Federal Housing Enterprises: OFHEO Faces Challenges In Implementing a
Comprehensive Oversight Program (Chapter Report, 10/22/97, GAO/GGD-98-6).

Pursuant to a legislative requirement, GAO assessed the Office of
Federal Housing Enterprise Oversight's (OFHEO) capacity to fulfill its
mission of helping to ensure the safety and soundness of the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac), focusing on: (1) identifying the
reasons why OFHEO has not issued final risk-based capital standards for
the enterprises even though there was a December 1, 1994, deadline for
doing so; and (2) assessing OFHEO's implementation of its safety and
soundness examination responsibilities.

GAO noted that: (1) to fulfill its statutory safety and soundness
mission, OFHEO is to establish risk-based capital standards that are
sufficient to withstand the rigors of a complex stress test and
implement a comprehensive and timely examination program; (2) to date,
OFHEO has not fully completed either of these tasks; (3) OFHEO has not
established the risk-based capital standards because it must first
develop the stress test; (4) development of a stress test has been
protracted primarily due to: (a) the complexity of the development
process as specified in the act; and (b) OFHEO's decision in 1994 to
develop its own sophisticated stress test rather than adopting and
modifying stress tests that were already under development; (5) OFHEO
has already missed its December 1994 statutory deadline for completing a
stress test and establishing risk-based capital standards by almost 3
years; (6) tasks remaining include making key policy decisions about the
stress test and continuing to translate its components into proposed and
final rules; (7) GAO believes that it is essential that OFHEO complete
the tasks remaining to develop those standards as expeditiously as
possible; (8) OFHEO has not fully implemented a timely and comprehensive
enterprise safety and soundness examination program; (9) OFHEO
established an examination plan in September 1994 that provided for a
2-year cycle for the assessment of six core risks; (10) OFHEO's current
3- to 4-year cycle for assessing the six core risks is considerably
longer than the 2-year cycle established in the plan; (11) GAO's
analysis found that, among other factors, limited resources allocated to
the examination office were largely responsible for OFHEO's inability to
comply with the 1994 plan; (12) according to OFHEO officials, the
organization plans to reassess its examination strategy and make changes
necessary by early 1998 to ensure that its examination staff cover all
six core risk areas within a 1-year period; (13) GAO believes that,
without a reassessment, and potentially a reallocation of resources,
OFHEO may not be able to implement an annual examination cycle by early
1998 that fully covers all risk areas, since the organization has been
unable to implement a 2-year cycle with the current assignment of staff
to the examination function; and (14) OFHEO could usefully include
consideration of different examination cycles and related coverage that
could be accomplished with alternative resource levels.

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

 REPORTNUM:  GGD-98-6
     TITLE:  Federal Housing Enterprises: OFHEO Faces Challenges In 
             Implementing a Comprehensive Oversight Program
      DATE:  10/22/97
   SUBJECT:  Financial management systems
             Government sponsored enterprises
             Federal agency accounting systems
             Risk management
             Interagency relations
             Mortgage programs
             Standards evaluation
             Capital
             Bank examination
             Banking regulation
IDENTIFIER:  HUD Central Accounting and Program System
             OFHEO Performance Evaluation Management System
             Mexico
             
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Cover
================================================================ COVER


Report to Congressional Committees

October 1997

FEDERAL HOUSING ENTERPRISES -
OFHEO FACES CHALLENGES IN
IMPLEMENTING A COMPREHENSIVE
OVERSIGHT PROGRAM

GAO/GGD-98-6

Federal Housing Enterprises

(233512)


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

  ANPR - Advanced Notice of Proposed Rulemaking
  APA - Administrative Procedure Act
  FHEO - Office of Fair Housing and Equal Opportunity (HUD)
  FMS - Financial Management System (Department of Veterans Affairs)
  HAAS - HUD Administrative Accounting System
  HUD - Department of Housing and Urban Development
  HUDCAPS - HUD Central Accounting and Program System
  LTV - loan-to-value ratio
  MBS - Mortgage-Backed Security
  NPR - Notice of Proposed Rulemaking
  OCC - Office of the Comptroller of the Currency
  OEO - Office of Examination and Oversight (OFHEO)
  OFA - Office of Finance and Administration (OFHEO)
  OFHEO - Office of Federal Housing Enterprise Oversight
  OGC - Office of General Counsel (OFHEO)
  OMB - Office of Management and Budget
  OPA - Office of Policy Analysis (OFHEO)
  ORACS - Office of Research and Capital Standards (OFHEO)
  PASA - Participating Agency Service Agreement
  PEMS - Performance Evaluation Management System (OFHEO)
  SEDESOL - Mexico's Secretariat for Social Development
  USAID - United States Agency for International Development
  VA - Department of Veterans Affairs

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


B-275470

October 22, 1997

Congressional Committees

This report addresses requirements that we assess the operations of
the Office of Federal Housing Enterprise Oversight (OFHEO) contained
in Sec.  430 of the Department of Veterans Affairs/Department of
Housing and Urban Development Appropriations Act of 1997 (P.L. 
104-204).  The report assesses OFHEO's capacity to fulfill its
mission of helping to ensure the safety and soundness of the Federal
National Mortgage Association and the Federal Home Loan Mortgage
Corporation. 

As such, the report provides information on OFHEO's development of
risk-based capital standards, implementation of an examination
program, establishment of mission support functions, and
participation in a U.S.  initiative to assist Mexico in developing a
secondary mortgage loan market.  We also provide recommendations to
the acting director of OFHEO on strengthening reporting to Congress
on the development of the risk-based capital standards and ensuring
adequate resources for the examinations program. 

We are sending copies of the report to other appropriate
congressional committees, the Acting Director of OFHEO, the Chairman
of the Board of Governors of the Federal Reserve System, the
Comptroller of the Currency, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, and other
interested parties.  We will also make copies available to others
upon request. 

Major contributors to this report are listed in appendix V.  If you
have any questions about this report, please call me on (202)
512-8678. 

Thomas J.  McCool
Director, Financial Institutions
 and Markets Issues


List of Congressional Committees

The Honorable Christopher Bond
Chairman
The Honorable Barbara A.  Mikulski
Ranking Minority Member
Subcommittee on Veterans Affairs,
 HUD, and Independent Agencies
Committee on Appropriations
United States Senate

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

The Honorable Robert F.  Bennett
Chairman
The Honorable Barbara Boxer
Ranking Minority Member
Subcommittee on Financial Services
 and Technology
Committee on Banking,
 Housing, and Urban Affairs
United States Senate

The Honorable Richard H.  Baker
Chairman
The Honorable Paul E.  Kanjorski
Ranking Minority Member
Subcommittee on Capital Markets, Securities,
 and Government Sponsored Enterprises
Committee on Banking and Financial Services
House of Representatives

The Honorable Jerry Lewis
Chairman
The Honorable Louis Stokes
Ranking Minority Member
Subcommittee on Veterans Affairs,
 HUD, and Independent Agencies
Committee on Appropriations
House of Representatives


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

There is a widespread perception in the financial markets that,
during a financial emergency, the U.S.  government would rescue
either or both of the two largest federal housing enterprises, the
Federal National Mortgage Association (Fannie Mae) and the Federal
Home Loan Mortgage Corporation (Freddie Mac), which had combined
financial obligations of $1.5 trillion at year-end 1996.  To lower
the probability that such a costly government intervention would ever
be considered necessary, it is important that the Office of Federal
Housing Enterprise Oversight (OFHEO) fulfill its mission of helping
to ensure the safety and soundness of Fannie Mae and Freddie Mac (the
enterprises) pursuant to the Federal Housing Enterprises Financial
Safety and Soundness Act of 1992 (the act).  OFHEO's primary means
for fulfilling its mission are establishing capital standards for the
enterprises and conducting on-site examinations to assess their
management practices and financial condition. 

The Department of Veterans Affairs (VA)/Department of Housing and
Urban Development (HUD) Appropriations Act of 1997 required GAO to
assess OFHEO's fulfillment of its safety and soundness mission. 
Based on discussions with congressional staff, GAO established the
following two major objectives to respond to the mandate:  (1)
identify the reasons why OFHEO has not issued final risk-based
capital standards for the enterprises even though there was a
December 1, 1994, deadline for doing so and (2) assess OFHEO's
implementation of its safety and soundness examination
responsibilities. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

Congress established and chartered the enterprises as
government-sponsored, privately owned and operated corporations to
enhance the availability of mortgage credit across the nation during
both good and bad economic times.  The enterprises are to accomplish
this mission by purchasing mortgages from lenders (banks, thrifts,
and mortgage bankers) who can then use the proceeds to make
additional mortgage loans to home buyers.  The enterprises issue debt
to finance some of the mortgage assets that they retain in their
portfolios.  A majority of the mortgages, however, are pooled to
create mortgage-backed securities (MBS) that may be sold to investors
or repurchased by the enterprises and held in their portfolios.  The
enterprises charge fees for guaranteeing the timely payment of
principal and interest on MBS held by investors.  At year-end 1996,
the enterprises had combined debt obligations of $487 billion and
combined MBS obligations to investors of $1.021 trillion (a total of
about $1.5 trillion). 

The federal government's creation of and continued relationship with
Fannie Mae and Freddie Mac have created the perception in the
financial markets that it would not allow the enterprises to default
on their debt and MBS obligations, even though there is no
requirement that it do so.  As a result, Fannie Mae and Freddie Mac
can borrow money in the capital markets at lower interest rates than
comparably creditworthy private corporations that do not enjoy
federal sponsorship, and at least a portion of the financial benefits
that accrue to the enterprises have been passed along to homeowners
in the form of lower mortgage interest rates.  However, the potential
also exists that the government would choose to intervene to rescue
the enterprises in a financial emergency.  In fact, during the 1980s,
the government did provide limited regulatory and financial relief to
Fannie Mae when it experienced significant financial difficulties,
and, in 1987, Congress authorized $4 billion to bail out the Farm
Credit System, another government-sponsored enterprise. 

Recognizing the potentially large costs that Fannie Mae and Freddie
Mac pose to taxpayers, Congress passed the act, which established
OFHEO as an independent regulator within HUD whose mission is to help
ensure the enterprises' safety and soundness.  Under the act, OFHEO's
director, who is presidentially appointed and must be confirmed by
the Senate, has wide independent authority to ensure that OFHEO
fulfills its safety and soundness mission.  For example, the director
has the authority to take enforcement actions against the enterprises
without the review and approval of the HUD Secretary.  OFHEO had a
budget of about $15.5 million in fiscal year 1997 and a professional
staff of about 85 individuals consisting of full-time staff,
temporary staff, contract employees, and detailees from bank
regulatory agencies.  OFHEO's budget is subject to the congressional
appropriations process, but its expenditures are financed, to the
extent provided in appropriations acts,\1 by annual assessments on
Fannie Mae and Freddie Mac rather than with taxpayer funds. 

As required by the act, OFHEO is to carry out its oversight function
in part by establishing minimum capital standards.  The act also
mandated that OFHEO develop a stress test that serves as the basis
for the risk-based capital standards.  Under the act, the purpose of
a stress test is to lower taxpayer risks by simulating in a computer
model situations where the enterprises are exposed to adverse credit
and interest rate scenarios and requiring them to hold sufficient
capital to withstand these scenarios for a 10-year period plus an
additional 30 percent to cover management and operations risk.  The
act establishes the broad outlines of a stress test, but OFHEO is
required to complete several projects to further specify the adverse
credit and interest rate scenarios and their impacts on the
enterprises.  Under the act, the stress test and risk-based capital
standards were to have been completed by December 1, 1994.  The act
also requires OFHEO to conduct annual, on-site safety and soundness
examinations of the enterprises to assess their operations and
financial condition.  In OFHEO's opinion, this requirement can be and
has been met without conducting full-scope\2 enterprise examinations
on an annual basis. 

Since the mid-1980s, Fannie Mae and Freddie Mac have been
consistently profitable, and, in 1997, the Standard & Poor's credit
rating firm gave both enterprises relatively high "AA-" government
risk credit ratings.\3 However, OFHEO officials have pointed out that
current profitability does not guarantee future profitability.  Since
Congress passed the act, which established OFHEO in 1992, enterprise
assets, which consist primarily of mortgages and MBS that the
enterprises retain in their portfolios, have more than doubled. 
Although potentially more profitable than issuing MBS to investors,
larger retained holdings of mortgages and MBS expose the enterprises
to potentially greater losses resulting from fluctuations in interest
rates. 

To identify the reasons why OFHEO has not issued risk-based capital
standards, GAO interviewed OFHEO and enterprise officials, as well as
former HUD officials who worked on enterprise safety and soundness
issues at HUD prior to OFHEO's creation.  GAO also reviewed a variety
of OFHEO documents, such as internal memorandums and written
explanations of the stress test development process provided at GAO's
request.  GAO did not assess the adequacy or appropriateness of
OFHEO's approach to developing the stress test.  Since OFHEO has not
completed its development of risk-based capital standards, GAO could
not evaluate the usefulness of specific steps OFHEO has taken to
reach a final rule promulgating a risk-based capital standard.  GAO
assessed OFHEO's implementation of its examination responsibilities
by determining the organization's adherence to an examination
schedule and plan that was established in September 1994. 


--------------------
\1 OFHEO's budget authority is included in the annual VA/HUD
Appropriations Act. 

\2 Full-scope examinations are generally understood to mean thorough
assessments of all of the management practices and business
strategies of a financial institution that could affect its safety
and soundness. 

\3 Standard & Poor's assessed the risks that the enterprises'
financial activities pose to the U.S.  government.  The firm rates
companies on a scale ranging from "AAA" for the lowest credit risks
to "CC" for the greatest credit risks. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

To fulfill its statutory safety and soundness mission, OFHEO is to
establish risk-based capital standards that are sufficient to
withstand the rigors of a complex stress test and implement a
comprehensive and timely examination program.  To date, OFHEO has not
fully completed either of these tasks. 

OFHEO has not established the risk-based capital standards because it
must first develop the stress test.  Development of a stress test has
been protracted primarily due to (1) the complexity of the
development process as specified in the act and (2) OFHEO's initial
decision in 1994 to develop its own sophisticated stress test rather
than adopting and modifying stress tests that were already under
development.  OFHEO officials told GAO that they chose not to adopt
existing stress tests because, in their judgment, those tests did not
provide an adequate basis for understanding the risks facing the
enterprises or the capital necessary to offset those risks.  OFHEO
officials also said that the organization faced significant and
time-consuming challenges in acquiring expertise, obtaining accurate
financial information from the enterprises, initiating the federal
rulemaking process, and completing several financial modeling and
computer programming projects. 

OFHEO has already missed its December 1994 statutory deadline for
completing a stress test and establishing risk-based capital
standards by almost 3 years.  Tasks remaining include making key
policy decisions about the stress test and continuing to translate
its components into proposed and final rules.  OFHEO now estimates
that it will not complete this part of the statutory mandate until
1999.  Because the risk-based capital standards are among OFHEO's
primary tools for helping to ensure the enterprises' safety and
soundness, GAO believes that it is essential that OFHEO complete the
tasks remaining to develop those standards as expeditiously as
possible. 

OFHEO has not fully implemented a timely and comprehensive enterprise
safety and soundness examination program.  OFHEO established an
examination plan in September 1994 that provided for a 2-year cycle
for the assessment of six "core" risks, such as interest rate and
credit, facing the enterprises.  As of May 1997, OFHEO had completed
or initiated examinations covering five of these six "core" risks. 
However, OFHEO's current 3- to 4-year cycle for assessing the six
core risks is considerably longer than the 2-year cycle established
in the plan.  In addition, OFHEO has scaled back the planned coverage
of its most recently completed core risk examination. 

GAO's analysis found that, among other factors, limited resources
allocated to the examination office were largely responsible for
OFHEO's inability to comply with the 1994 plan.  According to OFHEO
officials, the organization plans to reassess its examination
strategy and make changes necessary by early 1998 to ensure that its
examination staff cover all six core risk areas within a 1-year
period.  GAO believes that, without a reassessment and potentially a
reallocation of resources, OFHEO may not be able to implement an
annual examination cycle by early 1998 that fully covers all risk
areas, since the organization has been unable to implement a 2-year
cycle with the current assignment of staff to the examination
function.  Thus, GAO believes that, in the reassessment of its
examination strategy, OFHEO could usefully include consideration of
different examination cycles and related coverage that could be
accomplished with alternative resource levels. 


   PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4


      OFHEO'S DEVELOPMENT OF A
      STRESS TEST AND RISK-BASED
      CAPITAL STANDARDS HAS BEEN
      PROTRACTED
-------------------------------------------------------- Chapter 0:4.1

In OFHEO's planning process and its published documents, the
organization has consistently underestimated the time necessary to
complete major components of the stress test and risk-based capital
standards.  For example, in 1995 OFHEO estimated that the final rule
would be issued in May 1997, but OFHEO now expects that the process
will not be completed until 1999.  GAO's review identified several
reasons why OFHEO did not comply with the statutory deadline.  GAO
also found that OFHEO faces continuing challenges and may not meet
its current estimate. 

OFHEO's statutory mandate to develop a stress test and risk-based
capital standards presented complex and time-consuming challenges to
the organization.  For example, according to OFHEO, the final stress
test must be flexible and capable of assessing the effects of
different credit and interest rate scenarios on differing components
of the enterprises' mortgage portfolios, such as single family and
multifamily mortgages, as well as new financial products.  By
contrast, the risk-based capital standards developed by federal
banking regulators permit institutions to hold the same level of
capital against corporate loans that represent high credit risks as
against corporate loans that represent low credit risks. 

During OFHEO's start-up phase in 1993 and 1994, there were strategies
available that OFHEO could have pursued that might have resulted in
the faster completion of a stress test and risk-based capital
standards.  As the foundation of the stress test, OFHEO could have
adopted and modified a stress test under development by HUD in 1992,
or the financial models that the enterprises had established to
assess the potential impacts of alternative credit and interest rate
scenarios.  However, OFHEO officials determined that pursuing these
strategies would have left the organization with an inadequate basis
for assessing the risks facing the enterprises.  For example, OFHEO
officials determined that the available HUD stress test only allowed
for very broad estimates of the potential impacts that different
interest rate and credit scenarios would have on the enterprises'
financial condition.  Consequently, OFHEO concluded that it could
develop capital standards that would be more closely related to
enterprise risks by developing its own sophisticated stress test and
associated financial modeling capability.  GAO notes that the
implementation of this strategy is requiring a substantial
development period and resource costs. 

Between 1994 and 1997, OFHEO experienced other sources of delay in
completing the stress test and risk-based capital standards.  For
example, OFHEO had not completed hiring half of its full-time
research staff until 1996.  OFHEO officials also told GAO that the
development of the stress test has been delayed by OFHEO's need to
(1) obtain accurate enterprise financial data on a timely basis; (2)
initiate the federal rulemaking process, which involved a substantial
commitment of staff time; and (3) complete a variety of economic and
financial modeling and computer programming projects that involved
greater managerial and technical challenges than OFHEO initially
anticipated.  OFHEO officials told GAO that most of these financial
modeling and computer programming projects had been completed by
April 1997, although some final testing was required. 

Given OFHEO's history of underestimating the time necessary to
complete the stress test and risk-based capital standards and given
the challenges that remain, GAO is concerned that OFHEO may not meet
its current estimate of issuing a final rule by 1999.  To comply with
its plan, OFHEO has to initiate an interagency review of the proposed
rule by the Office of Management and Budget (OMB) and other agencies,
and has to make key policy decisions necessary to complete the stress
test.  OFHEO must also continue to translate the complex financial
modeling components of the stress test and risk-based capital
standards into proposed and final rules.  GAO believes it is
essential that OFHEO complete the tasks remaining to develop the
stress test and establish the risk-based capital standards as
expeditiously as possible because they are among OFHEO's primary
tools for helping to ensure the enterprises' safety and soundness. 


      OFHEO HAS NOT FULLY
      IMPLEMENTED ITS SEPTEMBER
      1994 EXAMINATION PLAN
-------------------------------------------------------- Chapter 0:4.2

In September 1994, OFHEO established a "risk-focused" examination
schedule and plan that senior OFHEO officials said they believed was
necessary for helping to ensure the safety and soundness of Fannie
Mae and Freddie Mac.  The plan, as subsequently modified, identified
six core risks facing the enterprises, such as credit and interest
rate risks, and established a 2-year cycle for OFHEO examiners to
assess each of these six risks.  In addition, the plan identified
specific areas that OFHEO examiners were to assess during each
scheduled examination.  OFHEO's risk-focused examination strategy is
generally consistent in concept but not in timing with risk-focused
examination strategies that the Office of the Comptroller of the
Currency (OCC) and the Federal Reserve System have established to
assess the safety and soundness of large commercial banks.  For
example, OCC and Federal Reserve System examiners are to assess the
major risks--such as credit and interest rate--facing large
commercial banks but, as required by law, they are to do so on an
annual basis.\4

Between September 1994 and May 1997, OFHEO made important progress in
implementing the plan, such as completing or initiating examinations
at both enterprises that addressed five of the six core risks. 
However, GAO found that OFHEO was not able to implement other
important components of the 1994 plan.  For example, OFHEO's current
3- to 4-year examination cycle for covering the six core risk areas
is considerably longer than the 2-year cycle established in the 1994
plan.  Moreover, OFHEO also scaled back the planned coverage of its
core business risk examination.  OFHEO completed this risk
examination in May 1997 but covered only one of the four areas
identified in the 1994 plan.  OFHEO's relatively long examination
cycle and limited examination coverage raise questions about the
organization's ability to fully monitor the enterprises' financial
activities and risks.  In particular, with its current examination
schedule, OFHEO may not be able to do another on-site examination of
the enterprises' interest rate risks until 1999 or 2000, even though
such risks may have increased because of increased holdings of
debt-financed mortgage assets, since the previous interest risk
examination was completed in 1996. 

In May 1995, GAO reported that limited staff resources had impeded
OFHEO's initial efforts to implement the 1994 plan.\5

This situation persisted between 1995 and 1997.  As of June 1997,
OFHEO's examination office had 17 authorized positions of which 12
were reserved for line examiners and specialists directly responsible
for conducting examinations; the other 5 positions consisted of the
office director and deputy director, executive secretary, and 2
financial analysts.  In its two most recently completed core risk
examinations, OFHEO assigned 9 and 8 of its line examiner and
specialist positions, respectively, to each examination for 1 year to
complete them.  This significant staff commitment limits OFHEO's
ability to complete examinations covering three core risks per year,
the minimum necessary to cover all six risks in the 2-year period
stipulated in the 1994 plan.  In addition, as of March 31, 1997,
OFHEO's examination office had five vacancies, including the director
position, which had further limited its capacity to implement the
1994 plan.  By August 1997, an OFHEO official reported that the
organization had filled three of the examination office positions,
including the director position, and the two others were in the
process of being advertised. 

OFHEO officials said that another important factor that has
contributed to OFHEO's inability to fully implement the 1994
examination plan was the time that OFHEO examination staff needed to
develop an understanding of the enterprises' operations and risk
management.  Prior to 1993 when OFHEO began operations, the
enterprises had not been subjected to an examination oversight
program.  OFHEO officials said that the first round of examinations
has taken longer than initially anticipated in 1994 because of the
time necessary to obtain basic information about the enterprises'
operations and risk management practices. 

OFHEO officials told GAO that the organization plans to reassess its
examination program and make changes as necessary to ensure that the
enterprises' safety and soundness are adequately monitored.  They
also said that the planned reassessment is to include a review of the
adequacy of OFHEO's examination staff resources to ensure that it has
a sufficient number of line examiners and specialists to cover all
core risk areas within a 1-year period.  OFHEO's acting director said
that OFHEO may have some flexibility to increase its examination
staff resources by shifting staff from its research activities as the
stress test and risk-based capital standards are completed. 

GAO believes that, without a reassessment of resources, OFHEO may not
be able to implement an annual examination cycle by early 1998, since
it has not implemented a 2-year cycle with its existing allocation of
resources to the examination function.  In fact, as of June 1997,
OFHEO had not yet initiated important components of the 1994 plan,
such as the remaining core risk examination, which could take
considerable time to complete.  Thus, GAO believes that by including
in the reassessment an analysis of the staff resources necessary to
adequately carry out alternative examination cycles, such as 1 or 2
years, OFHEO could help ensure a fuller consideration of the
trade-offs associated with examination coverage provided versus costs
involved and thereby engage in a more informed decisionmaking
process. 


--------------------
\4 The Federal Deposit Insurance Corporation Improvement Act of 1991
(Pub.  L.  No.  102-242, as amended) requires bank regulators to do
full-scope examinations of large banks (total assets of $250 million
or more) on an annual basis. 

\5 Government-Sponsored Enterprises:  Development of the Federal
Housing Enterprise Regulator (GAO/GGD-95-123, May 30, 1995). 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5

Because it is essential that OFHEO complete its efforts to develop
and issue risk-based capital standards as soon as possible, it is
important that congressional oversight be provided to help ensure
that OFHEO's current plan to do so is accomplished in a timely
manner.  To that end, GAO recommends that OFHEO's director
periodically report to Congress on OFHEO's progress toward complying
with the current estimate of completing a stress test and risk-based
capital standards by 1999.  GAO also recommends that OFHEO's director
(1) assess the examination staff resources necessary to adequately
cover all risk areas on 1- and 2-year examination cycles, (2)
identify the most appropriate examination cycle after considering the
trade-offs between examination coverage and resource requirements
that would be involved, and (3) develop a strategy for obtaining the
necessary examination office resources, which may involve
reallocating existing resources over time. 


   AGENCY COMMENTS AND GAO'S
   EVALUATION
---------------------------------------------------------- Chapter 0:6

OFHEO's acting director provided written comments on a draft of this
report, which are summarized in chapters 2 and 3 and reprinted in
appendix IV.  OFHEO also provided technical comments that were
incorporated in the report where appropriate. 

OFHEO generally agreed with the report's findings and
recommendations.  With respect to the reasons for the protracted
development of the stress test and risk-based capital standards,
OFHEO cited the complexity of the process as specified in the act and
OFHEO's decision to develop its own stress test rather than
redesigning existing stress tests.  OFHEO also said that GAO's report
should not be interpreted to suggest that using an existing stress
test would have produced an acceptable result.  With regard to
OFHEO's examination program, OFHEO said that the office plans to
transition to an annual cycle by year-end 1997.  In addition, the
acting director stated that OFHEO will review the adequacy of its
examination staff resources to ensure that a comprehensive program
can be implemented. 

GAO did not take a position on the adequacy or appropriateness of
OFHEO's approach to developing the stress test.  To do so would have
required that GAO demonstrate whether the other alternatives could
have been modified sufficiently to meet the requirements of the act
in a shorter period of time.  Rather, GAO pointed out that there were
potential trade-offs associated with the time that would have been
required to adopt and modify existing stress tests compared to the
comprehensive development approach that OFHEO chose.  While OFHEO has
agreed to review the adequacy of its examination resources, GAO
believes it is essential that OFHEO promptly specify the resources
necessary to carry out an appropriate examination cycle and develop a
plan to obtain these resources as may be necessary. 


INTRODUCTION
============================================================ Chapter 1

Congress has a long-standing concern that the safety and soundness of
the two largest government-sponsored enterprises,\1 the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac), be maintained so that they can
meet their intended purposes and that their financial activities do
not pose risks to taxpayers.  Consequently, Congress passed the
Federal Housing Enterprises Financial Safety and Soundness Act of
1992 (the act),\2 which established the Office of Federal Housing
Enterprise Oversight (OFHEO) within the Department of Housing and
Urban Development (HUD) as an independent financial safety and
soundness regulator of Fannie Mae and Freddie Mac (the enterprises). 
For reasons relating to the federal charters and structures of the
enterprises--which had combined financial obligations of $1.5
trillion at year-end 1996--investors and rating agencies perceive the
enterprises' securities as implicitly guaranteed by the federal
government, despite there being no such statutory obligation.  We
have been mandated by the Department of Veterans Affairs (VA)/HUD
Appropriations Act of 1997\3 to assess OFHEO's fulfillment of its
safety and soundness mission.  Based on discussions with
congressional staff, our major objectives were to (1) identify why
OFHEO has not finalized risk-based capital standards for the
enterprises even though there was a December 1, 1994, deadline for
doing so and (2) assess OFHEO's implementation of its enterprises'
safety and soundness examination responsibility.  We are also
providing information on OFHEO's implementation of key mission
support functions and participation in a U.S.  government initiative
to assist Mexico in developing a secondary mortgage loan market. 


--------------------
\1 Government-sponsored enterprises 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. 

\2 Housing and Community Development Act of 1992, Pub.  L.  No. 
102-550, Title XIII, 12 U.S.C.  4501, et.  seq. 

\3 Pub.  L.  No.  104-204 ï¿½ 430, 110 Stat.  2874, 2930 (September 26,
1996). 


   BACKGROUND
---------------------------------------------------------- Chapter 1:1

The enterprises help ensure that mortgage funds are available to home
buyers by buying mortgages from mortgage originators, such as
commercial banks, thrifts, and mortgage bankers.  In turn, the
originators use the funds supplied by the enterprises to make
additional mortgage loans thereby helping ensure a continuous supply
of mortgage credit nationwide during both good and bad economic
periods. 

The enterprises hold some of the mortgages they purchase in portfolio
as direct investments on their books and issue debt and equity
securities to finance these holdings.  However, a majority of
mortgages that the enterprises buy from mortgage originators are
"securitized"--that is, the enterprises package them into mortgage
pools to support mortgage-backed securities (MBS).  These mortgage
pools receive interest and principal payments from the mortgages in
the pools and pass them on to the investors who purchased MBS.  The
enterprises guarantee the timely payment of principal and interest on
MBS held by investors, administer the payments, and charge "guarantee
fees" for providing these services.  The enterprises may also
repurchase MBS and hold the securities in their mortgage portfolios. 

The enterprises are government-sponsored in that they operate under
federal charters that convey certain benefits, impose certain
restrictions, and permit the enterprises to earn a profit while
serving public policy purposes, such as providing liquidity\4 to
mortgage markets.  In 1992, Congress expanded the enterprises' public
purpose by requiring annual goals for the purchase of mortgages on
housing serving very-low, low-, and moderate-income and other
households that are underserved by the residential mortgage market.\5
These goals are to be set, monitored, and enforced by HUD.  The
charters restrict the enterprises to buying mortgages that do not
exceed a set dollar amount, known as the conforming loan limit.\6

A major factor that enhances the enterprises' profitability is the
financial markets' perception that there exists an implied federal
guarantee of their debt and MBS obligations.  Investors perceive that
this implied guarantee decreases the risk of default on the
enterprises' financial obligations.  Consequently, this perception
reduces the enterprises' borrowing costs because investors are
willing to accept lower expected returns on enterprise debt than they
would for similar private firms without government ties.  Likewise,
interest rates on MBS are lowered by this perception.\7

Their lower funding costs allow the enterprises to increase their
purchases and give them a cost advantage over their potential
competitors.  This perception of a federal guarantee remains, even
though laws chartering the enterprises contain explicit language
stating that there is no such guarantee. 

The market perception of the implied federal guarantee is based on,
among other things, federal ties to the enterprises, including
government-sponsored status, each enterprise's $2.25 billion
conditional line of credit with the Department of the Treasury, and
their exemptions from state and local income taxes and securities
registration fees imposed by the Securities and Exchange Commission. 
In 1996, we estimated that the financial benefits that accrue to the
enterprises from their federal sponsorship ranged from about $2.2
billion to $8.3 billion on a pretax basis and from about $1.6 billion
to $5.9 billion on an aftertax basis in 1995.\8

We also reported that approximately 80 percent to 95 percent of these
estimated benefits were derived from the lower funding costs that the
enterprises accrue as a result of the perception of a federal
guarantee. 


--------------------
\4 A market is more liquid if investors can buy and sell large
amounts of holdings without affecting the prices of the traded
securities. 

\5 Federal Housing Enterprises Safety and Soundness Act of 1992, Pub. 
L.  No.  102-550, ï¿½ï¿½ 1331-1334, 12 U.S.C.  ï¿½ï¿½ 4561-4564. 

\6 The conforming loan limit depends on how many housing units are
financed by a single residential mortgage loan.  Currently, the
conforming loan limit on a single-unit residence is $214,600. 

\7 Investors will accept lower expected returns on enterprise MBS,
just as for enterprise debt, because of the perception of an implied
federal guarantee.  This, in turn, lowers the cost of funding
mortgages through issuance of MBS. 

\8 See Housing Enterprises:  Potential Impacts of Severing Government
Sponsorship (GAO/GGD-96-120, May 13, 1996).  Some analysts contend
that these benefits pass entirely through to mortgage borrowers in
the form of lower mortgage rates, while others contend that some of
the value of the benefits could be retained by the enterprises in the
form of higher profits or higher expenditures, such as for
compensation.  See FNMA and FHLMC:  Benefits Derived From Federal
Ties (GAO/GGD-96-98R, Mar.  25, 1996). 


      ENTERPRISE ACTIVITIES
      BENEFIT HOMEOWNERS BUT POSE
      POTENTIAL FINANCIAL RISKS TO
      TAXPAYERS
-------------------------------------------------------- Chapter 1:1.1

It is widely accepted that the enterprises' activities have generated
benefits to mortgage borrowers, such as lower mortgage interest
rates.  For example, in our 1996 report, we estimated that the
activities of the enterprises resulted in a savings on single-family
fixed-rate home mortgages below the conforming loan limit of about 15
to 35 basis points.\9 Thus, a borrower with a $100,000 thirty-year,
fixed-rate mortgage saves about $10 to $25 a month on mortgage
payments as a result of the enterprises' activities.\10 For the
approximately $2 trillion in outstanding conventional conforming
fixed-rate mortgages in 1995, we estimated that the aggregate annual
savings in mortgage payments were in the range of $3 billion to $7
billion.  Other benefits of the enterprises are that they have
reduced regional disparities in interest rates and mortgage
availability, and spurred the development of new technologies that
facilitate the home financing process. 

However, the potential also exists that, in the event of a financial
emergency, the federal government would choose to intervene and
assist either Fannie Mae or Freddie Mac or both in meeting their debt
and MBS obligations, which stood at a combined $1.5 trillion at
year-end 1996 (see table 1.1),\11 potentially exposing the taxpayers
to losses.  In fact, during the early 1980s when short-term interest
rates rose dramatically, Fannie Mae experienced substantial financial
difficulties because the enterprise had funded its mortgage portfolio
with short-term debt.  As rates increased, Fannie Mae had to issue
new short-term debt at higher rates to replace existing short-term
debt that came due.  Because interest earned on the old mortgages in
portfolio was less than interest expenses on new debt, Fannie Mae
experienced total losses of about $277 million between 1981 and 1984. 
(The type of risk Fannie Mae faced in the early 1980s is referred to
as interest rate risk.) In response, the federal government provided
limited tax relief and regulatory forbearance in the form of relaxed
capital requirements.  Similarly, in 1987, Congress authorized $4
billion to support the Farm Credit System--another
government-sponsored enterprise--when it experienced financial
difficulties. 



                               Table 1.1
                
                   Total Enterprise Debt and Net MBS
                  Outstanding as of December 31, 1996

                         (Dollars in billions)

                                                   Net MBS
                                        Debt  outstanding\
Enterprise                       outstanding             a       Total
------------------------------  ------------  ------------  ==========
Fannie Mae                              $331          $548        $879
Freddie Mac                              156           473         630
======================================================================
Total                                   $487        $1,021      $1,509
----------------------------------------------------------------------
\a Excludes MBS that the enterprises have repurchased and hold in
their portfolios. 

Sources:  Fannie Mae and Freddie Mac. 


--------------------
\9 A basis point equals 1/100 of a percentage point.  See Housing
Enterprises:  Potential Impacts of Severing Government Sponsorship
(GAO/GGD-96-120, May 13, 1996). 

\10 These estimates are based on an analysis of the increases in
mortgage rates that would likely occur if the federal government
fully severed its ties with the enterprises, and the perception of a
federal guarantee were removed.  Assuming that federal ties remain,
we estimated that the rate on single-family fixed-rate housing
mortgages below the conforming loan limit are lowered by 15 to 35
basis points.  See Housing Enterprises:  Potential Impacts of
Severing Government Sponsorship (GAO/GGD-96-120, May 13, 1996). 

\11 Even in the event of a major financial disaster and the
insolvency of both enterprises, it is unlikely that the government
would lose $1.5 trillion in providing support to the enterprises. 
This is because the government, as the conservator of the
enterprises, would foreclose on the residences securing the
mortgages, and the government could liquidate these properties to
help offset its initial expenditures. 


   CONGRESS ESTABLISHED OFHEO TO
   HELP ENSURE THE SAFETY AND
   SOUNDNESS OF THE ENTERPRISES
---------------------------------------------------------- Chapter 1:2

Recognizing the potentially large financial costs that Fannie Mae and
Freddie Mac posed to taxpayers, in 1992, Congress passed the act,
which established OFHEO as an independent regulator within HUD whose
mission is to help ensure the enterprises' safety and soundness.  One
of OFHEO's most important means of helping to ensure the enterprises'
financial soundness is to establish capital requirements that are
related to potential risks that the enterprises face.  Further, the
act gave OFHEO broad authority to examine the activities of the
enterprises, such as the requirement that OFHEO conduct annual
on-site examinations of the enterprises to assess their financial
condition.  During fiscal year 1997, OFHEO had a budget of about
$15.5 million and a total staff--full-time staff, temporary staff,
contract employees, and detailees from bank regulatory agencies--of
85 individuals as of March 31, 1997,\12

to carry out its safety and soundness responsibilities and to perform
administrative support functions. 

The act established OFHEO as an independent office within HUD with
respect to safety and soundness matters, and reserved for the
Secretary of HUD the responsibility to oversee the enterprises'
efforts to meet the housing goals as well as general regulatory power
over the enterprises.  However, 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 belongs to OFHEO exclusively. 
OFHEO was intended to operate separately from HUD as a safety and
soundness regulator and to be staffed with experts in financial
analysis 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 adequacy, and take enforcement
actions.  The act also gave the director exclusive authority to
manage OFHEO, which includes preparing annual budgets and hiring
personnel.  Thus, the director leads and directs OFHEO's activities
by setting internal and external policies, managing overall
operations, and serving as the chief spokesperson for the
organization.  OFHEO's first director was appointed on June 1, 1993,
and resigned on February 13, 1997, to become the Administrator of the
Small Business Administration.  As of June 1997, OFHEO was headed by
the acting director, while the President and Congress considered
potential candidates for the organization's new director. 

OFHEO is organized into six offices, which report to the director and
deputy director.  Figure 1.1 illustrates OFHEO's organizational
structure. 

   Figure 1.1:  OFHEO's
   Organizational Structure

   (See figure in printed
   edition.)

  -- The Office of the General Counsel (OGC) has responsibility for
     preparing regulations required by the act and advising the
     director on legal issues, including financial institutions
     regulatory issues, applicable corporate law principles, and
     general legal matters. 

  -- 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. 

  -- The Office of Finance and Administration (OFA) is responsible
     for ensuring that OFHEO has the infrastructure to function
     independently.  This office 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.  OFA is also responsible for
     developing annual budgets and serving as the liaison with the
     Office of Management and Budget (OMB). 

  -- 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. 

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

  -- The Office of Research, Analysis and Capital Standards (ORACS)
     is responsible for developing and implementing a financial
     "stress test," which uses interest rate and credit risk
     scenarios prescribed in the act to determine the enterprises'
     risk-based capital requirements.  The office is also responsible
     for conducting research and financial analysis on issues related
     to the enterprises' activities, such as simulating Treasury
     yields and associated interest rate movements. 

Compared to other federal financial regulators, such as the Federal
Reserve System and the Office of the Comptroller of the Currency
(OCC), which have thousands of employees, OFHEO is a small
organization.  Table 1.2 shows the distribution of OFHEO's authorized
and onboard permanent employees as of March 31, 1997, among the six
offices discussed above.  As table 1.2 indicates, OFHEO had an
authorized staffing level of 72 full-time permanent positions but had
only 58 full-time permanent staff on board as of March 31, 1997. 
OFHEO supplements its permanent full-time staff with full-time and
part-time temporary employees, contractors, and detailees from other
financial regulatory agencies that perform key functions on a
reimbursable basis.  For example, OFHEO has used contract staff and
bank regulatory detailees to assist in developing capital standards
and in performing on-site safety and soundness examinations.  As of
March 31, 1997, OFHEO had 6 full-time temporary staff, 1 part-time
temporary staff, 19 contractor staff, and 1 bank regulatory detailee
on board.  Thus, OFHEO had a total onboard staff of 85 individuals
(58 full-time permanent, 7 temporary, 19 contract, and 1 detailee). 



                                    Table 1.2
                     
                          OFHEO's Full-Time, Temporary,
                     Contractor, and Bank Regulator Detailee
                            Staff as of March 31, 1997

                               Full-time   Full-time   Full-time
                               permanent   permanent   temporary  Contra
Unit                          positions\       staff      staff\      ct  Detail
----------------------------  ----------  ----------  ----------  ------  ------
Director                               7           5
Research, Analysis, and               17          14         4\a      14
 Capital Standards
Examination and Oversight             17          12                   3       1
General Counsel                        9           8           1
Finance and Administration            11          11           1       2
Policy Analysis                        6           4           1
Congressional and Public               5           4
 Affairs
================================================================================
Total                                 72          58           7      19       1
--------------------------------------------------------------------------------
\a One of the four staff members was part-time. 

Source:  OFHEO. 

Table 1.3 shows actual, estimated, and requested OFHEO obligations
for fiscal years 1996 through 1998.  Most OFHEO expenses cover
personnel and contractor services.  For fiscal year 1997, OFHEO
estimated in its fiscal year 1998 budget request to Congress that it
will spend about $9.1 million (about 59 percent of its $15.5 million
total) on personnel services (i.e., expenses related to personnel
compensation and benefits, but exclusive of contractors).  According
to OFHEO, it sets its salaries and benefits, as required by the act,
by maintaining comparability with federal banking regulatory
agencies.  The second largest category of expenses ("other services")
generally covers OFHEO's contractor services.  In fiscal year 1997,
OFHEO expects to spend nearly $3.8 million (about 25 percent of total
obligations) 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 percentage of OFHEO's total
obligations.  These expenses cover such fundamental items as computer
acquisition, travel, and rent, some of which fluctuate with changing
numbers of staff and contractors on location. 



                               Table 1.3
                
                 OFHEO's Obligations, Fiscal Years 1996
                              Through 1998

                         (Dollars in thousands)

                                                                 1997-
                                Actual   Estimated   Requested    1998
Obligation category               1996        1997        1998  change
------------------------------  ------  ----------  ----------  ------
Personnel services              $7,234      $9,119      $9,572    $453
Other services                   4,800       3,793       3,664    -129
All other                        2,758       2,588       3,076     488
======================================================================
Total                           $14,79     $15,500     $16,312   $ 812
                                     2
----------------------------------------------------------------------
Source:  OFHEO's fiscal year 1998 budget request to Congress. 

Although OFHEO's financial plans and forecasts are to be included in
the budget of the United States and are subject to the appropriations
process,\13 the organization is not funded with tax dollars.  Rather,
the act requires the enterprises to pay annual assessments to cover
OFHEO's costs.  Each enterprise is required to pay an amount in
proportion to the ratio of its individual assets to the total
combined assets of both enterprises.  The assessment is to be paid
semiannually into a Department of Treasury fund, known as the Federal
Housing Enterprises Oversight Fund. 


--------------------
\12 OFHEO's staffing levels tend to fluctuate throughout the year as
full-time staff resign or are hired and contractors and detailees
either complete or begin their assignments. 

\13 OFHEO's budget authority is included in the annual VA/HUD
Appropriations Act. 


      OFHEO CARRIES OUT ITS
      OVERSIGHT MISSION BY
      DEVELOPING CAPITAL STANDARDS
      AND CONDUCTING EXAMINATIONS
-------------------------------------------------------- Chapter 1:2.1

Under the act, OFHEO is to establish two sets of capital standards to
help ensure the safety and soundness of the enterprises and minimize
taxpayer risks.  The first standard, which is called the "minimum
capital" standard, requires a minimum amount of capital that an
enterprise must hold.  Minimum capital is computed on the basis of
capital ratios specified in the act that are applied to certain
on-balance-sheet and off-balance-sheet obligations of the
enterprises.  The ratios are (1) 2.50 percent of aggregate
on-balance-sheet assets; (2) 0.45 percent of the unpaid principal
balance of outstanding MBS and substantially equivalent instruments;
and (3) 0.45 percent of other off-balance-sheet obligations (with
some exclusions), except as the OFHEO Director adjusts the ratio to
reflect differences between the credit risk of such obligations and
MBS.  OFHEO has classified Fannie Mae and Freddie Mac as "adequately
capitalized" under the minimum standard in each quarter beginning in
the quarter that ended on June 30, 1993.\14

The act also requires OFHEO to establish a stress test to serve as
the basis for the development of risk-based capital standards.  The
stress test is intended to lower taxpayer risks by simulating in a
computer model situations where the enterprises are exposed to
adverse credit and interest rate shocks, and requiring the
enterprises to hold sufficient capital to withstand these shocks. 
The capital amount must be adequate to last during a 10-year period
(the stress period), within specific parameters relating to credit
risk,\15 interest rate risk,\16 new business, and other activities. 
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 of that amount to allow for management
and operations risk.\17 Further, the act required the director to
issue final regulations establishing the stress test within 18 months
of the Director's appointment (i.e., by December 1, 1994).  However,
as we discussed in our May 1995 report on OFHEO's operations,\18
OFHEO did not meet this deadline.  As of April 1997, OFHEO's acting
director said that OFHEO expects to issue a proposed rule
implementing the stress test and risk-based capital standards by
September 1998, with a final rule to be issued in 1999.  We discuss
OFHEO's development of the stress test and risk-based capital
standards in chapter 2 of this report. 

In the absence of risk-based capital standards, OFHEO's primary means
of monitoring the safety and soundness of the enterprises is its
examination program.  The act gave OFHEO broad authority to examine
the enterprises and requires annual on-site examinations.  At such
examinations, OFHEO full-time staff, with the assistance of temporary
contractors and detailees from bank regulatory agencies, are to
assess the financial condition of the enterprises and recommend
improvements as necessary.  OFHEO also has the authority to take
enforcement actions against the enterprises, such as cease and desist
orders, to stop unsafe and unsound practices.  Further, OFHEO has the
authority to place an enterprise into a conservatorship when certain
circumstances exist and the enterprise is unable to meet its
financial obligations or is critically undercapitalized.  We discuss
OFHEO's examination program and the adequacy of its resources in
chapter 3. 


--------------------
\14 OFHEO issued the final rule implementing the minimum capital
standard on July 8, 1996, and the final rule was first used to
classify the enterprises as adequately capitalized in the third
quarter of 1996.  Prior to the issuance of the final rule, OFHEO
classified the enterprises as adequately capitalized under interim
standards. 

\15 In general, 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. 

\16 In general, interest rate risk is the exposure to possible losses
and changes in value arising from changes in interest rates. 

\17 In general, management risk and operations risk are the exposure
to financial loss from inadequate systems, management failure, faulty
controls, or human error. 

\18 Government Sponsored Enterprises:  Development of the Federal
Housing Enterprise Financial Regulator (GAO/GGD-95-123, May 30,
1995). 


   OVERVIEW OF THE ENTERPRISES'
   FINANCIAL PERFORMANCE AND
   BUSINESS STRATEGIES
---------------------------------------------------------- Chapter 1:3

Since the mid-1980s, Fannie Mae and Freddie Mac have been
consistently profitable.  In 1997, the enterprises received
relatively high ratings for financial performance and management from
the Standard & Poor's credit rating company.  Nevertheless, the
enterprises have adopted business strategies in recent years that
OFHEO officials believe could potentially weaken their future
financial performance.  For example, since OFHEO's creation in 1992,
the enterprises have substantially increased their holdings of
mortgage assets in lieu of issuing MBS to investors.  According to
OFHEO's former director, increased holdings of mortgage assets
potentially expose the enterprises to greater interest rate risks. 
OFHEO has also reported that there is some evidence that the
enterprises have taken on increased credit risk since 1992.  The
enterprises have also developed sophisticated strategies since the
early 1980s that were intended to better manage the interest and
credit risks that they face. 


      ENTERPRISES HAVE
      CONSISTENTLY DONE WELL
      FINANCIALLY IN RECENT YEARS
-------------------------------------------------------- Chapter 1:3.1

Tables 1.4 and 1.5 show selected year-end profitability data for
Fannie Mae and Freddie Mac for the years 1990 through 1996.  As the
tables indicate, during those years, the enterprises consistently
earned profits for their stockholders; this occurred despite
significant downturns in regional mortgage markets, such as those in
New England and California during the early 1990s.  In 1996, Fannie
Mae had a net income of $2.7 billion, while Freddie Mac had a net
income of about $1.2 billion.  The financial data also indicate that
since 1990 the enterprises have consistently achieved a return on
average common equity, a common measure of profitability, exceeding
20 percent.  By contrast, the return on average common equity for the
commercial banking industry between 1990 and 1996 was about 12.5
percent. 



                               Table 1.4
                
                Fannie Mae Year-end Profitability Data,
                              1990 to 1996

                         (Dollars in billions)

                                                             Return on
                                                               average
Year                                        Net income   common equity
--------------------------------------  --------------  --------------
1990                                             $1.17           33.7%
1991                                              1.36            27.7
1992                                              1.62            26.5
1993                                              1.87            25.3
1994                                              2.13            24.3
1995                                              2.14            20.9
1996                                              2.73            24.1
----------------------------------------------------------------------
Sources:  Fannie Mae and OFHEO. 



                               Table 1.5
                
                Freddie Mac Year-end Profitability Data,
                              1990 to 1996

                         (Dollars in billions)

                                                             Return on
                                                   Net         average
Year                                            income   common equity
----------------------------------------------  ------  --------------
1990                                             $ .41           20.5%
1991                                               .56            23.6
1992                                               .62            21.2
1993                                               .79            22.2
1994                                               .98            23.2
1995                                              1.09            21.9
1996                                              1.24            22.1
----------------------------------------------------------------------
Sources:  Freddie Mac and OFHEO. 

On February 3, 1997, the Standard & Poor's rating firm gave both
Fannie Mae and Freddie Mac a relatively high "point-in-time"\19

risk-to-the-government credit rating of "AA-."\20 OFHEO commissioned
Standard & Poor's to evaluate the enterprises' financial condition
and issue the ratings pursuant to its authority under the act.  In
the Standard & Poor's report accompanying the rating, the firm
generally cited the enterprises for their consistent profitability,
demonstrated ability to withstand regional downturns in mortgage
markets during the early 1990s, historically conservative credit and
interest rate risk strategies, and the quality of their management. 
In addition, Standard & Poor's stated that the enterprises'
domination of the secondary conforming mortgage market and the
benefits of their ties to the federal government, such as relatively
low borrowing costs, also justified the "AA-" rating.  However,
Standard & Poor's did find that both enterprises could face capital
adequacy shortages if a severe, nationwide downturn occurred in the
mortgage markets or interest rates rose precipitously. 


--------------------
\19 Under a "point-in-time" credit rating, Standard & Poor's rates
the financial condition of a company on a single day; in the case of
the enterprises, the ratings were for February 3, 1997.  Standard &
Poor's issued a point-in-time credit rating because OFHEO did not ask
the firm to rate the enterprises on an ongoing basis. 

\20 Standard & Poor's uses long-term issuer credit ratings ranging
from "AAA" for the highest credit rating to "CC" for highly
speculative.  According to OFHEO, the risk-to-the-government rating
evaluates the risk that Fannie Mae or Freddie Mac will become
financially troubled and require government assistance.  According to
Standard & Poor's, the AA- rating is probably higher than the ratings
that the enterprises would receive in the absence of government
sponsorship. 


      ENTERPRISE GROWTH HAS BEEN
      RAPID, WHICH HAS
      IMPLICATIONS FOR INTEREST
      AND CREDIT RISKS
-------------------------------------------------------- Chapter 1:3.2

Although Fannie Mae and Freddie Mac have been consistently
profitable, the enterprises have adopted strategies that could
potentially increase their interest rate and credit risks.  Since
1992, when Congress passed the act that established OFHEO, the
enterprises' combined assets have more than doubled in size, although
Freddie Mac's growth has been relatively faster (see table 1.6 ). 
During 1996, Fannie Mae's total assets\21 grew at about an 11 percent
annual rate, and Freddie Mac's assets grew at about a 27 percent
annual rate.  In 1995, Fannie Mae's total assets grew at about a 16
percent annual rate, and Freddie Mac's assets grew at about a 29
percent annual rate.  Table 1.7 indicates that the enterprises'
retained mortgage portfolios, which include whole mortgages and MBS
that the enterprises have repurchased, have been growing as a
percentage of their total mortgage portfolios (retained mortgages
plus outstanding MBS held by investors), although this growth has
also been relatively faster at Freddie Mac.  For example, Freddie
Mac's retained mortgage assets as a percentage of its total mortgage
portfolio increased from about 8 percent at year-end 1992 to about 23
percent at year-end 1996.  Fannie Mae's retained mortgage assets
increased from about 27 percent of its total mortgage portfolio at
year-end 1992 to about 34 percent at year-end 1996.  In previous
reports on bank and thrift failures, we found that rapid asset growth
in the double digit range, unless carefully managed, can result in a
deterioration in management controls and ultimately poor financial
performance.\22



                               Table 1.6
                
                 Fannie Mae and Freddie Mac Total Asset
                       Growth Rates, 1992 to 1996

                         (Dollars in billions)

Growth rate                       1992    1993    1994    1995    1996
------------------------------  ------  ------  ------  ------  ------
Fannie Mae
Total assets                      $181    $217    $273    $317    $351
Annual growth                      N/A     20%     26%     16%     11%
Freddie Mac
Total assets                       $60     $84    $106    $137    $174
Annual growth                      N/A     40%     26%     29%     27%
Fannie Mae and Freddie Mac
Total assets                      $241    $301    $379    $454    $525
Annual growth                      N/A     25%     26%     20%     16%
----------------------------------------------------------------------
N/A = Not applicable. 

Sources:  Fannie Mae, Freddie Mac, and OFHEO. 



                               Table 1.7
                
                Growth of Enterprises' Retained Mortgage
                  Assets as Percentage of Mortgages in
                     Total Portfolio, 1992 to 1996

                         (Dollars in billions)

                                  1992    1993    1994    1995    1996
------------------------------  ------  ------  ------  ------  ------
Fannie Mae
Retained mortgage assets          $156    $190    $221    $253    $287
Net MBS\a                         $424    $471    $486    $513    $548
Retained as percentage of          27%     29%     31%     33%     34%
 total portfolio
Freddie Mac
Retained mortgage assets           $34     $56     $73    $108    $138
Net MBS\a                         $408    $439    $461    $459    $473
Retained as percentage of           8%     11%     14%     19%     23%
 total portfolio
----------------------------------------------------------------------
\a Excludes MBS that the enterprises have repurchased and hold in
their portfolios. 

Sources:  Fannie Mae, Freddie Mac, and OFHEO. 

According to OFHEO's 1996 annual report, the enterprises' increasing
reliance on retained mortgage assets, which are financed by debt and
equity, potentially exposes them to greater interest rate risk.  The
enterprises have incentives to finance mortgages (or repurchase
previously issued MBS) with debt because the difference between
mortgage yields and borrowing costs generally exceeds MBS guarantee
fees.  However, the increased proportion of retained mortgage assets
could expose Fannie Mae and Freddie Mac to greater interest rate
risks because they assume the risks for changes in the market value
of the retained mortgage assets due to fluctuations in interest
rates.  By contrast, when the enterprises issue MBS to investors, the
investors who purchase the securities assume responsibility for
losses due to interest rate fluctuations.  In testimony before the
House Subcommittee on Capital Markets, Securities, and
Government-Sponsored Enterprises on April 17, 1996, OFHEO's former
director expressed concern that the combined retained mortgage assets
of the enterprises exceeded $360 billion at year-end 1995, which, at
that time, was more than twice the combined portfolio that the
enterprises had when OFHEO was created in 1992.  Nevertheless, at
year-end 1996, the enterprises' combined retained mortgage assets had
grown another $63 billion to $424 billion, or about 17 percent, since
year-end 1995. 

OFHEO's 1996 annual report also suggested that the enterprises may be
facing somewhat increased credit risks in the future.  The report
attributed the potentially increasing credit risks to the fact that
fewer homeowners chose to refinance their existing mortgages in 1994
and 1995 because mortgage interest rates were higher than they had
been in 1992 and 1993.  According to the annual report, refinanced
mortgages tend to be less risky than mortgages that have not been
refinanced because they have lower loan-to-value (LTV) ratios,\23 and
those who choose to refinance generally have equity in their homes. 
The enterprises have also embarked on business strategies that have
resulted in a larger share of mortgage purchases with higher LTV
ratios.  Between year-end 1992 and year-end 1995, the percentage of
Fannie Mae mortgage purchases with LTV ratios exceeding 90 percent
rose from 6 percent of all purchases to 19 percent of all purchases. 
Freddie Mac's percentage of mortgage purchases with LTV ratios
exceeding 90 percent increased from 3 percent of all purchases to 14
percent of all purchases.  At Fannie Mae, credit losses, provision
for loss expenses plus foreclosed property expenses, increased from
$335 million in 1995 to $409 million in 1996 (about a 22-percent
increase) while Freddie Mac's credit losses increased from $541
million in 1995 to $608 million in 1996 (a 12-percent increase). 


--------------------
\21 The enterprises' total assets generally consist of retained
mortgages, investments, cash and cash equivalents, accrued interest
receivable, receivables from currency swaps, acquired property and
foreclosure claims, and other assets.  MBS guarantees are
off-balance-sheet items and therefore not part of total assets. 

\22 See, for example, Deposit Insurance:  A Strategy for Reform
(GAO/GGD-91-26, Mar.  4, 1991). 

\23 In general, loans with lower LTV ratios represent smaller
borrower risks to mortgage loan originators and the enterprises than
loans with higher LTV ratios.  The LTV ratio is determined by
dividing the balance of the mortgage loan outstanding by the
estimated value of the residential property.  Thus, the LTV ratio on
an outstanding mortgage balance of $60,000 on a single-family
residence with an estimated value of $100,000 would be 60 percent. 
The enterprises generally require private mortgage insurance or other
credit enhancements on mortgage loans with LTV ratios exceeding 80
percent. 


      ENTERPRISES HAVE IMPLEMENTED
      STRATEGIES TO MITIGATE RISKS
-------------------------------------------------------- Chapter 1:3.3

The enterprises have developed strategies to lower the interest rate
risks that they face from increased mortgage asset holdings.  For
example, both enterprises issue callable bonds that can be paid off
early if interest rates fall.  By calling the bonds and issuing new
debt as interest rates fall, the enterprises curtail interest
expenses.  Conversely, if rates increase, the enterprises continue to
pay below-market rates on their existing bonds.  The enterprises have
also developed other methods, including using certain derivative
products, to control the volatility of their interest expenses as the
economy varies.\24

The enterprises also use strategies to minimize potential credit
risks.  For example, for mortgage purchases with LTV ratios exceeding
80 percent, the enterprises usually require mortgage insurance from
highly rated providers or other kinds of credit protection.  The
enterprises also have nationwide, geographically diversified mortgage
portfolios that afford protection against regional downturns in
housing markets, as has been demonstrated in the past.  In addition,
according to OFHEO's 1996 annual report, the enterprises have further
protected themselves against credit risk by shifting an increasing
percentage of the primary risk of default to mortgage originators,
such as commercial banks.  Lenders bear primary default risk if they
pledge collateral or agree to repurchase mortgages that default.  The
OFHEO report states that the percentage of Freddie Mac purchased
mortgage loans where the lender bears primary default risks rose from
12 percent of purchases in 1994 to 22 percent in 1995. 


--------------------
\24 Derivatives are financial products whose value is determined by
an underlying reference rate, index, or asset.  The underlying
include stocks, bonds, commodities, interest rates, foreign currency
exchange rates, and indexes that reflect the collective value of
various financial products. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:4

The VA/HUD Appropriations Act of 1997 required us to do a
comprehensive audit of OFHEO's overall operations concerning staff
organization, expertise, capacity, and contracting authority to
ensure that OFHEO's resources are adequate and being used
appropriately to ensure that the enterprises are adequately
capitalized and being safely operated.  Based on discussions with
congressional staff, we established the following three objectives to
assess OFHEO's overall operations and its capacity to fulfill its
safety and soundness mission:  (1) identify the reasons that OFHEO
did not complete the stress test and risk-based capital standards by
December 1, 1994, (2) assess OFHEO's implementation of its
examination responsibilities, and (3) review the status of OFHEO's
implementation of key mission support functions and determine whether
OFHEO's participation in a U.S.  government initiative to assist
Mexico in developing a secondary mortgage market has had a material
impact on OFHEO's ability to fulfill its mission.\25

To identify the reasons for OFHEO's delays in developing the stress
test and risk-based capital standards, we interviewed senior
officials in OFHEO's Office of Research and Capital Standards
(ORACS), as well as former HUD officials who worked on enterprise
safety and soundness issues prior to OFHEO's establishment in 1992. 
We also reviewed key OFHEO documents, such as internal memorandums,
written explanations of the development of the stress test that OFHEO
provided at our request, and staff vacancy and attrition data in
ORACS.  We also met with senior Fannie Mae and Freddie Mac officials
to obtain their views on OFHEO's development of the stress test and
capital standards.  The scope of our work did not involve assessing
the adequacy or the appropriateness of OFHEO's approach to developing
the stress test.  Since OFHEO has not yet completed the development
of risk-based capital standards, we could not evaluate the usefulness
of specific steps OFHEO has taken to reach a final rule promulgating
a risk-based capital standard. 

With respect to assessing OFHEO's implementation of its safety and
soundness responsibilities, we interviewed senior examination
officials and their counterparts at the enterprises.  We also
reviewed the following documents:  (1) OFHEO's September 1994
examination schedule and plan, (2) OFHEO's draft examination
handbook, (3) statistics on the number of staff assigned to each exam
as well at the time needed to complete each exam, and (4) attrition
and vacancy data for OFHEO examiners.  We assessed OFHEO's compliance
with the 1994 plan and compared OFHEO's plan with plans that the
Office of the Comptroller of the Currency (OCC) and the Federal
Reserve System have established for examining large commercial banks. 
The scope of our work did not involve making an independent
assessment of the accuracy of OFHEO's examination findings,
conclusions, and/or recommendations. 

We reviewed the status of OFHEO's implementation of key mission
support functions by interviewing officials in the Office of Finance
and Administration.  We also reviewed relevant documentation such as
administrative policies and procedures, contracts, and cost data. 

We assessed the impact of OFHEO's participation in the Mexico
initiative by reviewing cost and travel data and identifying staff
members who made foreign trips.  We also asked senior OFHEO officials
to estimate the amount of time that they have devoted to developing
presentations for the initiative and going on foreign travel.  We did
not independently verify the cost and travel data or OFHEO officials'
estimates of the time that they devoted to the Mexico initiative. 

We did our work between December 1996 and April 1997 in accordance
with generally accepted government auditing standards. 

We provided copies of a draft of this report to OFHEO for review and
comment.  The Acting Director provided written comments on the draft
report's analysis and recommendations, which are summarized in
chapters 2 and 3 and reprinted in appendix IV.  OFHEO also provided
technical comments on the draft report, which have been incorporated
where appropriate. 


--------------------
\25 In floor debate regarding the VA/HUD Appropriations Act of 1997,
two Senators expressed concern that foreign travel by OFHEO officials
had diverted the organization from completing the risk-based capital
standards within established deadlines.  OFHEO's participation in the
Mexico initiative during 1995 and 1996 represented its largest
foreign travel expense. 


OFHEO'S DEVELOPMENT OF A STRESS
TEST AND RISK-BASED CAPITAL
STANDARDS HAS BEEN PROTRACTED
============================================================ Chapter 2

The act required OFHEO to develop a stress test and risk-based
capital standards as essential components of the organization's
mission to help ensure the safety and soundness of Fannie Mae and
Freddie Mac.  Although OFHEO faced a deadline of December 1, 1994, to
issue a final rule implementing the stress test and capital
standards, OFHEO officials estimate that the final rule will not be
issued until 1999. 

Our review found that the delay in the ongoing development process
had been caused primarily by (1) the complex challenges of developing
the stress test as required by the act and (2) OFHEO officials'
decision in 1994 that the organization develop its own sophisticated
stress test rather than adopting and modifying stress tests that were
already under development.  OFHEO concluded that it could develop
capital standards that would be more closely related to enterprise
risks by developing its own sophisticated stress test and associated
financial modeling capability.  However, we note that it has also
involved a substantial development period and resource costs. 
Related factors that have contributed to the delay in OFHEO's ongoing
development of the stress test have included the time necessary to
hire expert staff, obtain accurate financial data, and initiate the
federal rulemaking process.  These tasks have taken more time than
OFHEO initially anticipated in 1994. 

To meet its anticipated issuance of the final rule by 1999, OFHEO
faces other important challenges.  In particular, senior OFHEO
officials must coordinate the issuance of the stress test with
executive branch agencies, such as OMB, HUD, and the Department of
the Treasury, and make key policy decisions about various components
of the stress test.  In addition, OFHEO's attorneys and others must
continue to translate the economic and financial modeling components
of the proposed stress test and capital standards into proposed and
final rules that comply with applicable federal statutes.  Given the
importance of the risk-based capital standards, we believe it is
essential that OFHEO complete the tasks remaining to develop those
standards as expeditiously as possible. 


   OFHEO HAS CONSISTENTLY
   UNDERESTIMATED THE TIME
   NECESSARY TO COMPLETE STRESS
   TEST DEVELOPMENT
---------------------------------------------------------- Chapter 2:1

OFHEO's development of a stress test and risk-based capital standards
is an essential component for helping to ensure the safety and
soundness of Fannie Mae and Freddie Mac.  Essentially, the purpose of
the stress test that OFHEO is required to develop under the act is to
lower potential taxpayer risks by requiring the enterprises to hold
sufficient capital to withstand a severe interest rate shock coupled
with adverse credit conditions over a 10-year period, plus an
additional 30 percent to protect against management and operations
risk.  Under the act, OFHEO was to have completed the final rule
implementing the stress test and risk-based capital standards by
December 1, 1994, but, as discussed earlier and shown in table 2.1,
OFHEO did not comply with this mandate. 



                                Table 2
                
                1: OFHEO's Planned Completion Dates for
                 Developing the Stress Test and Issuing
                 the Final Risk-Based Capital Standards

                Estimated completion of major components of the stress
OFHEO plan      test and capital standards
--------------  ------------------------------------------------------
May 1994        Complete stress test by December 1995 and publish
                final rule by March 1996.

July 1995 plan  Complete stress test by January 1996 and publish final
                rule by May 1997.

September 1996  Complete stress test by March 1997. OFHEO 1996 annual
plan            report stated that the completed stress test would be
                put forward for public comment in 1997.

April 1997      Propose completed stress test by September 1998 and
plan            issue final rule in 1999.
----------------------------------------------------------------------
Sources:  OFHEO's acting director and OFHEO's 1996 annual report. 

In OFHEO's planning process and its published documents, the
organization has consistently underestimated the time necessary to
complete major components of the stress test and resulting risk-based
capital standards.  For example, in its May 1994 plan for the
development of the stress test, OFHEO estimated that the final rule
would be issued in March 1996.  Moreover, OFHEO's revised July 1995
and September 1996 plans also underestimated the time necessary to
complete the stress test and risk-based capital standards.  In
OFHEO's 1996 annual report, the former director stated that in 1997
the organization would have developed, tested, and put forward for
public comment an operational stress test.  However, in April 1997,
OFHEO's acting director said that the organization does not expect to
submit an operational stress test for public comment until 1998, with
the final rule expected to be issued in 1999. 

The remainder of this chapter provides a general discussion of the
reasons why OFHEO did not comply with the statutory deadline and
points out several continuing challenges that the organization faces
in complying with its current estimate for issuing a final rule. 


   THE COMPLEXITY OF THE
   DEVELOPMENT PROCESS HAS
   CONTRIBUTED TO DELAYS
---------------------------------------------------------- Chapter 2:2

The complex requirements of the stress test as specified in the act
have contributed to the time being taken by OFHEO to complete the
process.  OFHEO is legislatively required to develop a stress test to
establish risk-based capital standards.  In addition, the act
establishes the broad outlines of the stress test, but requires OFHEO
to complete several important projects before the final rule can be
issued. 


      OFHEO'S MANDATE TO DEVELOP
      CAPITAL STANDARDS PRESENTED
      COMPLEX CHALLENGES
-------------------------------------------------------- Chapter 2:2.1

OFHEO's development of a stress test and risk-based capital standards
for the enterprises presented highly complex challenges.  According
to OFHEO, the stress test should be flexible and allow OFHEO to
adjust the enterprises' capital requirements on a periodic basis as
the financial risks that they face change.  For example, under the
completed stress test, an enterprise would be required to hold
additional capital if OFHEO determined that the enterprise had made
changes in its asset and liability structure that would result in
greater losses under alternative credit and interest rate shock
scenarios.  Similarly, OFHEO, via the stress test, could require
Fannie Mae or Freddie Mac to hold additional capital against new
activities that may represent greater risks than their more
traditional activities. 

By contrast, the risk-based capital standards that have been
developed by OCC, the Federal Reserve System, and the Federal Deposit
Insurance Corporation for federally regulated banks categorize assets
into broad groups, which may not account for changes in the
institutions' business practices that could affect their risk
profiles.  For example, banks are permitted to hold the same level of
capital for loans made to corporations with high credit ratings as
they are required to hold for corporations with speculative credit
ratings.  In addition, federal bank regulators have not established
and implemented uniform risk-based capital standards to address
interest rate risks.\26 Instead, regulators assess the interest rate
risks facing banks during scheduled examinations and make
case-by-case decisions as to whether the banks hold adequate capital
to protect against these risks. 


--------------------
\26 Section 305 of the Federal Deposit Insurance Corporation
Improvement Act of 1991 required bank and thrift regulators to revise
risk-based capital standards in order to take adequate account of
interest rate risk and other risk factors, such as concentrations of
credit and nontraditional products risks.  12 U.S.C.  1828 note. 


      OFHEO MUST COMPLETE SEVERAL
      COMPLEX TASKS TO DEVELOP THE
      STRESS TEST AND RISK-BASED
      CAPITAL STANDARDS
-------------------------------------------------------- Chapter 2:2.2

The act establishes the broad outlines of a stress test involving the
impact of adverse credit and interest scenarios on the enterprises'
financial condition.  According to OFHEO's 1995 and 1996 annual
reports, OFHEO must further specify the adverse credit and interest
rate scenarios for the stress test by carrying out the following
complex tasks: 

Develop a credit stress benchmark:  Under conditions specified in the
act,\27 OFHEO is required to identify the region and time period
associated with the highest mortgage default and loss severity rates
in the United States, and then simulate the effect of these stressful
conditions on the enterprises' nationwide total mortgage portfolios. 

Identify an appropriate house price index:  Changes in home prices,
and the corresponding changes in loan-to-value ratios (LTV), affect
mortgage defaults and loss severity.  The act requires that OFHEO
reflect these factors by establishing the current LTV ratios of
enterprise mortgages outstanding at the start of the stress test. 
For this purpose, the act specifies the use of an appropriate house
price index, such as the Department of Commerce's Constant Quality
Home Price Index or an index of similar quality used by the federal
government. 

Develop a methodology to assess the performance of various mortgage
types, such as single and multifamily mortgages, under differing
credit and interest rate risk scenarios:  The act requires that the
stress test reflect differing risk characteristics of various
mortgage types.  For example, the differences in risk for
single-family home mortgages, which primarily serve as residences and
capital investments, and multifamily building mortgages, which
primarily serve as income-producing businesses.  Multifamily loans
are less homogeneous and tend to be subject to more diverse risks
than single-family mortgages. 

Determine the risks of enterprise commitments:  In developing the
stress test, OFHEO is required to assume that the enterprises fulfill
all outstanding commitments to purchase mortgages or to issue
securities.  OFHEO must determine how to translate the contractual
commitment into portfolio assets and associated funding, and into
MBS, so that their credit and interest rate risk can be factored into
the stress test. 

Develop an interest rate model to better understand interest rate
risks facing the enterprises:  The act requires that the specified
stressful credit conditions be combined with one of two interest rate
scenarios that result in the highest capital requirement.\28 In one
scenario, the 10-year constant Treasury yield rises during the first
year of the stress period and remains at the new level for the
remainder of the stress period.\29 In the other scenario, the 10-year
yield decreases during the first year of the stress period and
remains at that level for the remainder of the stress period.\30

Other market interest rates must be simulated relative to the 10-year
note yield in a manner reasonably related to historical experience. 
OFHEO must develop appropriate interest rate models to simulate the
specified interest rate changes on the enterprises' financial
condition. 


--------------------
\27 "With respect to mortgages owned or guaranteed by the enterprise
and other obligations of the enterprise, losses occur throughout the
United States at a rate of default and severity (based on any
measurements of default reasonably related to prevailing practice for
the industry in determining capital adequacy) reasonably related to
the rate and severity that occurred in contiguous areas of the United
States containing an aggregate of not less than 5 percent of the
total population of the United States that, for a period of not less
than 2 years, experienced the highest rates of default and mortgage
losses, in comparison with such rates of default and severity of
mortgage losses in other such areas for any period of such duration."

\28 Rising interest rates increase interest expenses as debt turns
over and decrease the value of existing assets that are paying a
below market rate.  When interest rates decline, homeowners tend to
prepay mortgages more quickly, resulting in a decrease of the net
average interest rates received by the enterprises on mortgages held
in their portfolios. 

\29 Under the act, the 10-year constant maturity Treasury yield
increases to the greater of (1) 600 basis points above the average
yield during the preceding 9 months or (2) 160 percent of the average
yield during the preceding 3 years, but in no case to a yield greater
than 175 percent of the average yield during the preceding 9 months. 

\30 The 10-year constant maturity Treasury yield decreases to the
lesser of (1) 600 basis points below the average yield during the
preceding 9 months or (2) 60 percent of the average yield during the
preceding 3 years, but in no case to a yield less than 50 percent of
the average yield during the preceding 9 months. 


   OFHEO'S DECISION TO DEVELOP A
   SOPHISTICATED STRESS TEST HAS
   BEEN A KEY FACTOR IN THE
   ONGOING DEVELOPMENT PROCESS
---------------------------------------------------------- Chapter 2:3

When OFHEO began operations in June 1993, there were potential
strategies that it could have pursued that might have resulted in the
faster completion of a stress test and risk-based capital standards. 
For example, OFHEO could have adopted an enterprise stress test that
had been under development by HUD after making several significant
adjustments to bring it into compliance with the act.  Or, Fannie Mae
officials told us that OFHEO could have adopted an approach that the
enterprise had developed to assess the impacts of various credit and
interest rate shocks on its financial condition.  Instead, OFHEO
officials decided to create a new and comprehensive stress test that
they believed would provide a better basis for establishing
risk-based capital standards than modifying existing stress tests. 
OFHEO officials concluded that their strategy will result in capital
standards that better reflect enterprise risk.  However, we note that
implementation of the strategy has resulted in the protracted period
of time and the substantial resources that are being devoted to
completing the process. 


      OFHEO HAD ALTERNATIVE
      STRATEGIES TO CHOOSE FROM IN
      DEVELOPING A STRESS TEST
-------------------------------------------------------- Chapter 2:3.1

One possible strategy that OFHEO could have chosen was to make
significant adaptations to a stress test for the enterprises that HUD
had developed by 1992.  HUD used the results of its stress test in
its annual reports to Congress where it assessed the financial
condition of the enterprises if subjected to mortgage credit
conditions that existed during the Great Depression.\31 HUD's stress
test, which was similar to that used by credit rating agencies, such
as Moody's Investors Service, began with the development of economic
relationships among key variables such as interest rates, house
prices, and unemployment in the national economy.  According to the
former HUD officials who developed the stress test, they wanted a
test that would be able to simulate the consequences of a variety of
economic scenarios, such as rising unemployment rates and subsequent
mortgage default rates, on the enterprises' financial condition. 

However, these former HUD officials also said that the stress test
would have required extensive development to meet the requirements of
the act.  The former officials said that the HUD stress test assigned
enterprise balance sheet items into broad asset and liability
categories, or "buckets,"\32 and would still have required the
disaggregation of enterprise assets and liabilities based on risk
characteristics.  The former officials added that in 1992, HUD lacked
the staff and computer resources necessary to make such detailed
assessments.  They also said that the HUD stress test did not meet
the act's requirement that OFHEO specify credit risk relationships
for the enterprises based on historic mortgage default rates in
specific areas of the country (the credit stress benchmark).\33 The
former HUD officials said that developing such a geographic credit
stress benchmark would have required substantial additional work. 
Nevertheless, the former officials said that they believed the
adaptations necessary to bring the HUD stress test into compliance
with the act could have been completed faster than the time it is
taking OFHEO to develop its stress test. 

Alternatively, Fannie Mae officials told us that OFHEO could have
adopted an approach to developing the stress test similar to the
approaches that Fannie Mae follows to assess the impacts of various
credit and interest rate scenarios.  The officials said that Fannie
Mae's approach--which they referred to as "top down"--combines assets
and liabilities with similar performance characteristics into
aggregated categories and tests their performance under specified
interest and credit risk scenarios.\34 Using such an approach, a
Fannie Mae official said that OFHEO could possibly have met the
18-month deadline.  In addition, Fannie Mae officials said that any
stress test and risk-based capital standards that OFHEO ultimately
develops must be consistent with the enterprises' capacity to
implement them and the enterprises' business practices. 

OFHEO could also have chosen other options requiring different levels
of aggregation of enterprise assets and liabilities.\35 For such
options, the trade-off between resource requirements and specificity
in estimating enterprise risks would be similar to the two options
previously discussed. 


--------------------
\31 U.S.  Department of HUD, 1991 Report to Congress on the Federal
Home Loan Mortgage Corporation (December 1992) and 1991 Report to
Congress on the Federal National Mortgage Association (December
1992). 

\32 In such a "bucket analysis," financial analysts normally create
simplified, called synthetic, assets and liabilities that are meant
to mimic the general characteristics of the overall assets or
liabilities contained in the bucket.  The approach lacks specificity
but requires less time input by analysts and fewer computer
resources. 

\33 According to HUD's reports, the HUD stress test is perhaps more
stringent than the one called for in the act; consequently, the HUD
stress test may require higher capital levels at each enterprise at
any one point in time than the capital levels ultimately established
by OFHEO.  We identified one source for this discrepancy:  the HUD
test postulated a Depression scenario.  The credit risk specified in
the act depends on default and loss severity data that lend
themselves to statistical analysis.  According to OFHEO, the
enterprises' historical loan data are generally only statistically
reliable since the first quarter of 1980.  Credit conditions since
1980 have been more favorable than those that occurred during the
Depression. 

\34 Our ability to demonstrate a comparison between Fannie Mae's
approach and OFHEO's approach is limited because we cannot disclose
information that Fannie Mae considers to be proprietary or components
from OFHEO's stress test development that are not in the public
domain. 

\35 For example, 30-year fixed-rate mortgages can be aggregated
according to coupon rates on the mortgage loans (i.e., the interest
rates paid by borrowers).  Aggregation simplifies the analysis at the
possible loss of specificity in estimating risks.  For example,
homeowners with mortgage rates below prevailing mortgage rates on
newly originated mortgage loans tend to default less frequently than
homeowners paying higher interest rates. 


      OFHEO DECIDED TO DEVELOP ITS
      OWN SOPHISTICATED STRESS
      TEST
-------------------------------------------------------- Chapter 2:3.2

According to an internal OFHEO memorandum dated February 22, 1994,
senior OFHEO officials determined that the alternative strategies
discussed above were not sufficient to serve as the basis for the
statutory stress test.  For example, OFHEO officials determined that,
among other limitations, the HUD stress test was insufficient because
it would have limited OFHEO's ability to evaluate the impacts of
various economic scenarios and business strategies on the
enterprises' financial condition.  In our discussions with OFHEO
officials, they said that the HUD stress test had other significant
limitations that made it unusable.  For example, ORACS' director said
that the HUD stress test lacked the capacity to assess the
consequences of adverse interest rate and credit scenarios on the
enterprises' derivative instruments. 

In 1994, OFHEO officials also determined that they could not use the
enterprises' existing financial models for assessing the impact of
various credit and interest rate scenarios and developing the stress
test for several reasons.  For example, OFHEO officials determined
that, although the enterprises' financial models may have been
sufficient to meet their business needs, the models were not adequate
for meeting the requirements of the statutory stress test.  OFHEO
officials also decided that the financial models used by the
enterprises differed substantially and, therefore, OFHEO needed to
develop a common model to ensure regulatory consistency.  In
addition, OFHEO officials wanted the organization to develop an
independent capacity to assess the risks facing the enterprises and
to make regulatory decisions as it was deemed necessary. 

Consequently, OFHEO officials told us that in 1994 they decided to
develop a comprehensive and sophisticated stress test to comply with
the act's requirements and establish the organization's regulatory
independence.  To develop such a stress test, OFHEO officials said
that they needed to collect and test extensive data on the historical
performance of enterprise loans as well as their current books of
business on a disaggregated basis.  OFHEO officials also determined
that the organization needed to develop sophisticated models and
computer programs to assess how alternative economic scenarios would
affect the enterprises' financial condition and capital positions. 
OFHEO officials said that they believed that the final stress test
will result in risk-based capital standards that better reflect the
risks facing the enterprises. 


   OFHEO'S NEED TO HIRE EXPERTISE
   AND OBTAIN ACCURATE FINANCIAL
   DATA PROVED TIME-CONSUMING
---------------------------------------------------------- Chapter 2:4

Our review identified several other factors that have contributed to
OFHEO's ongoing development of the stress test and risk-based capital
standards.  First, once senior OFHEO officials had made the decision
to develop a sophisticated stress test, the organization had to hire
expert staff and purchase a powerful computer network system capable
of running financial models.  Second, OFHEO officials said the
enterprises did not always provide accurate financial data on a
timely basis.  Third, OFHEO officials initiated the federal
rulemaking process, which involved significant staff time and
resources.  Finally, between 1994 and 1997, OFHEO had to initiate and
complete several economic modeling, financial modeling, and computer
programming projects, which proved more challenging than the
organization had initially anticipated. 


      OFHEO HAD TO OBTAIN NEEDED
      EXPERTISE AND A COMPUTER
      NETWORK
-------------------------------------------------------- Chapter 2:4.1

The need to hire expertise and acquire a sophisticated computer
network are factors that contributed to the time needed for the
ongoing development of the stress test and risk-based capital
standards.  According to the ORACS director, OFHEO viewed hiring and
developing a capable staff of permanent employees and contractors as
another means for the organization to establish itself as a viable,
independent regulatory agency.  ORACS has focused its hiring efforts
on individuals who had substantial expertise in housing economics,
the capital and mortgage markets, computer programming, or computer
systems.  We reviewed OFHEO personnel records and determined that the
ORACS staff have extensive experience in housing economics, financial
analysis, residential mortgage markets, and computer systems.  In
addition, senior ORACS officials have postgraduate degrees and
experience in relevant settings, such as securities firms or other
federal financial regulatory agencies. 

However, OFHEO also provided hiring data that indicate that it took
ORACS a substantial period of time to recruit the individuals deemed
necessary to develop and implement the stress test and risk-based
capital standards.  For example, the data indicated that 7 of the 14
full-time staff in ORACS in May 1997 were hired in 1995 and 1996.  In
addition, OFHEO's acting director said that between October 1996 and
April 1997, OFHEO lost several key staff members from ORACS and its
Office of Policy Analysis, including a senior policy analyst, a
senior economist, and a systems administrator, which further
contributed to the challenges of completing the stress test and
capital standards within established deadlines.  Moreover, it has
taken considerable time for OFHEO to hire key contract staff to
develop essential components of the stress test.  For example, OFHEO
did not contract with Price Waterhouse to develop financial reporting
software and a consolidated data format for both enterprises until
August 1995. 

OFHEO also needed to acquire a sophisticated computer network on
which the financial models are to be run.  In 1994, based on an
analysis of available computer hardware and software, OFHEO officials
decided to purchase a powerful computer network.  According to
OFHEO's acting director, the computer network did not become fully
operational until late 1994.  Without the computer network, OFHEO's
growing ORACS staff could not make significant progress on many of
the complex economic modeling, financial modeling, and computer
software projects necessary to develop the stress test and risk-based
capital standards. 


      OFHEO ENCOUNTERED SOME
      DIFFICULTIES OBTAINING
      ACCURATE FINANCIAL DATA ON A
      TIMELY BASIS
-------------------------------------------------------- Chapter 2:4.2

OFHEO officials said another factor that has contributed to the
ongoing development of the stress test was that OFHEO and the
enterprises had to establish a workable system for delivering large
amounts of financial data.  OFHEO required large amounts of
historical and current financial data from the enterprises so that it
could, among other tasks, determine the benchmark loss experience and
develop models of mortgage performance; such work was necessary
before the impact of the various credit and interest rate scenarios
on the enterprises financial condition could be determined.  OFHEO
first requested that the enterprises provide comprehensive financial
data on loan performance in May 1994 and the enterprises responded
over the next 18 months.  Although ORACS' director stated that the
enterprises generally made good faith efforts to supply the requested
data, various problems and delays were encountered.  For example, he
said that the enterprises did not always provide all necessary data
in their initial submissions, which resulted in repeated follow-up
requests.  Also, he said that OFHEO technical staff sometimes
encountered problems and delays contacting their counterparts at the
enterprises without first being routed through regulatory compliance
officials. 

OFHEO officials also stated that they encountered some difficulties
obtaining accurate financial data from Freddie Mac on a timely basis
and that this has delayed the development of the stress test.  OFHEO
initiated a targeted examination of "data integrity" issues at
Freddie Mac in August 1996 which, when completed in November 1996,
stated that Freddie Mac had not established adequate controls to
ensure the accuracy of information submitted to OFHEO.  According to
OFHEO, Freddie Mac has agreed to correct these problems.  However, a
Freddie Mac official told us that data integrity issues did not
result in delayed completion of the stress test.\36

Fannie Mae officials we contacted said that OFHEO's initial requests
for information imposed certain regulatory burdens on the enterprise. 
In keeping with their view that OFHEO could have relied on a
"top-down" approach to developing the stress test, Fannie Mae
officials said they did not fully understand why OFHEO required such
a substantial amount of data about individual mortgage loans.  They
said that requesting such detailed mortgage loan data is not
necessary and slows the development of the stress test.  OFHEO
officials said they needed individualized loan data to better model
the enterprises' financial condition and better understand the
potential impacts of various credit and interest rate scenarios. 

Freddie Mac officials we interviewed had a different perspective
toward OFHEO's development of the stress test and the potential for
regulatory burden.  Freddie Mac officials told us that they do not
know what stress test OFHEO will ultimately develop.  They said that
OFHEO should take the time necessary to "do the job right," and
attributed this view to the position that both enterprises are
currently well capitalized and therefore the risk of delay is low. 
Freddie Mac officials also said that they understood OFHEO's position
that developing an in-house understanding of enterprise risks was
important.  Freddie Mac officials, however, expressed the concern
that OFHEO could end up developing a stress test that relied too
heavily on disaggregated information.  The officials said that their
potential concerns with a highly refined stress test and capital
standards were that they could create (1) a regulatory burden; and
(2) unintended consequences by ignoring beneficial linkages, such as
those associated with hedging activities, among financial assets and
liabilities. 


--------------------
\36 The Freddie Mac official said that error-free data are not
essential in the early stages of designing a financial model and that
testing of data can be accomplished through the use of smaller data
sets.  In addition, the official said that Freddie Mac has provided
OFHEO with substantial support in its development of the risk-based
capital standards and associated financial models. 


      OFHEO OFFICIALS INITIATED
      RULEMAKING PROCESS
-------------------------------------------------------- Chapter 2:4.3

OFHEO officials also cited the protracted federal rulemaking process
as a factor that has contributed to the ongoing development of the
stress test and risk-based capital standards.  The officials said
that complying with the federal rulemaking requirements placed
important demands on the time of OFHEO's staff.  For example, ORACS'
director said that the office staff responsible for the development
of the stress test worked with OFHEO attorneys in drafting rulemaking
proposals, which are summarized below.  ORACS' director and other
officials said that OFHEO's staff must frequently assume such
time-consuming responsibilities to compensate for the organization's
relatively small size as compared to other federal financial
regulators. 

On February 8, 1995, OFHEO issued an Advance Notice of Proposed
Rulemaking (ANPR), which solicited public comment for a period of 120
days on a variety of technical and policy issues and a range of
alternative approaches to modeling the enterprises' credit and
interest rate risks.  ANPR covered such subjects as defining the
credit stress benchmark, assessing the default and loss
characteristics of a wide range of mortgage types, and the effects of
high inflation rates on mortgage losses.  When the period for public
comment closed in June 1995, OFHEO had received a total of 15
comments from a variety of interested parties, including the
enterprises and two mortgage banking firms, which OFHEO officials
said they have considered in the development of the stress test.  On
June 10, 1996, OFHEO published a Notice of Proposed Rulemaking (NPR),
which described two key elements of the stress test--the benchmark
loss experience and the house price index.  These issues are
discussed below and in appendix I.  During 1997, OFHEO staff are
working on a second NPR that will cover issues not addressed in the
first NPR, such as interest rates and mortgage performance. 


      OFHEO MANAGED MULTIPLE
      PROJECTS TO DEVELOP THE
      STRESS TEST AND CAPITAL
      STANDARDS
-------------------------------------------------------- Chapter 2:4.4

OFHEO also initiated and completed several complex and time-consuming
projects between 1994 and 1997 to develop the stress test and
risk-based capital standards.  The projects that OFHEO initiated
included (1) establishing the credit stress benchmark, (2) developing
a consistent format for data provided by Fannie Mae and Freddie Mac,
(3) identifying an appropriate house price index, and (4) developing
econometric models and computer programs to simulate enterprise
financial performance.  Most of these projects had been completed by
June 1997 (see app.  I).  According to OFHEO's acting director, OFHEO
faced significantly greater technical and managerial challenges than
initially anticipated, developing an integrated financial model to
simulate the behavior of the enterprises' assets, liabilities, and
off-balance-sheet obligations under adverse credit and interest rate
conditions.  This financial model is to serve as the foundation of
the final stress test.\37

According to ORACS' director, however, OFHEO had largely completed
the integrated financial model by April 1997, although some final
testing and documentation projects were to have been completed during
the summer of 1997. 


--------------------
\37 OFHEO refers to the model as the Financial Simulation Model. 
OFHEO's work on the model includes assessing the impact of
fluctuations in interest rates on mortgage performance, determining
the impact of rising house prices on the enterprises' financial
condition, estimating mortgage prepayment and default and loss
severity rates, and simulating the cash flows of enterprise assets,
liabilities, and off-balance-sheet obligations and translating these
cash flows into pro forma accounting statements. 


   OFHEO FACES CONTINUING
   CHALLENGES IN IMPLEMENTING THE
   FINAL RISK-BASED CAPITAL RULE
   BY 1999
---------------------------------------------------------- Chapter 2:5

OFHEO faces continuing challenges in meeting its proposed deadline of
issuing the final rule implementing the stress test and risk-based
capital standards by 1999.  In particular, OFHEO officials must
coordinate the interagency review process and make key policy
decisions about the stress test.  Further, OFHEO must translate the
components of the stress test and capital standards into proposed and
final rules in compliance with federal statutes. 


      OFHEO MUST COORDINATE
      INTERAGENCY REVIEW PROCESS
-------------------------------------------------------- Chapter 2:5.1

OFHEO's acting director said that OFHEO plans to share the basic
components of the stress test and related financial models on an
informal basis with OMB, HUD, and Treasury in the summer of 1997.  He
said that given the complexity of the stress test and its related
financial models, it will be important to provide information about
them at the earliest possible stage.  The acting director said the
informal interagency review process can go forward before the stress
test is finalized because the goal will be to explain the technical
components of the stress test and related financial models to OMB and
Treasury technical staff and to receive their comments and analysis. 


      OFHEO NEEDS TO MAKE KEY
      POLICY DECISIONS ABOUT THE
      STRESS TEST
-------------------------------------------------------- Chapter 2:5.2

OFHEO's acting director told us that the organization needs to make
key policy decisions about various components of the stress test by
early 1998.  OFHEO's chief economist said that OFHEO's technical
staff had the responsibility to lay out options on various
complicated issues that are necessary to complete the stress test,
such as assumptions about future interest rates, the shape of the
yield curve, the enterprises' future debt issuances, and the
relationship between home prices and interest rates, but it is up to
OFHEO management to choose the appropriate option.  Once these
decisions have been made, then OFHEO will have a better idea as to
how the stress test will affect the enterprises' financial condition
and risk-based capital levels. 


      OFHEO MUST TRANSLATE THE
      COMPONENTS OF THE STRESS
      TEST INTO PROPOSED AND FINAL
      RULES WHILE PROTECTING
      PROPRIETARY ENTERPRISE DATA
-------------------------------------------------------- Chapter 2:5.3

OFHEO's general counsel told us that once ORACS completes development
of the stress test, OFHEO's staff will face the task of translating
the stress test into proposed and final rules.  The general counsel
stated that OFHEO wants to avoid having the final rule successfully
challenged in court under the Administrative Procedure Act (APA). 
OFHEO's general counsel said that another concern that will confront
the organization in drawing up the proposed and final rules will be
the need to give adequate notice to the public to provide for comment
on the development of the stress test as required by APA without
compromising proprietary enterprise data. 

Enterprise officials we contacted said they are very concerned that
OFHEO not disclose proprietary information during the rulemaking
process.  In fact, Fannie Mae officials told us that OFHEO has
already publicly disclosed some proprietary information in research
papers.  Although the Fannie Mae officials said that OFHEO
researchers attempted to disguise the proprietary data through
high-level aggregation, the officials said that this high-level
approach was not effective because OFHEO only supervises two
companies.  OFHEO's acting director stated that the research papers
did not disclose proprietary enterprise data.  He also said that
OFHEO has established a rigorous policy for preventing the release of
such proprietary data; for example, OFHEO researchers are to submit
all proposed papers to senior officials who determine if the papers
disclose confidential information.\38


--------------------
\38 Fannie Mae and OFHEO officials have a basic disagreement as to
what constitutes disclosure of proprietary information.  On this
subject, Freddie Mac officials also indicated a disagreement with
OFHEO. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 2:6

The stress test and risk-based capital standards that OFHEO is
legislatively required to develop are essential means by which the
organization is to fulfill its mission of helping to ensure the
safety and soundness of Fannie Mae and Freddie Mac.  The stress test
is to simulate the effects that various adverse credit and interest
rate shocks would have on the enterprises, and the risk-based capital
standard is to be designed to ensure that the enterprises hold
adequate capital to withstand such stress for a period of 10 years. 
OFHEO has already missed the December 1, 1994, deadline for
completing the process by almost 3 years and estimates that it will
be 1999 at the earliest before this statutorily mandated task is
completed. 

Although developing the stress test under the act presented complex
challenges, OFHEO's decision in 1994 to develop its own sophisticated
stress test rather than adopting and modifying stress tests that were
already under development resulted in a substantial commitment of
time and resources.  Related factors contributing to the delay in
implementing this decision included OFHEO (1) failing to hire its
full complement of research staff until 1996 or get its computer
network operational until late 1994, (2) experiencing delays in
obtaining accurate enterprise financial data, (3) devoting
considerable staff time and resources to the federal rulemaking
process, and (4) encountering greater managerial and technical
challenges than initially anticipated in developing an integrated
financial model that serves as the basis of the stress test.  An
OFHEO official said that this financial model had largely been
completed by April 1997, although final testing needed to be
completed during the summer of 1997. 

We recognize the complexity of the challenges that OFHEO has faced. 
However, we note that OFHEO has consistently underestimated the time
needed to complete its tasks.  Given OFHEO's history of failing to
meet its own publicly announced completion targets and considering
the challenges that remain, we are concerned that OFHEO may not meet
its current estimate of issuing a final rule by 1999.  For example,
to meet the schedule in the current plan, OFHEO must coordinate the
interagency review process and make key policy decisions, such as
forecasts about future interest rates.  In addition, OFHEO must
translate the complex components of the stress test and capital
standards into proposed and final rules as required by APA while
protecting against the unauthorized disclosure of proprietary
enterprise data. 

We believe it is essential that OFHEO take all feasible steps to
comply with its plan and complete the stress test and risk-based
capital standards as soon as possible because they are critical to
helping maintain the safety and soundness of Fannie Mae and Freddie
Mac.  Although the enterprises have been consistently profitable in
recent years, their rapid growth and potentially increasing interest
rate risks pose potential costs to taxpayers that exceeded $1.5
trillion at year-end 1996.  Without a stress test and risk-based
capital standards in place, OFHEO's capacity to lower such taxpayer
risks is limited. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 2:7

Given the history of OFHEO's failure to meet its own publicly
announced plan to complete the stress test and risk-based capital
standards, strong congressional oversight appears necessary to ensure
that OFHEO issues its final rule in a timely manner.  Accordingly, we
recommend that OFHEO's director report to Congress periodically on
the organization's progress towards compliance with its current plan. 
We also recommend that the director include in such reports
information on the status of OFHEO's progress towards important
milestones, such as its (1) projected completion of final testing on
the financial model that comprises the stress test, (2) progress
toward completing the interagency review process, (3) estimated
completion of key policy decisions regarding the stress test by early
1998, and (4) progress in translating the components of the stress
test into proposed and final rules.  Finally, we recommend that the
director inform Congress of any problems that may arise in completing
the stress test and risk-based capital rules by 1999 and of actions
that the organization plans to take to correct such problems. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 2:8

In written comments, OFHEO's acting director agreed with the report's
analysis of why the development of the stress test and risk-based
capital standards has been protracted and stated that OFHEO is
implementing our recommendation that Congress be informed of progress
in completing the final rule.  He emphasized that the complexity of
the development process as specified in the act and OFHEO's decision
to develop its own sophisticated stress test have been the primary
factors in delaying the completion of the final rule.  The acting
director also said that the report should not be interpreted to
suggest that using the HUD stress test or using the enterprises'
financial models would have produced an acceptable result.  As
examples, he said that the HUD stress test did not include the credit
stress benchmark, and a simplified stress test would not adequately
address the enterprises' increased interest rate risks resulting from
their larger retained mortgage portfolios.  He said that the
enterprises' mortgage portfolios are becoming increasingly complex
and involve large volumes of derivative instruments.  Among other
reasons, the acting director said that relying on the enterprises'
financial models would not have been appropriate because it
potentially would have jeopardized OFHEO's independence as a
regulatory agency. 

We did not take a position in the report on the adequacy or
appropriateness of OFHEO's approach to developing the stress test and
risk-based capital standards.  To do so would have required that we
demonstrate whether the other alternatives could have been modified
sufficiently to meet the requirements of the act in a shorter period
of time.  Given that the time is long past when such a demonstration
would have affected OFHEO's approach, we chose not to pursue such an
assessment.  Rather, we pointed out that there were potential
trade-offs associated with the time that would have been necessary to
adopt and modify the HUD stress test, or another aggregated type of
stress test, and the comprehensive development approach that OFHEO
has chosen. 


OFHEO HAS NOT FULLY IMPLEMENTED A
COMPREHENSIVE ENTERPRISE SAFETY
AND SOUNDNESS EXAMINATION PROGRAM
============================================================ Chapter 3

OFHEO's examination program is its primary means of helping to ensure
the safety and soundness of Fannie Mae and Freddie Mac in the absence
of risk-based capital standards.  Since 1994, OFHEO has made
important progress in fulfilling its essential examination oversight
function, such as by establishing a "risk-focused" examination
strategy, defining six "core risks" facing the enterprises, and by
completing or initiating on-site examinations to monitor five of
these risks.  However, OFHEO has also scaled back the implementation
of a detailed examination schedule and plan that was developed in
September 1994.  In particular, OFHEO's current 3- to 4-year cycle
for examining the six core risks facing the enterprises is
considerably longer than the 2-year cycle established in its 1994
examination plan, and OFHEO's most recently completed core risk
examination covered fewer areas than planned.  Without a more timely
and comprehensive examination program, OFHEO faces limitations in its
ability to monitor the risks facing the enterprises, such as their
potentially greater interest rate risks resulting from increasing
holdings of debt-financed mortgage assets. 

The evidence we obtained indicated that, among other factors, limited
resources applied to the examination function were largely
responsible for OFHEO's inability to fully implement the 1994
examination plan.  Our analysis found that to complete each core risk
examination, OFHEO was required to commit a significant majority of
its 12 line examiner and specialist positions to the examination for
a period of 1 year as well as noncore risk--or targeted
risk--examinations that were required.  As a result, OFHEO may lack
the line examiner and specialist staff resources necessary to
complete examinations covering three core risks per year, the minimum
necessary to cover all six core risks in a 2-year cycle.  In
addition, staff attrition in 1996 and early 1997 left the examination
office with 5 vacancies out of 17 authorized full-time positions--a
vacancy rate of 30 percent--as of March 31, 1997, which further
limited OFHEO's ability to implement the 1994 plan.  By August 1997,
an OFHEO official reported that the organization had filled three of
the positions and two others were being advertised. 

OFHEO officials said that they recognize the need to shorten the 3-
to 4-year examination cycle to adequately assess the enterprises'
financial condition and management practices.  During 1997, OFHEO
plans to reassess its examination strategy and make changes to
shorten the examination cycle for all six core risks to 1 year.  In
the reassessment of its examination strategy, OFHEO could usefully
include consideration of different examination cycles and related
coverage that could be accomplished with alternative resource levels. 


   OFHEO ESTABLISHED A DETAILED
   ENTERPRISE EXAMINATION SCHEDULE
   AND PLAN IN 1994
---------------------------------------------------------- Chapter 3:1

In September 1994, OFHEO established a detailed examination strategy,
schedule, and plan to help ensure the safety and soundness of Fannie
Mae and Freddie Mac.  The plan identified six "core risks," such as
interest rate risk, facing the enterprises, and established a 2-year
cycle for OFHEO examination staff to assess these risks.  OFHEO's
examination plan is generally consistent in substance but not in
timing with risk-focused examination plans that OCC and the Federal
Reserve System have established to annually assess the safety and
soundness of large commercial banks.  Although we recognize that
large banks may engage in a wider variety of potentially risky
activities than the enterprises, we believe a generally consistent
examination approach by OFHEO and the bank regulators is important
because the potential exists that a large bank or enterprise failure
could cause substantial taxpayer losses.\39


--------------------
\39 The Federal Deposit Insurance Corporation administers the Bank
Insurance Fund, which uses premiums paid by banks to protect the
depositors of failed banks.  The potential exists that during a
financial emergency, a large bank failure or series of large bank
failures could drain the Bank Insurance Fund, thereby requiring a
taxpayer bailout.  As discussed in the report, the potential exists
that the government would choose to rescue the enterprises if they
could not meet their debt and MBS obligations. 


      OFHEO'S EXAMINATION PROGRAM
      CALLED FOR ASSESSING
      ENTERPRISE RISKS ON A 2-YEAR
      CYCLE
-------------------------------------------------------- Chapter 3:1.1

The act requires OFHEO to conduct annual, on-site safety and
soundness examinations of the enterprises to assess their operations
and financial condition.  According to an OFHEO attorney, this
requirement can be and has been met without conducting full-scope
enterprise examinations on an annual basis.  Full-scope examinations
are generally understood to mean thorough assessments of all of the
management practices and business strategies of a federally regulated
financial institution that could affect its safety and soundness. 

During 1994, senior OFHEO officials established a "risk-focused"
examination schedule and plan to assess the risks facing Fannie Mae
and Freddie Mac on a 2-year cycle.  Under the plan OFHEO adopted in
September 1994 and has subsequently modified,\40 OFHEO identified six
core risks, which OFHEO officials believed represent the greatest
risks to the enterprises.  These six core risks are corporate
governance, interest rate, credit, operations, business, and
information technology.  Although there are six core risks, OFHEO's
plan stipulated that examiners could cover these risks in five exams
by consolidating the credit risk and interest rate risk components
into a single risk management examination (see table 3.1).  The risk
management examination was also intended to cover five other risk
areas, such as asset growth and composition, which OFHEO does not
consider to be core risks.  Under the plan, the four other core risk
examinations designated specific areas that OFHEO examiners were to
cover.  For example, the business line examination was to assess the
adequacy of the enterprises' risk management of the following
businesses:  single-family mortgage guarantee, multifamily mortgage
guarantee, portfolio, and financial services. 



                               Table 3.1
                
                OFHEO's Examination Plan for Monitoring
                  the Six Core Risks on a 2-Year Cycle

Exam type           Summary of examination objectives
------------------  --------------------------------------------------
Corporate           Assess enterprise board of directors oversight,
governance risk     organization structure, internal controls, and
                    information flows.

Risk management     Assess interest rate risk, credit risk, and five
                    other risk areas.

Business risk       Assess risks in four enterprise business areas,
                    including single-family mortgages, multifamily
                    mortgages, portfolio, and financial services.

Operations risk     Assess operational practices in four areas, such
                    as securitization.

Information         Assess the enterprises' use of computer technology
technology risks    and associated risks.\a
----------------------------------------------------------------------
\a OFHEO did not identify information technology risk as a core risk
until 1995.  However, the September 1994 plan did identify
information technology risk as an area that required a targeted
examination. 

Source:  OFHEO. 

OFHEO's 1994 examination plan also identified other risks that
examiners were to assess within a 2-year period.  These exams were
considered to be more targeted than the exams established to assess
the six core risks.  In particular, OFHEO examiners were to assess
the books and records of both enterprises to determine the accuracy
and reliability of their financial reporting.  These books and
records examinations were to encompass the financial reporting
underlying the enterprises' public financial statements and the
internal reporting supporting management processes.  The plan also
called on OFHEO examiners to assess the enterprises' use of
sophisticated derivative instruments.  In addition, the plan called
for OFHEO to develop the capacity to monitor the enterprises'
financial condition on an off-site basis, such as by collecting
periodic financial information from the enterprises that show trends
in asset growth, financial performance, and funding. 

OFHEO uses a "top-down" approach to examinations to assess the six
core risks as well as targeted risks.  The examination of a
particular risk is to begin with a "Level I" review in which
examiners evaluate board of directors oversight and planning and
review internal and external audits.  The examiner is to proceed to a
Level II review if deficiencies in the management of risk are found. 
This level of review usually would involve additional testing of
controls.  If a Level II exam does not resolve all areas of concern,
a Level III review--a detailed review of the control environment,
including extensive transaction testing--is to be conducted. 


--------------------
\40 For example, OFHEO did not identify information technology risks
as a core risk until 1995. 


      OFHEO EXAMINATION PLAN IS
      GENERALLY CONSISTENT IN
      SUBSTANCE BUT NOT IN TIMING
      WITH PLANS DEVELOPED BY BANK
      REGULATORS
-------------------------------------------------------- Chapter 3:1.2

The risk-focused examination plan and 2-year cycle OFHEO established
in 1994 is generally consistent in concept but not in timing with
risk-focused examination plans that OCC and the Federal Reserve have
recently established to examine large commercial banks.  By law, bank
regulators are required to conduct full-scope examinations of the
financial condition and safety and soundness of large banks at least
once a year.\41 OCC has chosen to implement the full-scope
requirement by developing a risk-focused examination system that
identifies nine major risks, such as interest rate and credit risks,
facing national banks; some of these risks are similar to the core
risks OFHEO has identified as facing the enterprises.  According to
OCC, its staff are to assess each of the risks facing particular
national banks on an off-site basis prior to initiating an
examination.  These off-site assessments are to be accomplished by
reviewing previous examination reports and available financial data
among other documents.  OCC staff are then to focus the majority of
their time and resources on the greatest risks facing particular
banks during the on-site examination process.  The Federal Reserve
System has established a risk-focused annual examination program,
which is similar to that of OCC, for large banks under its
supervisory responsibility. 

We recognize that large commercial banks engage in a variety of
potentially risky activities, such as trading securities and lending
for many purposes, on a worldwide basis, while the enterprises'
activities are generally confined to a single line of business,
mortgage purchases, in the United States.  Consequently, it could be
argued that large banks should be subjected to a more rigorous level
of supervision and examination than the enterprises.  However, as
pointed out in our previous reports, we believe that the enterprises
should generally be subjected to a similar level of supervision as
banks, although some modifications to adjust for their differing risk
characteristics may be necessary.\42 For example, banks and the
enterprises share some risk characteristics, such as interest rate,
credit, business, and management risks, and the failure of either an
enterprise or a large commercial bank could potentially impose losses
on taxpayers. 


--------------------
\41 See Federal Deposit Insurance Corporation Act of 1991, Pub.  L. 
No.  242, ï¿½ 111(a), as amended, 12 U.S.C.  ï¿½ 1820d.  Under this act,
bank and thrift regulators are required to do annual, full-scope
examinations of banks or thrifts with total assets of $250 million or
more. 

\42 We have observed that bank regulation is a useful starting point
for determining the regulatory structure that should apply to
government-sponsored enterprises, such as Fannie Mae and Freddie Mac. 
As examples, we have stated that government-sponsored enterprises
should be subject to capital standards and periodic on-site
examinations.  See Government-Sponsored Enterprises:  A Framework for
Limiting the Government's Exposure to Risks (GAO/GGD-91-90, May 22,
1991) and Government-Sponsored Enterprises:  The Government's
Exposure to Risks (GAO/GGD-90-97, Aug.  15, 1990). 


   OFHEO HAS NOT BEEN ABLE TO
   FULLY IMPLEMENT THE 1994
   EXAMINATION PLAN
---------------------------------------------------------- Chapter 3:2

Our review found that, despite making important progress, OFHEO has
not been able to fully implement the enterprise examination schedule
and plan that was established in September 1994.  Although OFHEO has
completed or initiated examinations covering five of the six core
risks, at its current rate it will take OFHEO 3 to 4 years to examine
all six core risk areas, which is considerably longer than the 2-year
cycle established in the 1994 plan.  Moreover, OFHEO scaled back the
planned coverage of the most recently completed core risk
examination.  OFHEO's relatively long examination cycle and limited
examination coverage raise questions about its capacity to fully
assess the enterprises' management, financial practices, and risks on
a timely basis. 


      OFHEO HAS MADE PROGRESS IN
      IMPLEMENTING THE 1994 PLAN
-------------------------------------------------------- Chapter 3:2.1

Between August 1994 and May 1997, OFHEO made important progress in
implementing the 1994 examination schedule and plan.  As of May 1997,
OFHEO had completed or initiated examinations covering five of the
six core risk areas, and OFHEO plans to initiate the remaining core
examination covering operations risk in 1997 (see table 3.2).  OFHEO
also completed three targeted examinations covering the enterprises'
use of nonmortgage derivative contracts, the enterprises' compliance
with a flood insurance statute,\43 and data integrity issues at
Freddie Mac. 



                               Table 3.2
                
                OFHEO's Completed, Ongoing, and Planned
                      Examinations as of May 1997

Exam type                               Start date\a    End date\a
--------------------------------------  --------------  --------------
Core risks

Corporate governance                    August 1994     June 1995

Risk management (credit and interest    May 1995        June 1996
rate risks)

Business                                June 1996       May 1997

Information technology                  March 1997      Planned
                                                        September 1997

Operations                              Planned 1997    Planned 1997
                                                        or 1998

Targeted

Nonmortgage derivatives                 May 1994        November 1994

Flood insurance                         January 1996    May 1996

Freddie Mac data integrity              August 1996     November 1996
----------------------------------------------------------------------
\a Includes both Fannie Mae and Freddie Mac exams.  The end date is
for the enterprise exam that OFHEO completed last.  All of the Fannie
Mae and Freddie Mac exams were completed within several weeks of one
another. 

Source:  OFHEO. 

OFHEO's examination office has also established an off-site capacity
to monitor the enterprises' financial condition and safety and
soundness as specified in the 1994 plan.  The Office of Examination
and Oversight (OEO) staff collects financial information from the
enterprises and produces internal reports that discuss relevant
supervisory issues.  OEO's acting director said that the examination
staff works closely with ORACS staff to develop a better
understanding of the enterprises' financial activities.  He also said
that OFHEO plans to more fully integrate off-site monitoring into the
examination process.  For example, OFHEO plans to produce internal
reports focusing on each of the six core risks.  These reports would
be reviewed by examiners prior to initiating a risk-based
examination, potentially creating examination efficiencies. 


--------------------
\43 The National Flood Insurance Reform Act of 1994 requires the
enterprises to implement procedures that are reasonably designed to
ensure that adequate flood control insurance is in place over the
term of the mortgage loans the enterprises purchase after September
28, 1995.  Pub.  L.  No.  103-325 ï¿½ 522, 42 U.S.C.  ï¿½ 4012a(b)(3). 
According to an OFHEO official, OFHEO ensures that the enterprises
comply with these requirements on a biennial basis. 


      OFHEO HAS NOT IMPLEMENTED
      OTHER IMPORTANT COMPONENTS
      OF THE 1994 EXAMINATION PLAN
-------------------------------------------------------- Chapter 3:2.2

Despite making progress, OFHEO has not implemented other important
components of the 1994 examination plan.  As shown in table 3.2,
OFHEO completed examinations covering four--corporate governance,
credit, interest rate, and business--of the six core risk areas
between 1995 and 1997, plans to complete the information technology
examination in 1997, and plans to initiate the operations risk
examination in 1997, which may not be completed until 1998. 
Therefore, OFHEO's first cycle for covering all six core risk areas
will take 3 to 4 years (1994 to 1997 or 1994 to 1998)\44 rather than
the 2-year cycle established in the 1994 plan. 

OFHEO also scaled back the planned coverage of its most recently
completed core risk examination.  The core business risk examination
that OFHEO completed in May 1997 covered risk management in one of
the four business areas specified in the 1994 plan--the single-family
guarantee component.  OFHEO's inability to cover the other three
business areas (in particular, the multifamily mortgage guarantee
business) has limited the organization's capacity to fully monitor
the enterprises' safety and soundness.  OFHEO's 1997 annual report
states that the enterprises' purchases and new guarantees on
multifamily mortgages tripled from $3 billion at year-end 1992 to $9
billion at year-end 1996.  According to the annual report,
multifamily mortgage loans are relatively risky.  For example,
although the delinquency rates on the enterprises' multifamily
mortgages have improved significantly since 1992, they are still
higher than the delinquency rates on the enterprises' single-family
mortgages.\45

In addition, OFHEO was not able to implement the objective in the
1994 examination schedule and plan that it assess the books and
records of the enterprises to assess the accuracy of their financial
reporting.  We pointed out in chapter 2 that OFHEO did initiate a
"data integrity" examination at Freddie Mac in 1996 that identified
significant problems in the controls over data submitted to OFHEO for
development of the stress test and risk-based capital standards. 
Thus, such examinations appear to be important for ensuring accurate
enterprise financial data.  OFHEO has not yet initiated a data
integrity or books and records targeted examination at Fannie Mae,
although it plans to do so as part of the information technology
examination, according to OFHEO officials. 


--------------------
\44 OFHEO initiated the corporate governance risk exam in August
1994. 

\45 Single-family mortgage loan delinquency rates at both enterprises
equaled .58 percent of outstanding single-family mortgages in 1996. 
During 1996, Fannie Mae's delinquency rate on multifamily mortgages
was .68 percent, which was well below the delinquency rate of 2.65
percent in 1992.  Freddie Mac's delinquency rate on multifamily
mortgages was 1.96 percent in 1996, having fallen from 4.45 percent
in 1992. 


      OFHEO'S CAPACITY TO FULLY
      ASSESS ENTERPRISE
      RISK-TAKING IS LIMITED
-------------------------------------------------------- Chapter 3:2.3

OFHEO's inability to fully implement the 1994 examination schedule
and plan limits its capacity to fully assess the enterprises'
management practices, financial condition, and risks.  For example,
although Fannie Mae and Freddie Mac have been consistently profitable
in recent years, we pointed out in chapter 1 that the enterprises
have adopted business strategies that could potentially weaken their
future financial performance, such as by growing at rapid rates and
potentially incurring greater interest rate risks through increased
holdings of debt-financed mortgage assets.  Under its current 3- to
4-year examination cycle, however, OFHEO may not be able to do an
on-site examination to assess the enterprises' interest rate risks
until 1999 or 2000, since the previous risk management examination
was completed in 1996. 


   LIMITED EXAMINATION STAFF
   RESOURCES IMPEDED OFHEO'S
   ABILITY TO IMPLEMENT THE 1994
   EXAMINATION SCHEDULE AND PLAN
---------------------------------------------------------- Chapter 3:3

The evidence indicates that limited examination staff resources were
largely responsible for the fact that OFHEO has not been able to
fully implement the 1994 examination plan.  In particular, OFHEO has
too few examiners and specialists to fully cover the six core risks
within a 2-year period.  Although OFHEO supplements its examination
staff with temporary contractors and detailees, their use has not
been sufficient to ensure compliance with the plan.  OFHEO officials
said that another contributing factor was the time that its examiners
needed to develop an understanding of the enterprises' operations and
risk management. 


      OFHEO'S LIMITED EXAMINATION
      STAFF RESOURCES HAVE BEEN A
      LONG-STANDING CONCERN
-------------------------------------------------------- Chapter 3:3.1

In testimony before the House Banking, Finance, and Urban Affairs
Committee, Subcommittee on Housing and Community Development on
October 29, 1993, OFHEO's former director stated that the
organization was relatively understaffed as compared to other federal
financial regulators.  For example, the former director said that
OFHEO was relatively understaffed as compared to the Federal Housing
Finance Board, the Office of Thrift Supervision, and OCC, and that
OFHEO staff were responsible for assessing more assets per employee
than other regulators.  OFHEO's former director told us in December
1996 that the small size of the examination office remained an area
of concern.  In our 1995 report on OFHEO's development as an
independent regulator, we also stated that limited staff resources
had impeded OFHEO's ability to implement its examination program; for
example, OFHEO had just seven staff members in its examination office
at year-end 1994.\46 In addition, OFHEO officials we contacted said
that limited staff resources impeded their ability to implement the
1994 plan. 

Another factor that OFHEO officials cited for the organization's
inability to fully comply with the 1994 plan was that the examination
staff needed to take the time necessary to develop an understanding
of the enterprises' operations and risk management practices. 
OFHEO's acting director said that prior to 1993 when OFHEO began
operations, Fannie Mae and Freddie Mac had never been subjected to a
safety and soundness examination program.  Consequently, he said that
OFHEO's first cycle of examinations has proved more time-consuming
than OFHEO officials initially anticipated in 1994.  He also said
that subsequent examination cycles would proceed faster because of
the experience gained during the first cycle. 


--------------------
\46 GAO/GGD-95-123. 


      EACH CORE RISK EXAMINATION
      THAT OFHEO HAS INITIATED
      TIED UP A SIGNIFICANT
      MAJORITY OF LINE EXAMINATION
      STAFF FOR ABOUT 1 YEAR
-------------------------------------------------------- Chapter 3:3.2

We analyzed OEO's allocation of examination staff resources and found
that it appears to lack an adequate number of positions to cover the
six core risks within a 2-year period.  During fiscal year 1997, OEO
had 17 authorized full-time permanent positions (see fig.  3.1).  As
the figure indicates, 12 of the 17 positions were assigned to line
examiners and specialists, those individuals who are assigned
full-time to conduct the labor-intensive tasks associated with core
risk and targeted examinations (such as conducting and writing up
interviews with enterprise officials, reviewing policies, collecting
and analyzing financial data, reviewing the enterprises' asset and
liability management practices, writing examination drafts, and
documenting findings). 

Although OEO's director and deputy director also play a vital role in
the examination process, such as by reviewing examination reports and
communicating findings to senior enterprise officials, they have
other responsibilities that claim their time as well.  As examples,
the director and deputy director are to establish policies and plans
for the office, prepare annual budgets, and conduct internal and
external meetings, among other responsibilities.  The two financial
analyst positions are primarily responsible for conducting OFHEO's
off-site financial monitoring program.  The remaining position is for
the executive secretary, who is responsible for maintaining the
correspondence of the office and other administrative support
functions. 

   Figure 3.1:  Line and Nonline
   Full-Time Permanent Positions
   in OFHEO's Office of
   Examination and Oversight

   (See figure in printed
   edition.)

In the two most recent core risk examinations,\47 OFHEO needed to
commit a significant majority of its line examination staff to each
exam for a period of about 1 year to complete them (see table 3.3). 
Specifically, OFHEO assigned nine of its line examiners and
specialists full-time to the business risk examination and eight
examiners full-time\48 to the risk management examination.  In
addition, OFHEO assigned a financial analyst to work on the risk
management examination even though this individual's primary
responsibility is to produce off-site financial reports.  Further,
OFHEO's staff of line examiners and specialists is required to do
targeted examinations, such as of the enterprises' compliance with
flood insurance requirements.  With such a large majority of its line
examination and specialist staff assigned to one core risk management
examination for a whole year and with various targeted examination
requirements, it appears that OFHEO lacks adequate examination
resources to cover three core risks per year, the minimum necessary
to cover all six core risk areas on a 2-year cycle as stipulated in
the 1994 plan. 



                               Table 3.3
                
                    OFHEO Line Examination Positions
                 Assigned to Completed Enterprise Core
                           Risk Examinations

                          Line examiners      Total line
                                     and        examiner  Exam start
                             specialists  and specialist  and
Examination type                assigned       positions  end dates
------------------------  --------------  --------------  ------------
Business                               9              12  June 1996
                                                           to
                                                           May 1997
Risk management                      8\a              12  May 1995 to
                                                           June 1996
----------------------------------------------------------------------
\a Includes an examiner who resigned from OFHEO approximately 75
percent of the way through the examination.  Also, excludes a
financial analyst who was assigned to the examination. 

Source:  OFHEO. 


--------------------
\47 We did not include OFHEO corporate government risk examination in
this analysis because it was initiated in 1994 when the examination
office only had a total of seven staff, including the director,
deputy director, and executive secretary. 

\48 One OFHEO examiner resigned approximately 75 percent of the way
through the risk management examination. 


      EXAMINATION OFFICE HAS HAD
      ATTRITION
-------------------------------------------------------- Chapter 3:3.3

During 1996 and 1997, OFHEO's examination office experienced
significant attrition of permanent full-time staff, which has further
limited its ability to implement the 1994 plan.  During 1996, three
full-time permanent staff--two examiners and a capital markets
specialist---resigned, and, in January 1997, OEO's director passed
away.  As of March 31, 1997, OEO had five full-time permanent
position openings, which represented a vacancy rate of 30 percent. 
Of the five vacancies in the examination office, one was for the
director, three were for line examiner or specialist positions, and
one was for a financial analyst. 

According to OEO's acting director, the office places a high priority
on filling these vacancies in 1997 through a competitive civil
service announcement because the vacancies further limit OEO's
capacity to do examinations on a timely basis.  As of August 1997, an
OFHEO official said that the organization had filled the OEO director
position, a financial analyst position, and a specialist position. 
In addition, the official said that OFHEO was in the process of
announcing the other two specialist positions. 

OFHEO officials told us that the organization prefers to recruit
senior-level examiners who have substantial experience in overseeing
the operations of financial companies.  OFHEO officials said they
adopted this strategy for the following reasons:  (1) experienced
examiners can more quickly understand the operations of the
enterprises, (2) OFHEO grants considerable latitude to its examiners
so they must have credibility with senior enterprise officials, (3)
senior examiners allow OFHEO to minimize its staffing levels, and (4)
it is too expensive to establish an examiner development program that
would focus on recruiting more junior-level examiners.  However,
OFHEO officials also said that it can be difficult to attract and
retain senior examiners because they are also in demand by large
financial corporations and other financial institution regulators
that may be able to offer higher salaries and career opportunities
than OFHEO. 

We reviewed the backgrounds of OFHEO's full-time examination staff
and found that they have substantial backgrounds in examining
financial institutions and financial analysis.  For example, the
acting director had served a total of 15 years with the Office of
Thrift Supervision and OCC.  Other staff had also worked for
financial regulators and had postgraduate degrees in finance,
business, accounting, and/or professional certifications from
relevant accrediting organizations. 


      OFHEO'S USE OF CONTRACTORS
      MAY HAVE BEEN AFFECTED BY
      COST AND OTHER FACTORS
-------------------------------------------------------- Chapter 3:3.4

OEO's acting director said that OFHEO plans to continue supplementing
its examination staff with contract employees and detailees from
other financial regulators.  In the past, contract employees and
detailees have performed most functions of OFHEO examiners, such as
conducting examinations and documenting their findings.  However, OEO
officials said that OFHEO examiners make all final examination
conclusions and recommendations that are based on the work of the
contract employees and detailees.  In April 1997, OFHEO's contract
with a private firm for examination and related support services
expired.  The firm provided five examiners who worked on the risk
management examination and three examiners who worked on the business
risk examination.  This contract was replaced by another contract
that was signed in March 1997 to provide support for OFHEO's ongoing
information technology risk examination.  OFHEO plans to use its
full-time staff, including new hires, to staff the operations risk
examination that is also scheduled to begin in 1997. 

Despite relying on contractors to supplement its full-time
examination staff, OFHEO has not been able to fully implement the
1994 plan.  One factor that may have limited OFHEO's use of
contractors is cost.  For example, OEO's acting director estimated
that hiring a contractor full-time for 1 year costs approximately
$175,000 to $200,000 per year.\49 By contrast, he estimated that
OFHEO's compensation and travel costs for a full-time examiner are
about $125,000.  He also estimated that OFHEO's compensation and
travel costs for a detailee from a bank regulatory agency vary from
about $100,000 to $150,000, depending upon whether the detailee
normally works in a regional office and OFHEO must pay temporary
housing costs in the Washington, D.C., area. 

Another factor that appears to have limited OFHEO's use of
contractors is an ongoing dispute between Fannie Mae and OFHEO over
the potential disclosure of proprietary information; OEO's acting
director said that OFHEO temporarily stopped using contractors during
the course of the risk management exam as a result of this dispute. 
Fannie Mae officials told us that they believe OFHEO lacks the
statutory authority to use contractors as full-fledged examiners. 
Instead, Fannie Mae officials said they believe that OFHEO only has
the authority to use contractors for temporary technical assistance. 
Fannie Mae officials said that contractors could disclose proprietary
information gained during the examination process to the enterprise's
direct competitors.  In response, OFHEO's general counsel told us
that the organization has statutory authority to use contractors
during the examination process.  The general counsel also said that
OFHEO has implemented adequate procedures to protect proprietary
enterprise information.  Among other procedures, OFHEO generally
requires contractors to (1) sign oaths to the effect that they will
not disclose proprietary information obtained from the enterprises
and (2) turn over to OFHEO officials materials obtained from the
enterprises during the examination process. 


--------------------
\49 OFHEO limits its contractor costs by hiring on a part-time basis. 


   OFHEO PLANS TO REASSESS ITS
   EXAMINATION STRATEGY AND STAFF
   RESOURCES
---------------------------------------------------------- Chapter 3:4

OEO's acting director stated to us that OFHEO plans to shorten the
time that it takes to complete the core risk examinations.  He said
that OFHEO plans to initiate an assessment of its examination program
during 1997 and to make procedural changes as necessary to enhance
enterprise oversight by early 1998.  The acting director stated that
OFHEO plans to assess the appropriate mix of full-time staff,
contractors, and detailees as well as potential examination
strategies that would shorten the current examination cycle for
assessing the core risks from 3 to 4 years to 1 year rather than the
2-year cycle in the 1994 plan.  The acting director stated that
shortening the examination cycle to 1 year is a reasonable goal
because OFHEO plans to fill its five vacant positions during 1997,
which would facilitate a faster examination cycle.  Moreover, the
acting director said that the experience OFHEO has gained during the
first round of examinations should also shorten subsequent
examination cycles.  OFHEO has hired OCC's former Chief National Bank
Examiner as a consultant to advise the organization on assessing its
examination strategy. 

OEO's acting director said that, as part of its reassessment, OFHEO
plans to determine the appropriate number of examiners and
specialists necessary to shorten the examination cycle to 1 year. 
According to OFHEO's acting director, OFHEO may shift resources from
ORACS to OEO after the stress test and risk-based capital standards
are completed.  Consequently, OFHEO may have some flexibility over
time to increase the resources in its examination office without
necessarily increasing its overall staffing levels or budget. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 3:5

OFHEO's examination program, along with the development of minimum
and risk-based capital standards, is an essential component for
helping to ensure the safety and soundness of Fannie Mae and Freddie
Mac.  Since OFHEO began operations in 1993, the organization has made
important progress in developing a viable examination program.  This
progress included developing a risk-focused approach to examinations,
identifying six core risks facing the enterprises, and completing or
initiating examinations to cover five of those six risks.  In
addition, OFHEO has completed special exams of the enterprises'
nonmortgage derivatives activities, compliance with flood insurance
requirements, and data integrity issues at Freddie Mac. 

OFHEO has also assembled an examination staff that has substantial
experience in monitoring financial institutions.  However, limited
staffing levels and staff attrition--among other factors, such as the
need for OFHEO to develop an understanding of the enterprises'
operations and risk management--have compelled OFHEO to scale back
the implementation of a detailed examination schedule and plan that
it established in 1994.  As a result, OFHEO has a 3- to 4-year cycle
for examining the enterprises, which is considerably longer than the
2-year cycle in the plan.  OFHEO also reduced the planned coverage of
its business risk examination.  In our view, OFHEO's inability to
fully implement a comprehensive examination program limits the
organization's ability to adequately monitor the enterprises'
management practices and financial condition. 

According to OFHEO officials, the organization plans to reassess its
examination strategy and to make changes as necessary to shorten the
examination cycle from 3 to 4 years to 1 year.  We are concerned
that, without a reassessment of resources, OFHEO may not be able to
implement an annual enterprise examination program that adequately
covers all risk areas by early 1998.  Thus far, OFHEO has not been
able to implement a 2-year examination cycle that fully covers all
identified risk areas with examination office resources currently
assigned.  In fact, as of June 1997, OFHEO had not completed the
first cycle of examinations and important tasks remained.  Thus,
OFHEO's plan to implement, even after it fills existing OEO
vacancies, an annual examination strategy by early 1998 represents a
substantial additional challenge to an examination staff that already
has a significant workload. 

Therefore, we believe that including in OFHEO's assessment an
analysis of the staff resources necessary to adequately carry out
alternative examination cycles, such as 1 or 2 years, could help
ensure a fuller consideration of the trade-offs associated with
examination coverage provided versus costs involved and thereby
result in a more informed decisionmaking process. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 3:6

We recommend that OFHEO's and OEO's director promptly (1) conduct an
analysis to determine the examination office staff positions and
financial resources that would be needed to cover all core and
targeted risk areas within 1- or 2-year examination cycles; (2)
identify the most appropriate examination cycle after considering the
trade-offs between examination coverage and resource requirements
that would be involved; and (3) develop a strategy for obtaining the
necessary examination office resources, which may involve
reallocating OFHEO's existing full-time and contracting positions
over time. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 3:7

In written comments, the acting director of OFHEO agreed with our
findings and recommendations regarding the examination program.  The
acting director attributed OFHEO's relatively long 3- to 4-year
examination cycle to the fact that the enterprises had not been
subjected to a safety and soundness examination program prior to
OFHEO's creation.  He also stated that upon completion of the first
round of examinations at year-end 1997, OFHEO will have completed the
"discovery" process that is essential to understanding the quantity
and quality of risk at the enterprises.  The acting director further
stated that OFHEO will transition to a "continuous examination
process" at year-end 1997 that will allow for an annual examination
cycle.  Moreover, the acting director said that OFHEO's previous
examination work would allow it to prioritize future examination
activities while dramatically increasing the efficiency of the
examination process. 

The acting director agreed with the report's finding that adequate
resources must be committed to the examination program.  He also said
that OFHEO should be able to attract and retain qualified examiners
in the future as a result of its increasing visibility in the
regulatory community and efforts to ensure pay comparability. 
Further, the acting director stated that OFHEO will continue to
review the adequacy of its examination staff resources and supplement
its permanent examination staff with expertise from within OFHEO,
bank regulatory detailees, and contractors. 

While OFHEO has agreed to review the adequacy of its examination
staff resources, we believe it is essential that OFHEO promptly
specify the resources necessary to carry out an appropriate
examination cycle and develop a plan to obtain the permanent staff,
detailees, and contractors that may be required. 


OFHEO'S IMPLEMENTATION OF KEY
MISSION SUPPORT FUNCTIONS
============================================================ Chapter 4

In response to our statutory mandate to assess OFHEO's overall
operations, we reviewed OFHEO's implementation of key functions that
support the organization's safety and soundness mission-related
activities.  These mission-related support functions are OFHEO's
financial, human resources, and contract management systems.  Despite
some initial implementation challenges, OFHEO officials we contacted
said that these mission-support functions are now operating
satisfactorily. 

We also assessed whether OFHEO's participation in a U.S.  government
initiative to assist Mexico in developing a secondary mortgage loan
market has diverted OFHEO from fulfilling its safety and soundness
mission.  Although OFHEO officials made 10 trips to Mexico in 1995
and 1996 to support the initiative, the trips did not involve staffs
directly responsible for developing the stress test or conducting
examinations.  In addition, most of OFHEO's foreign travel and
related costs were paid by the United States Agency for International
Development (USAID). 

In this chapter, we also provide trend information on OFHEO's budget
and staff resources and discuss OFHEO's relationship with HUD to
provide further perspectives on how OFHEO has deployed its resources
during its first 4 years of operations. 


   OFHEO HAS IMPLEMENTED ITS
   FINANCIAL, HUMAN RESOURCES, AND
   CONTRACT MANAGEMENT FUNCTIONS
---------------------------------------------------------- Chapter 4:1

Since our first report on OFHEO's operations,\50 the organization has
implemented its financial management, human resource, and contracting
mission support functions.  According to OFHEO officials, the
organization experienced some problems in making the support
functions fully operational.  In particular, OFHEO experienced
repeated problems with HUD's operations of its financial management
systems, which OFHEO officials said compelled them to convert to a
different financial management system offered by VA.  Nevertheless,
OFHEO officials said that they are now generally satisfied with the
operational performance of these support functions. 


--------------------
\50 GAO/GGD-95-123. 


      OFHEO SWITCHED TO A NEW
      FINANCIAL MANAGEMENT SYSTEM
      IN 1996 AFTER REPEATED
      PROBLEMS WITH HUD'S SYSTEMS
-------------------------------------------------------- Chapter 4:1.1

When OFHEO began its operations in June 1993, it relied on HUD's
financial management system, which was called the HUD Administrative
Accounting System (HAAS).  Under HAAS, OFHEO staff reviewed invoices
and sent approved invoices to HUD for payment processing.  However,
we reported in 1995 that HAAS did not meet OFHEO's needs because,
among other reasons, OFHEO staff had limited access to the system and
experienced substantial delays in how HUD recorded OFHEO obligations
and expenses.  Also, HUD staff confused OFHEO with another HUD
agency, the Office of Fair Housing and Equal Opportunity (FHEO),
which resulted in errors in OFHEO's financial reports.  In October
1995, HUD converted OFHEO to its new accounting system, the HUD
Central Accounting and Program System (HUDCAPS). 

Although HUDCAPS offered improvements over HAAS, OFHEO officials said
that they remained dissatisfied with system access and performance
and the level of support provided by HUD.  For example, OFHEO
officials said that HUD staff continued to inaccurately record
transactions and did not provide OFHEO with the support necessary to
correct errors.  In addition, OFHEO officials said that there were
prolonged periods when HUDCAPS was unavailable, and OFHEO staff were
unable to record transactions.  These deficiencies with HAAS and
HUDCAPS caused OFHEO officials to initiate a search for a new
financial management system. 

In 1996, OFHEO entered into a "cross-servicing" arrangement\51 with
VA, a franchiser under the Government Management Reform Act,\52 to
operate OFHEO's financial management system beginning in fiscal year
1997.  During the first half of fiscal year 1997, OFHEO officials
concentrated on the conversion of the organization's financial
accounting activities from HUDCAPS to the VA Financial Management
System (FMS). 

OFHEO officials said that the VA FMS has met their initial
performance expectations, but the conversion process was more
difficult than initially planned due to the amount of reconciliation
needed to the financial data contained in the HUD records.  OFHEO
officials said that they plan to have the organization's fiscal year
1997 financial statements audited by an independent accounting firm. 


--------------------
\51 A "cross-servicing" agreement is an interagency agreement where
one agency agrees to provide specific services to another agency.  As
a small independent office, OFHEO is able to secure administrative
services from larger organizations having the capability to provide
services on a cost reimbursement basis. 

\52 Pub.  L.  No.  103-356, ï¿½ 403 (1994), 31 U.S.C.  ï¿½ 501 note. 
This act establishes pilot programs at six agencies designated by OMB
to provide administrative support services to other agencies. 


      OFHEO HAS IMPLEMENTED ITS
      HUMAN RESOURCE MANAGEMENT
      SYSTEMS
-------------------------------------------------------- Chapter 4:1.2

Under the act, OFHEO has exclusive authority over hiring and
compensation levels for its personnel.  The act further specifies
that OFHEO personnel may be paid without regard to certain provisions
of federal law\53 relating to classification and general pay rates. 
In concert with the act, OFHEO has developed an independent
classification and qualification system and pay structure. 
Occupations are to be 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.  The act also provides that
OFHEO's compensation levels should be comparable with those of OCC,
the Federal Reserve System, the Federal Deposit Insurance
Corporation, and the Office of Thrift Supervision.  According to
OFHEO, pay band levels are based on comparisons with similar
occupations in those other federal financial regulatory agencies. 
OFHEO's broad pay band structure is comprised of seven band levels,
plus the executive-level director position, which is set by law. 
OFHEO's staff members' pay band levels also depend upon the
complexity of the work, scope of responsibility, and supervisory
responsibility.  Table 4.1 shows the levels and number of positions
assigned to those levels. 



                               Table 4.1
                
                OFHEO's Pay Band Levels and Positions in
                           Each Band in 1996

                                                             Positions
Level                                            Pay range    in level
------------------------------------------  --------------  ----------
I                                                $15,876 -           0
                                                    26,460
II                                                21,168 -           8
                                                    42,337
III                                               31,753 -           8
                                                    58,213
IV                                                42,337 -           5
                                                    79,381
V                                                 52,921 -          22
                                                   105,842
VI                                                79,381 -          20
                                                   137,594
VII                                               89,966 -           8
                                                   142,886
Director                                           133,600           1
======================================================================
Total                                                               72
----------------------------------------------------------------------
Source:  OFHEO. 

OFHEO officials also said that the organization's performance
management system, the Performance Evaluation Management System
(PEMS), was fully implemented by March 31, 1995, and that OFHEO began
its first rating cycle in April 1995.  Changes in base pay occur once
a year, at the end of the PEMS performance review cycle, and are to
be based solely on merit.  An OFHEO official said that the
organization is currently evaluating PEMS to ensure that it remains
an effective tool for assessing the performance of the staff. 

According to an OFHEO official, on September 30, 1996, OFHEO's
Schedule A authority\54 to hire employees expired and by January
1997, the organization had converted to the federal civil service
competitive hiring system and procedures.  OFHEO officials expressed
generally negative views on the impact that the conversion from
Schedule A hiring authority to civil service hiring authority will
have on the organization.  The director of ORACS said that the civil
service procedures could impede OFHEO's capacity to hire necessary
expert staff.  OFHEO's Director of the Office of Finance and
Administration said that it is too soon to evaluate the impact of the
conversion.  However, she did say that the competitive service
requirements are much more time-consuming and cumbersome than the
Schedule A procedures. 


--------------------
\53 The act provides that OFHEO personnel may be paid without regard
to provisions of Title 5, United States Code, relating to
classification and General Schedule pay rates.  See 12 U.S.C.  ï¿½
4515(a). 

\54 Schedule A hiring authority is one of the federal government's
excepted appointing authorities used for hiring employees under
special circumstances.  This temporary authority, granted by the
Office of Personnel Management, permits agencies to fill positions
without following the extensive requirements of the competitive
service.  Schedule A hiring authority may be used if, for example, a
crash program or a new organization must be staffed so quickly that
there is not time for following established competitive service
procedures. 


      OFHEO'S CONTRACTING
      AUTHORITY CONSIDERED
      ADEQUATE FOR MISSION SUPPORT
-------------------------------------------------------- Chapter 4:1.3

During its start-up phase, OFHEO used HUD for procuring contracting
services but experienced various difficulties.  In our first report
on OFHEO's operations,\55 we stated that HUD was not staffed to
provide the expedited procurement processing that OFHEO's start-up
mode of operations required.  In June 1994, OFHEO hired its own
procurement contracting officer and exercised its contracting
authority as provided in the act.  According to an OFHEO official,
HUD's general counsel has written a legal opinion stating that OFHEO
is subject to both the Competition in Contracting Act and the Federal
Acquisition Regulation.  OFHEO officials we contacted said that the
organization has all of the contracting authority necessary to
provide mission support.  Table 4.2 lists all of the contracts OFHEO
entered into between 1994 and the second quarter of fiscal year 1997. 
With the exception of one contract terminated because of
nonperformance, OFHEO officials said they are generally satisfied
with their contractors' performance. 



                                    Table 4.2
                     
                      OFHEO Contracts By Value, 1994 to 1997

                                                  Award                 Contract
Contractor               Task description         date      End date      amount
-----------------------  -----------------------  --------  --------  ----------
General Analytics        ADP-related work         07/06/    09/30/    $6,235,000
Corporation                                       94        97

Haynes & Associates,     Examination-related      06/02/    04/12/     1,911,000
Inc.                     work                     95        97

Price Waterhouse         Design & development     08/31/    09/30/     1,450,000
                         work for the financial   95        00
                         simulation model

Computer Temporaries,    Various temporary        04/04/    09/30/     1,057,000
Inc.                     services                 94        97

Manufacturing            ORACS computer network   05/26/    09/01/       518,000
Technology, Inc.                                  94        94

Strategic Compensation   Executive compensation   09/27/    09/30/       289,000
Association              study                    96        00

Home Associates, Inc.    Construction of OFHEO    03/31/    03/31/       234,000
                         space                    97        97

Ernst & Young LLP        Information system &     03/21/    12/31/       212,000
                         technical examination    97        01
                         support

Standard & Poor's        Credit rating of         09/30/    03/31/       200,000
Rating Services          enterprises              96        97

INTEX Solutions, Inc.    Simulate cashflow        09/30/    09/30/       173,000
                         performance of           96        01
                         financial products

Risk Management          Design and development   08/08/    03/07/       101,000
Technologies             of financial database    95        96
--------------------------------------------------------------------------------
Source:  OFHEO. 


--------------------
\55 GAO/GGD-95-123. 


   OFHEO'S PARTICIPATION IN MEXICO
   INITIATIVE DID NOT INVOLVE
   RESEARCH OR EXAMINATION STAFFS
---------------------------------------------------------- Chapter 4:2

We assessed whether OFHEO's participation in a U.S.  government
initiative to assist Mexico in developing a secondary market for
mortgage loans has had a substantial impact on delaying the
development of the stress test and risk-based capital standards.  A
total of 8 OFHEO officials--the former director, 4 senior officials,
and 3 staff members--made a total of 10 foreign trips related to the
Mexico initiative in 1995 and 1996.\56 Other participants in the
initiative included officials from OCC, the enterprises, and private
sector institutions that specialize in housing finance.  Under an
agreement with USAID, USAID provided about $159,000 to OFHEO in 1996
to provide technical assistance to Mexico and for travel-related
purposes.  See appendix II for a more detailed discussion of OFHEO's
participation in the Mexico initiative and related costs. 

Based on a review of OFHEO's travel records and discussions with
senior staff, we do not believe that OFHEO's participation in the
Mexico initiative was a significant factor in delaying the
development of the stress tests and capital standards or OFHEO's
inability to fully implement its examination program.  For example,
staff from OFHEO's two principal mission-related offices, ORACS and
OEO, did not participate in the initiative or foreign trips.  Other
than the former director, the four senior staff who did participate
in the initiative, the current acting director, the chief economist,
the director of congressional affairs, and the director of public
affairs estimated that they spent less than 5 percent of their time
in 1996 on the Mexico initiative.\57 For example, the chief economist
estimated that he spent only about 2 weeks in 1996 traveling to
Mexico and preparing for presentations.  OFHEO officials said that
the organization benefits from participating in outside activities,
such as the Mexico initiative, because they increase staff
development and allow the agency to gain exposure to and credibility
with participants in the mortgage finance markets.  The other three
OFHEO officials who went on some of the foreign trips were staff
members in OFHEO's Office of the Director. 


--------------------
\56 Except for the former director, OFHEO officials did not all
participate in each of the 10 foreign trips.  See appendix II of this
report, table II.1. 

\57 OFHEO did not provide an estimate of the time that the former
director devoted to the Mexico initiative. 


   OFHEO'S FINANCIAL AND STAFF
   RESOURCES, 1993-1997
---------------------------------------------------------- Chapter 4:3

Since OFHEO began its operations in June 1993, its obligations
increased from about $2.1 million at fiscal year-end 1993 to about
$14.8 million at fiscal year-end 1995 (see table 4.3).  This growth
reflects the staff and contractors hired that OFHEO considered
necessary to carry out its mission, such as developing capital
standards and conducting examinations.  During fiscal year 1996,
OFHEO's obligations remained flat at $14.8 million and then increased
by an estimated 5 percent in fiscal year 1997.  Table 4.4 shows the
growth of OFHEO full-time, contractor, and detailee staff for fiscal
years 1993 through 1997.  Appendix III provides additional
information about OFHEO's staffing resources. 



                               Table 4.3
                
                 OFHEO's Obligations, Fiscal Years 1993
                              Through 1997

                         (Dollars in thousands)

                                                              Estimate
                              Actual  Actual  Actual  Actual         d
Obligation category             1993    1994    1995    1996      1997
----------------------------  ------  ------  ------  ------  --------
Personnel services\a            $163  $2,690  $5,783  $7,234    $9,119
Other services\b               1,956   2,473   5,858   4,800     3,793
All other\c                        7   1,323   3,139   2,758     2,588
======================================================================
Total                         $2,126  $6,486  $14,78  $14,79   $15,500
                                                   0       2
Growth (%)                       N/A    205%    128%     N/A        5%
----------------------------------------------------------------------
N/A = Not applicable. 

\a Obligations for the salaries and benefits of OFHEO personnel. 

\b Obligations for contractor services. 

\c Obligations for rent, travel, computer acquisition, etc. 

Source:  OFHEO. 



                               Table 4.4
                
                OFHEO's Full-time, Contractor, and Bank
                  Regulatory Detailee Staff, at End of
                         Fiscal Years 1993-1997

Staff                             1993    1994    1995    1996  1997\a
------------------------------  ------  ------  ------  ------  ------
Full-time permanent                  7      37      63      66      58
Full-time temporary                  1       4       4      10     7\b
Contract                           N/A     N/A      24      20      19
Detailee                           N/A     N/A       2       5       1
======================================================================
Total                                8      41      93     101      85
----------------------------------------------------------------------
N/A = Not applicable. 

\a As of March 31, 1997. 

\b Includes one part-time temporary staff member. 

Source:  OFHEO. 


   OFHEO'S RELATIONSHIP WITH HUD
---------------------------------------------------------- Chapter 4:4

OFHEO's relationship with HUD has provided mixed benefits.  For
example, OFHEO's acting director said that OFHEO's association with
HUD allows OFHEO staff to keep apprised of developing housing and
housing-finance issues.  In addition, the acting director said that
he believes that HUD has benefited from its relationship with OFHEO. 
For example, he said that OFHEO's review and comments on HUD's
proposed regulations implementing its oversight of the enterprises'
compliance with the act's housing-related goals resulted in
improvements.  However, OFHEO officials also said that HUD has not
always been able to provide adequate support, such as in the case of
its financial management systems. 

In a previously issued report,\58 we commented on the current
regulatory structure for the government-sponsored housing
enterprises.  One of the issues discussed was whether the regulation
should be done in a stand-alone organization or an office within an
executive branch agency. 


--------------------
\58 See Government-Sponsored Enterprises:  Advantages and
Disadvantages of Creating a Single Housing GSE Regulator
(GAO/GGD-97-139, July 9, 1997).  This report commented on the
potential benefits of merging OFHEO with the Federal Housing Finance
Board. 


FINANCIAL MODELING AND COMPUTER
PROGRAMMING PROJECTS OFHEO HAS
INITIATED TO COMPLETE DEVELOPMENT
OF THE STRESS TEST AND RISK-BASED
CAPITAL STANDARDS
=========================================================== Appendix I

Between 1994 and 1997, OFHEO initiated several financial modeling and
computer programming projects to complete the development of the
stress test and risk-based capital standards.  Most of these projects
had been completed by April 1997.  The following summarizes several
of the more important projects: 

OFHEO developed the benchmark loss experience by November 1995:  To
develop the benchmark loss experience, OFHEO reviewed nationwide data
provided by the enterprises that showed the loss histories on 5.6
million mortgage loans dating back to 1979.  Based on this analysis,
OFHEO has proposed that the benchmark loss experience be based on
mortgage loans originated in Arkansas, Louisiana, Mississippi, and
Oklahoma during 1983 and 1984. 

OFHEO translated the enterprises' financial data into a common
format.  This project was completed by January 1996:  According to
OFHEO, the stress test and capital standards must treat the assets,
liabilities, and off-balance-sheet obligations of both enterprises
equally and consistently.  OFHEO determined that the most efficient
way of doing this was to translate both enterprise balance sheets
into comparable standardized terms and units and run them through a
single financial model.  OFHEO has also reported that the most
challenging aspect of this process was translating Fannie Mae and
Freddie Mac's huge data files into a consistent format to support
stress test research.  The process was further complicated by the
differences in the ways that the enterprises record and report
financial information.  According to OFHEO, a contractor, Price
Waterhouse, is continuing to transform the data so that it can be
accessed more efficiently by OFHEO staff. 

OFHEO decided to create a house price index rather than relying on an
existing index.  This project was completed in March 1996:  To
respond to the act's stress test requirement that it assess the
impact changing house prices would have on the enterprises' mortgage
portfolios, OFHEO determined that it needed to develop a new house
price index rather than rely on the one available from the Department
of Commerce.  OFHEO's house price index combines similar indexes that
had been published jointly by Fannie Mae and Freddie Mac.  OFHEO made
some technical changes to publish an index that OFHEO officials said
better met the organization's regulatory requirements.  OFHEO's
index, first published in March 1996, provides historical house price
information on mortgage loans purchased by the enterprises since
1975.  According to OFHEO, the organization's house price index is
superior to the Department of Commerce index for the purpose of
determining the current values of single-family properties securing
enterprise loans.\59

OFHEO developed econometric models and computer programs to simulate
the financial performance of the enterprises.  This work was
completed by June 1997.  OFHEO developed software to simulate the
cash flows of all enterprise financial instruments and contracts,
based on interest rate and mortgage performance models.  OFHEO also
developed econometric models to estimate mortgage default rates and
loss severities and developed computer programs to simulate operating
decisions and translate cash flow simulations into pro forma
financial statements. 


--------------------
\59 OFHEO's index is produced using data on single-family detached
properties financed by conforming conventional mortgages purchased by
the enterprises.  Thus, mortgages on properties that exceed the
conforming loan limit are excluded.  The Department of Commerce index
includes such nonconforming loans, which was a reason OFHEO
determined that the index was not appropriate for the stress test. 


OFHEO OFFICIALS HAVE PARTICIPATED
IN A U.S.  GOVERNMENT INITIATIVE
ASSISTING MEXICO IN DEVELOPING A
SECONDARY MORTGAGE LOAN MARKET
========================================================== Appendix II

The proposal for OFHEO's collaborative efforts to facilitate a
secondary mortgage market in Mexico resulted from the May 1995
U.S.-Mexico Binational Commission meeting during which the former HUD
Secretary and Mexico's Secretariat of Social Development (SEDESOL)
Minister proposed a conference to be held in Mexico City in July
1995, to explore relevant policy issues.  On September 11, 1995,
OFHEO officials met with a subgroup of participants from the Mexico
City conference, including the World Bank, USAID, Freddie Mac, and
U.S.  private sector institutions, to discuss ways to facilitate the
development of a Mexican secondary mortgage loan market. 

Funding for most of OFHEO's initiative was provided by USAID in the
form of a Participating Agency Service Agreement (PASA), which went
into effect on September 30, 1995.  Under this agreement, USAID funds
were used to pay for direct expenses (travel, conferences, studies,
etc.) related to providing technical assistance to Mexico's SEDESOL
in the development of products, methodologies, and strategies to
eliminate barriers to the successful development and implementation
of a securitized secondary mortgage market in Mexico.  Total PASA
funds with USAID were $159,000 in fiscal year 1996, the first fiscal
year of the agreement. 

During fiscal year 1996, OFHEO used PASA USAID funds to provide
technical assistance to Mexico.  This assistance included sponsoring
seminars and papers on mortgage markets and related issues.  For
example, in April 1996, OFHEO sponsored a seminar and incurred
nontravel-related expenses of $6,850 for such services as
interpretation, transcription (English and Spanish), video and
recording coverage, printing, copying, postage, office materials,
telephone and fax charges, and a $6,400 consulting fee for a summary
of the proceedings and interviews with senior Mexican bankers in
preparation for a project analyzing mortgage data.  Other uses of
PASA funds by OFHEO included shooting footage for a video on the
development of a secondary mortgage market in Mexico and assembling a
glossary, in Spanish, of housing finance and secondary mortgage
market terms. 

During fiscal years 1995 and 1996, 8 OFHEO officials--the former
director, 4 senior officials, and 3 staff members--made 10 foreign
trips related to the Mexico initiative (see table II.1).  Travel
expenses for these foreign trips totaled about $49,999 with USAID
paying $27,018 in fiscal year 1996 and OFHEO expending a total of
$22,981 of its own funds in fiscal years 1995 and 1996.  The four
senior OFHEO officials--the acting director, chief economist,
director of congressional affairs, and director of public
affairs--who participated in the foreign trips relating to the Mexico
initiative estimated that they spent 5 percent or less of their time
on Mexico-related work in fiscal year 1996.  OFHEO did not provide
any estimates on the amount of time that the former director spent on
the Mexico initiative.  Due to the relatively small amount of time
committed to the Mexico initiative, OFHEO's acting director said he
does not believe that the organization's participation had a material
impact on the development of risk-based capital standards.  In
addition, he said that staff from OFHEO's ORACS and OEO did not
participate in the initiative.  OFHEO's support staff were used to
create and distribute written materials and to administer the PASA
agreement with USAID.  The three other OFHEO employees who
participated in some of the foreign trips are staff members in
OFHEO's Office of the Director. 



                Table II.1 OFHEO's International Travel
                Related to the Mexico Initiative, Fiscal
                          Years 1995 and 1996

                           OFHEO
Travel date            employees  Itinerary             Funds     Cost
--------------------  ----------  --------------------  ------  ------
FY 1995

June 1995                      4  DC-Mexico-DC          OFHEO   $5,507

July 1995                      5  DC-Mexico-DC          OFHEO    8,074

FY 1996

November 1995                  2  DC-Mexico-DC          USAID    3,401

February 1996                  3  DC-Mexico-DC          USAID    3,063

April 1996                     6  DC-Mexico-DC          USAID   10,353

May 1996                       5  DC-Mexico-DC          OFHEO    5,988

May 1996                       1  NY-Mexico-DC          OFHEO      617

June 1996                      1  DC-Turkey-DC          OFHEO    2,795

August 1996                    4  DC-Mexico-DC          USAID    5,384

September 1996                 4  DC-Costa Rica-DC      USAID    4,817

======================================================================
Total                                                           $49,99
                                                                     9
----------------------------------------------------------------------
Source:  OFHEO. 

OFHEO's acting director cited several benefits to OFHEO from its
participation in initiatives undertaken with PASA funds.  He said the
primary benefit for OFHEO was that it allowed the organization to
establish contacts with personnel in the mortgage industry and
develop its stature as an independent regulator.  In addition, he
said that OFHEO was able to share information on its role and
activities with interested parties. 


OFHEO'S STAFFING LEVELS, FISCAL
YEARS 1993 TO 1997
========================================================= Appendix III



                              Table III.1
                
                OFHEO's Full-time, Contractor, and Bank
                Regulatory Detailee Staff, Fiscal Year-
                                end 1993

                                 Full-
                                  time   Full-   Full-
                                perman    time    time
                                   ent  perman  tempor
                                positi     ent     ary  Contra
Unit                              ons\   staff  staff\      ct  Detail
------------------------------  ------  ------  ------  ------  ------
Director                                     3
Research, Analysis, and                      1       1
 Capital Standards
Examination and Oversight
General Counsel
Finance and Administration                   2
Policy Analysis
Congressional and Public                     1
 Affairs
======================================================================
Total                                        7       1
----------------------------------------------------------------------
Source:  OFHEO. 



                              Table III.2
                
                OFHEO's Full-time, Contractor, and Bank
                Regulatory Detailee Staff, Fiscal Year-
                                end 1994

                                 Full-
                                  time   Full-   Full-
                                perman    time    time
                                   ent  perman  tempor
                                positi     ent     ary  Contra
Unit                              ons\   staff  staff\      ct  Detail
------------------------------  ------  ------  ------  ------  ------
Director                                     6
Research, Analysis, and                      8       2
 Capital Standards
Examination and Oversight                    7
General Counsel                              3       2
Finance and Administration                   6
Policy Analysis                              3
Congressional and Public                     4
 Affairs
======================================================================
Total                               45      37       4
----------------------------------------------------------------------
Source:  OFHEO. 



                              Table III.3
                
                OFHEO's Full-time, Contractor, and Bank
                Regulatory Detailee Staff, Fiscal Year-
                                end 1995

                                 Full-
                                  time   Full-   Full-
                                perman    time    time
                                   ent  perman  tempor
                                positi     ent     ary  Contra
Unit                              ons\   staff  staff\      ct  Detail
------------------------------  ------  ------  ------  ------  ------
Director                             7       7       1       1
Research, Analysis, and             14      14       2      12
 Capital Standards
Examination and Oversight           14      13               7       1
General Counsel                      8       8       1               1
Finance and Administration          11      10               4
Policy Analysis                      6       6
Congressional and Public             5       5
 Affairs
======================================================================
Total                               65      63       4      24       2
----------------------------------------------------------------------
Source:  OFHEO. 



                              Table III.4
                
                OFHEO's Full-time, Contractor, and Bank
                Regulatory Detailee Staff, Fiscal Year-
                                end 1996

                                 Full-
                                  time   Full-   Full-
                                perman    time    time
                                   ent  perman  tempor
                                positi     ent     ary  Contra
Unit                              ons\   staff   staff      ct  Detail
------------------------------  ------  ------  ------  ------  ------
Director                             8       7       1
Research, Analysis, and             17      15       5      11
 Capital Standards
Examination and Oversight           17      14       1       7       4
General Counsel                      8       9       1               1
Finance and Administration          11      11       1       2
Policy Analysis                      6       5       1
Congressional and Public             5       5
 Affairs
======================================================================
Total                               72      66      10      20       5
----------------------------------------------------------------------
Source:  OFHEO. 



                              Table III.5
                
                OFHEO's Full-time, Contractor, and Bank
                Regulator Detailee Staff as of March 31,
                                  1997

                                 Full-
                                  time   Full-   Full-
                                perman    time    time
                                   ent  perman  tempor
                                positi     ent     ary  Contra
Unit                               ons   staff   staff      ct  Detail
------------------------------  ------  ------  ------  ------  ------
Director                             7       5
Research, Analysis, and             17      14     4\a      14
 Capital Standards
Examination and Oversight           17      12               3       1
General Counsel                      9       8       1
Finance and Administration          11      11       1       2
Policy Analysis                      6       4       1
Congressional and Public             5       4
 Affairs
======================================================================
Total                               72      58       7      19       1
----------------------------------------------------------------------
\a One of the four staff members was part-time. 

Source:  OFHEO. 




(See figure in printed edition.)Appendix IV
COMMENTS FROM THE OFFICE OF
FEDERAL HOUSING ENTERPRISE
OVERSIGHT
========================================================= Appendix III



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V


   GENERAL GOVERNMENT DIVISION,
   WASHINGTON, D.C. 
--------------------------------------------------------- Appendix V:1

William B.  Shear, Assistant Director
Wesley M.  Phillips, Evaluator-in-Charge
Thomas J.  Givens, III, Senior Evaluator


   OFFICE OF THE GENERAL COUNSEL,
   WASHINGTON, D.C. 
--------------------------------------------------------- Appendix V:2

Paul G.  Thompson, Attorney

*** End of document. ***