operation required.  OFHEO eventually hired its own
procurement contracting officer and exercised independent contracting
authority.  To date, HUD has handled OFHEO's payroll and other
personnel processing actions.  OFHEO inputs its time and attendance
data directly but uses HUD's contract with the National Finance
Center in New Orleans to process its payroll.  HUD has serviced
OFHEO's other personnel processing needs (such as processing tax
forms, health benefits enrollments, and direct deposit forms), but
not, according to OFHEO, without problems.  During OFHEO's early
months of existence, HUD did not understand or appreciate the
significance of OFHEO's Schedule A hiring authority and its authority
to make independent appointments.\14 This added considerable time to
the processing of personnel actions, since individuals unfamiliar
with OFHEO's exemptions subjected those actions to HUD's own internal
review procedures.  According to OFHEO, this processing relationship
smoothed out over time. 

Senior OFHEO officials expressed dissatisfaction with HUD's
accounting and financial management systems.  For example, OFHEO
experienced substantial delays in how HUD recorded OFHEO obligations
and expenses.  Additionally, HUD restricted access to its accounting
system, limiting the ability of OFHEO's finance and administration
staff to retrieve their data to support budget formulation and
financial management activities.  HUD staff also confused OFHEO with
another HUD agency, the Office of Fair Housing and Equal Opportunity
(FHEO), causing them to confuse financial transactions and misdirect
financial reports. 

OFHEO had procedures and controls in place that enabled it to detect
such problems.  Consequently, HUD's errors were corrected and OFHEO
ultimately was able to reconcile its fiscal year 1994 accounts. 
However, the lack of current accurate data during the year made it
difficult for OFHEO to determine its unobligated balances on a
monthly basis.  In turn, this hampered OFHEO's ability to notify the
enterprises with certainty what the next semiannual assessment would
be. 

Over time, OFHEO has recognized improvements in the data provided by
HUD's accounting system.  Senior OFHEO officials told us that they
have noted fewer errors and that HUD has been able to provide
information in a more timely manner.  According to the Director of
Finance and Administration, OFHEO had a great degree of confidence in
the accounting data on which it based its March 1, 1995, assessment
of the enterprises. 

HUD officials acknowledged that some problems existed with the
accounting system that processed OFHEO's financial data.  They told
us that HUD is replacing the system that generated many of the
problems, and OFHEO is to be switched to the new system later in
fiscal year 1995.  According to those officials, the new system
should fully meet OFHEO's needs and requirements, allowing OFHEO to
access its financial data and generate its own unique reports. 

As of February 1995, OFHEO had not yet decided how it would meet its
future administrative and accounting needs.  OFHEO has not determined
whether to continue using HUD systems, create and maintain its own,
or contract those functions out to another federal agency. 
Initially, OFHEO had decided against devoting its own staff to these
functions, believing that it would not be a cost-effective use of its
limited resources.  It approached nine other federal agencies,
focusing on financial regulators because they have similar missions
and compensation systems.  OFHEO eventually determined that none of
them would fully meet its needs.  In some cases, OFHEO questioned the
agencies' capacity.  In other cases, the agencies responded that
entering into a cross-servicing arrangement would not be practicable
or cost-effective.  According to a senior OFHEO official, the biggest
problem involved the particular systems OFHEO had implemented because
of exemptions in its statute, such as that exempting OFHEO from
certain provisions of Title 5 of the U.S.  Code, relating to
classification and General Schedule pay rates.\15

Resolving the cross-servicing issue is a priority for OFHEO's
Director of Finance and Administration.  Because OFHEO has been
unable to identify another agency that has the resources to meet its
unique accounting system needs, and because the quality of the
accounting information from HUD has improved significantly, OFHEO is
considering continued use of HUD accounting and financial management
systems.  OFHEO officials have also been encouraged by HUD's
willingness to work with them to ensure that the new accounting
system meets OFHEO's requirements and needs. 


--------------------
\14 Section 1315(a), 12 U.S.C.  4515.  Schedule A hiring authority is
one of the federal government's excepted appointing authorities used
for hiring employees under special circumstances.  This authority
permits agencies to fill positions without following the extensive
requirements of the competitive service.  According to the Federal
Personnel Manual, Schedule A authority may be used if, for example, a
crash program must be staffed so quickly that there is no time for
traditional examining.  OPM also granted Schedule A hiring authority
to the other financial regulatory agencies created by the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 for use
during their start-up phase. 

\15 Section 1315(a), 12 U.S.C.  4515. 


   EXAMINATIONS AND CAPITAL
   ADEQUACY FUNCTIONS:  APPROACHES
   TO MEETING KEY LEGISLATIVE
   MANDATES TAKING LONGER THAN
   ENVISIONED
------------------------------------------------------------ Letter :5

OFHEO has made considerable progress in establishing its key
functions--examining the enterprises' financial condition to ensure
their financial safety and soundness as well as developing and
implementing the required risk-based test to determine how much
capital the enterprises need (the "stress test").  After having hired
its key professional staff and establishing working relationships
with the enterprises, OFHEO conducted its first examinations,
purchased and installed the computer system needed to run the stress
test, and obtained the data needed for the financial modeling and
research that underlie the test.  Additionally, OFHEO established
plans to guide its work at least through the end of fiscal year 1995. 
OFHEO has met most of its legislated requirements, including making
determinations of the enterprises' capital adequacy during the
transition period prior to the release of the risk-based capital
standards. 

Despite this progress, OFHEO has experienced delays, causing some
important activities to fall behind schedule.  For example, OFHEO did
not meet the legislatively mandated deadline for issuing final
regulations establishing the risk-based test of the enterprises'
capital adequacy.\16 OFHEO has established intermediate milestones
and now expects to publish proposed stress test regulations in late
1995 and final regulations in 1996.  These delays, while unexpected,
are not unusual; most, such as hiring qualified staff and creating
internal processes, seem related to establishing a new organization. 
OFHEO has taken steps to address each problem encountered. 


--------------------
\16 Section 1361(e), 12 U.S.C.  4611. 


      OFHEO ESTABLISHED ITS
      EXAMINATION AND REGULATORY
      OVERSIGHT FUNCTION, BUT HAS
      BEEN UNABLE TO MEET ITS
      WORKPLAN
---------------------------------------------------------- Letter :5.1

OFHEO has established its examination function, adopting a general
examination methodology and setting out a 2-year workplan.  In 1994,
OFHEO completed its first examinations and began its second, along
with some off-site supervisory monitoring activities.  OFHEO has
experienced some unexpected delays that are related to establishing a
new organization.  As a result of these setbacks, some activities
scheduled to be done by the end of 1994 are behind schedule. 

The act gave OFHEO broad authority to examine the enterprises.  The
act requires OFHEO to do an annual on-site examination of each
enterprise to evaluate its financial condition for ensuring financial
safety and soundness.\17 In addition, the act authorizes OFHEO to do
other examinations necessary to ensure the financial safety and
soundness of the enterprises.\18

OFHEO plans to meet its mandate by doing a combination of on-site
examinations and off-site monitoring.  Examinations are to assess the
safety and soundness of the enterprises and the adequacy of their
books and records.  Supervisory monitoring is the ongoing assessment
of the enterprises' financial condition and performance.  Monitoring
projects include special studies of enterprise activities, quarterly
company analyses,\19 and the development of a call report.\20

OFHEO uses a "top down" examination approach to identify the risks
inherent in the enterprises' activities and to determine whether
risks are prudently managed and controlled.  This approach has three
levels.  First, OFHEO examiners are to meet and evaluate senior
management, analyze strategic and business plans, determine the
quality of internal and external audits, and verify records and
control systems.  Second, the examiners are to expand the examination
to include further testing, statistical sampling, and analyses of the
enterprises' systems.  If the second-level review raises any
questions, a team of examiners is to do a detailed third-level review
of these concerns. 

By September 1994, OEO had planned its activities through calendar
year 1995.  According to this schedule, OEO would have seven or more
projects ongoing at all times--at least two examinations at each of
the enterprises, along with at least three supervisory monitoring
projects.  OEO's director characterized this workplan as "ambitious."

Table 3 summarizes OEO's workplan from July 1994 through the end of
1995.  It shows, for example, that during the first half of 1995, OEO
staff are to complete "general," "specialty," and books and records
examinations of both enterprises.  In the general examination, OEO
staff will (1) examine each enterprise's risk management by assessing
the adequacy of management processes to identify, measure, monitor,
and control the risk exposure of the enterprise; (2) examine a
functional area of each enterprise's secondary market operations,
such as its marketing or mortgage securitization; or (3) assess the
adequacy of some aspect of each enterprise's business or product
lines, such as its single- or multifamily guarantee programs.  The
specialty examination is to cover the enterprises' electronic data
processing (EDP).  The objective of these examinations is to ensure
that EDP systems used by the enterprises are adequate, reliable,
accurate, and operated within a secure environment.  OFHEO plans to
test major systems to verify the data and report integrity.  In the
books and records examination, OEO staff are to evaluate the
accounting and auditing to determine the reliability of the
enterprises' financial information. 



                                     Table 3
                     
                     Summary of OFHEO's Office of Examination
                                and Oversight Plan

      Programs/
      projects           Second half 1994   First half 1995    Second half 1995
----  -----------------  -----------------  -----------------  -----------------
Safety and soundness/compliance
--------------------------------------------------------------------------------
      General            Corporate          Risks/functions/   Risks/functions/
                                            business           business

      Specialty          Derivatives        EDP                Charters acts

      Books and records                     Books and records

      Examination                                              Draft manual
      manual

Off-  Supervisory        Strategic/         MIS                Product lines
site  analysis           business plans
supe
rvis
ory
moni
tori
ng

      Company analysis   Report on 3rd      Report on 4th/     Report on 2nd/
                         quarter            1st quarters       3rd quarters

      Industry analysis                     Annual analysis
                                            with RACS

      Call report        Develop            Implement in       Implement in
                         specifications     phases             phases
--------------------------------------------------------------------------------
Source:  OFHEO. 

OEO's small staff has not been able to keep up with its workplan. 
OFHEO completed its first on-site examinations, focusing on the
enterprises' use of off-balance sheet financial derivatives, in
November 1994.  OFHEO reported that the enterprises used derivatives
for sound business purposes and that derivatives activities were
consistent with the enterprises' objectives.  OEO began its second
examination of both enterprises, the corporate examinations, in
October 1994 and anticipates completing those reports in April 1995,
4 months behind its original schedule.  OEO has completed one part of
its planned supervisory monitoring activities (an analysis of the
enterprises' strategic and business plans).  But two other activities
that were scheduled to be done by the end of 1994--the development of
OFHEO's call report and the third quarter company analysis of the
enterprises-- are also behind schedule.  All activities planned for
1995 are also behind schedule. 

The reasons OFHEO has fallen behind seem related to complications in
establishing a new organization.  First, according to the director of
OEO, OFHEO had trouble hiring qualified examination staff. 
Occasionally, OFHEO found it hard to attract qualified candidates,
because it was new and not well known.  According to OFHEO's
Director, there are a limited number of individuals with the
particular skills that OFHEO needs, forcing it to compete with other
financial regulators for qualified staff.  OFHEO also noted that it
had difficulty competing with private salary offers.  In addition,
some employees who accepted employment with OFHEO were unable to
begin as early as OFHEO management wanted. 

Second, OFHEO needed to establish its internal review processes to
help ensure quality reporting.  Upon completing its first
examinations, the draft report was reviewed by key OFHEO management
officials while developing a review procedure.  OFHEO hopes to
streamline its review process in the future.  Finally, senior OFHEO
officials told us that the amount of information from the enterprises
that its staff needs to review is voluminous.  OFHEO may have
underestimated the time needed for its small examination staff (five
staff examiners and regulatory specialists at the end of the calendar
year) to review and understand such large amounts of information.  On
the other hand, according to the director of OEO, the initial
examination activities have proven to be valuable exercises in
building OFHEO's overall knowledge and expertise, which should help
focus subsequent work. 


--------------------
\17 Section 1317(a), 12 U.S.C.  4517. 

\18 Section 1317(b), 12 U.S.C.  4517. 

\19 The quarterly company analyses are to focus on the financial
safety and soundness of the enterprises and include related
information on business activity, financial market measures, and
analysis and opinions of financial analysts. 

\20 Call reports document an institution's income and condition on a
quarterly basis. 


      RESEARCH, ANALYSIS AND
      CAPITAL STANDARDS: 
      CONSIDERABLE PROGRESS MADE
      TOWARD STRESS TEST
---------------------------------------------------------- Letter :5.2

The act requires OFHEO to establish a risk-based capital test for the
enterprises (the stress test) to determine the amount of capital the
enterprises must hold.  That amount must be adequate to last during a
10-year period (the stress period), which the act defines with
specific parameters relating to credit risk,\21 interest rate
risk,\22 new business, and other activities.\23 The act defines an
enterprise's required risk-based capital level as equal to the amount
calculated by applying the stress test, along with an additional 30
percent to allow for management and operations risks.\24 Using this
test, OFHEO is then to determine the enterprises' capital adequacy,
using classifications established in the act.  Further, the act also
required the Director to issue final regulations establishing the
stress test within 18 months of the Director's appointment\25 (i.e.,
by December 1, 1994). 

The Research, Analysis and Capital Standards section (RACS) is
responsible for developing and implementing the stress test.  By the
end of fiscal year 1994, OFHEO had hired the majority of its RACS
staff and completed the design, purchase, and installation of the
computer hardware and software (called the Research Systems
Environment, or RSE) needed to establish the financial simulation
modeling capability to run the stress test.\26 OFHEO has also begun
developing the computer programs and databases that will allow it to
simulate the enterprises' businesses for purposes of the stress test
and other tasks, such as the analysis of various economic scenarios,
new financial products, proposed policy initiatives, and new business
scenarios.  As of October 1994, RACS had received all historical data
requested from the enterprises.\27 Among other things, RACS staff has
transformed the data into a form necessary for simulation modeling,
created historical data sets, begun building the algorithms, and has
started drafting parts of the description of the stress test. 

Despite these accomplishments, OFHEO did not meet the December 1,
1994, deadline imposed by its authorizing legislation regarding the
development of the stress test.  OFHEO published the Advanced Notice
of Proposed Rulemaking in the Federal Register on February 8, 1995,
announcing its intention to develop the regulation and soliciting
public comment on a variety of issues.  Following a 90-day comment
period, OFHEO will consider those comments and incorporate them as
appropriate into a proposed rule to be published later in 1995. 
OFHEO expects to publish the final regulations in 1996.  The
enterprises will then have 1 year to bring their capital levels into
compliance. 


--------------------
\21 Credit risk is the risk of loss arising from borrowers failing to
repay their loans and/or other parties failing to meet their
obligations to administer or guarantee loans.  Credit risk is
inherent in the daily operations of all financial firms, including
the enterprises. 

\22 In general, interest rate risk is the exposure to possible losses
and changes in value arising from changes in interest rates. 

\23 Section 1361, 12 U.S.C.  4611. 

\24 Section 1361(c), 12 U.S.C.  4611.  Management risk is the
potential for losses resulting from the decisions or indecisiveness
of a company's managers.  Operations risk is the exposure to
financial loss from inadequate systems, management failure, faulty
controls, fraud, or human error. 

\25 Section 1361(e), 12 U.S.C.  4611. 

\26 OFHEO has since expanded the RSE's central storage to accommodate
all the data received from the enterprises and expects to add
additional workstations.  According to RACS' director, this system
will be similar to those used by research and financial firms that
work with comparable types and amounts of data. 

\27 Data from the enterprises will support the functions of both RACS
and OEO.  Once OFHEO determines which data it requires for its
ongoing research and examinations needs, it expects to receive
monthly and quarterly updates. 


   OFHEO HAS FULFILLED OTHER
   OPERATIONAL AND REPORTING
   REQUIREMENTS
------------------------------------------------------------ Letter :6

Although not meeting the legislatively mandated deadline for issuing
final regulations establishing the stress test of the enterprises'
capital adequacy and slightly behind on its internal examinations
workplan, OFHEO has met other important operational and reporting
requirements.  For example, OFHEO submitted annual written reports to
the Senate and House Banking Committees as required by the act,
covering such topics as actions taken by OFHEO and descriptions of
the financial safety and soundness of each enterprise.\28 In
addition, OFHEO submitted its annual report to the President and
Congress, as required by the Federal Managers' Financial Integrity
Act of 1982 (FIA),\29 on December 20, 1994.  The report noted that
OFHEO as a whole complied with FIA.\30 Perhaps most important, OFHEO
made quarterly determinations of the enterprises' capital adequacy. 
During the 18-month period following enactment (i.e., from October
28, 1992, through April 27, 1994), OFHEO was to classify the
enterprises as "adequately capitalized" if they maintained an amount
of core capital that equaled or exceeded certain minimum capital
levels that were to apply only during that "transition" period.\31
OFHEO determined the enterprises to be adequately capitalized for the
second, third, and fourth quarters of 1993 and for the first quarter
of 1994, applying those transitional minimum capital standards.  For
the second and third quarters of 1994, OFHEO determined the
enterprises to be adequately capitalized, applying other minimum
capital standards contained in the act.  The transition minimum
capital levels are lower than those effective following the
transition period. 

Table 4 summarizes the act's deadlines, other major requirements, and
actions taken by OFHEO through the end of calendar year 1994. 



                           Table 4
           
            Chronology of OFHEO's Development and
               Actions on Legislative Mandates

Key date/         Legislative mandate,
deadline          with U.S. Code cite   Action
----------------  --------------------  --------------------
October 28, 1992  Pub. L. 102-550
                  signed into law.

June 1, 1993                            OFHEO Director sworn
                                        in.

June 15, 1993     General report due    OFHEO issued written
                  annually to House     report on June 14,
                  and Senate banking    1993, to House and
                  committees            Senate Banking
                  (ï¿½1319B(a)).          Committees on
                                        operations of OFHEO,
                                        highlighting
                                        organizational
                                        structures created.

September 1,      OFHEO is to complete  OFHEO issued first
1993              first determination   capital
                  of capital adequacy   classification
                  of the enterprises.   report on January
                  Subsequent            31, 1994,
                  determinations due    classifying the
                  quarterly             enterprises as
                  (ï¿½1364(c)).           adequately
                                        capitalized as of
                                        June 30, 1993.

November 27,      OFHEO is to report    OFHEO issued report
1993              on its equal          on its equal
                  opportunity,          opportunity,
                  affirmative action,   affirmative action,
                  and minority          and minority
                  business enterprise   business enterprise
                  utilization programs  utilization programs
                  (ï¿½1315(f)).           on December 1, 1993.

December 1, 1993  Quarterly capital     OFHEO issued report
                  classifications due   on April 15, 1994,
                  (ï¿½1364(c)).           classifying
                                        enterprises as
                                        adequately
                                        capitalized as of
                                        September 30, 1993.

March 1, 1994     --Establish and       --OFHEO collected
                  collect annual        first semiannual
                  assessment (payable   assessment of
                  semiannually) from    enterprises.
                  the enterprises
                  (ï¿½1316(a) and         --OFHEO issued
                  ï¿½1316(b)(2)).         report on April 15,
                                        1994, classifying
                  --Quarterly capital   enterprises as
                  classifications due   adequately
                  (ï¿½1364(c)).           capitalized as of
                                        December 31, 1993.

March 15, 1994    Report on             OFHEO reported that
                  enforcement actions   the Director had
                  due (ï¿½1319B(b)).      made no requests to
                                        the Attorney General
                                        for enforcement
                                        actions under
                                        subtitle C of the
                                        act.

June 1, 1994      Quarterly capital     OFHEO issued report
                  classifications due   on June 14, 1994,
                  (ï¿½1364(c)).           classifying
                                        enterprises as
                                        adequately
                                        capitalized as of
                                        March 31, 1994.

June 15, 1994     General report due    OFHEO issued annual
                  annually to House     report to Congress
                  and Senate banking    covering examination
                  committees            of enterprises and
                  (ï¿½1319B(a)).          organizational
                                        development of
                                        OFHEO.

September 1,      --Establish and       --OFHEO collected
1994              collect annual        semiannual
                  assessment (payable   assessments from
                  semiannually) from    enterprises.
                  the enterprises
                  (ï¿½1316(a) and         --On September 29,
                  ï¿½1316(b)(2)).         1994, OFHEO issued
                                        reports classifying
                  --Quarterly capital   enterprises as
                  classifications due   adequately
                  (ï¿½1364(c)).           capitalized as of
                                        June 30, 1994.

December 1, 1994  --Final regulations   --OFHEO's
                  and orders covering   organizational
                  OFHEO operations due  regulation published
                  (ï¿½1319G(a)).          in Federal Register
                                        on December 5,
                  --Final regulations   1994.
                  on risk-based
                  capital test due      --OFHEO notified
                  (ï¿½1361(e)(1)).        House and Senate
                                        Banking Committees
                  --Quarterly capital   in writing on
                  classifications due   November 2, 1994,
                  (ï¿½1364(c)).           that risk-based
                                        capital test would
                                        be late.

                                        --OFHEO issued
                                        report on December
                                        29, 1994,
                                        classifying
                                        enterprises as
                                        adequately
                                        capitalized as of
                                        September 30, 1994.

December 31,      Statement of          OFHEO issued letter
1994              compliance with       on December 20,
                  Federal Managers      1994, noting that
                  Financial Integrity   OFHEO as a whole
                  Act due. (31 U.S.C.   complied with the
                  3512(d).              act.
------------------------------------------------------------

--------------------
\28 Section 1319B of the Act (12 U.S.C.  4521) also requires the
annual reports to include the results of OFHEO's examinations of the
enterprises.  Because OFHEO did not complete its first examinations
of the enterprises until November 1994, its first two annual reports
did not include those examination results. 

\29 31 U.S.C.  3512(d). 

\30 Because its financial data had been maintained in HUD's
accounting system, OFHEO's report made note of HUD's having reported
material weaknesses and nonconformance pertaining to its financial
management system in its FIA report. 

\31 Section 1362(b), 12 U.S.C.  4612; section 1364(d), 12 U.S.C. 
4614. 


   SUMMARY
------------------------------------------------------------ Letter :7

During its first 18 months, OFHEO has accomplished a great deal.  The
Director has filled all senior management staff and most key
professional, technical, and analytic staff positions.  OFHEO's human
resource, accounting, and financial systems are approaching full
implementation.  OFHEO has established its central mission-related
functions--examinations and capital adequacy--and met most of the
act's requirements in these areas.  Where OFHEO was unable to meet
legislated deadlines, we believe it has taken reasonable steps to
address its shortcomings. 

We also believe, however, that more major challenges remain.  All of
OFHEO's major management systems have yet to be fully implemented. 
Perhaps most importantly, OFHEO must still complete and implement its
risk-based capital stress test to determine the amount of capital the
enterprises must hold.  Along with its examination of the
enterprises, the stress test is central to OFHEO's ability to
accomplish its mission.  We are legislatively required to study
certain aspects of that test and will report our findings to the
House and Senate Banking Committees. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :8

We requested comments on a draft of this report from the Director of
OFHEO.  In its written comments, OFHEO agreed with the content and
conclusions.  OFHEO's comments are reprinted in appendix I. 


---------------------------------------------------------- Letter :8.1

We are sending copies of this report to the Director, OFHEO; the
Secretary, HUD; and other interested parties.  We will also make
copies available to others on request. 

This report was prepared under the direction of William J.  Kruvant,
Assistant Director, Financial Institutions and Markets Issues.  Other
major contributors are shown in Appendix II.  Please contact either
Mr.  Kruvant on (202) 942-3837 or me on (202) 512-8678 if you have
any questions about this report. 

James L.  Bothwell
Director, Financial Institutions
 and Market Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM OFHEO
============================================================== Letter 



(See figure in printed edition.)



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

Steven C.  Martin, Evaluator-in-Charge
Edwin J.  Lane, Evaluator

ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C. 

Janet M.  Krell, Assistant Director

OFFICE OF GENERAL COUNSEL,
WASHINGTON, D.C. 

Herbert I.  Dunn, Senior Attorney
