[Senate Hearing 108-849]
[From the U.S. Government Printing Office]



                                                        S. Hrg. 108-849
 
                        PROPOSALS FOR IMPROVING
                     THE REGULATION OF THE HOUSING
                    GOVERNMENT SPONSORED ENTERPRISES

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

                                HEARINGS

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                       FIRST AND SECOND SESSIONS

                                   ON

 ESSENTIAL ELEMENTS AND PROPOSALS OF REGULATORY REFORM, RESOLUTION OF 
        ACCOUNTING ISSUES, AND FUNDING OF A NEW OVERSIGHT OFFICE

                               __________

          OCTOBER 16, 23, 2003, FEBRUARY 10, 24, AND 25, 2004

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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                            senate05sh.html





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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire        THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina       DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island      JON S. CORZINE, New Jersey

             Kathleen L. Casey, Staff Director and Counsel
     Steven B. Harris, Democratic Staff Director and Chief Counsel
                    Douglas R. Nappi, Chief Counsel
                       Mark F. Oesterle, Counsel
                       Bryan N. Corbett, Counsel
               Peggy R. Kuhn, Senior Financial Economist
             Martin J. Gruenberg, Democratic Senior Counsel
              Stephen R. Kroll, Democratic Special Counsel
                   Sarah A. Kline, Democratic Counsel
             Jonathan Miller, Democratic Professional Staff
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                       George E. Whittle, Editor

                                  (ii)
























                            C O N T E N T S

                              ----------                              

                       THURSDAY, OCTOBER 16, 2003

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Sarbanes.............................................     2
    Senator Bennett..............................................     3
    Senator Reed.................................................     4
    Senator Dole.................................................     5
    Senator Corzine..............................................     6
    Senator Enzi.................................................     7
    Senator Schumer..............................................     8
        Prepared statement.......................................    71
    Senator Hagel................................................     8
    Senator Crapo................................................    10
    Senator Carper...............................................    11
    Senator Sununu...............................................    12
    Senator Stabenow.............................................    13
        Prepared statement.......................................    71
    Senator Bunning..............................................    13
    Senator Allard...............................................    15
    Senator Chafee...............................................    16

                               WITNESSES

John W. Snow, Secretary, U.S. Department of the Treasury, 
  Washington, DC.................................................    16
    Prepared statement...........................................    72
    Response to written questions of:
        Senator Shelby...........................................    91
        Senator Reed.............................................    92
        Senator Sununu...........................................    96
        Senator Bunning..........................................    96
        Senator Miller...........................................    97
Mel Martinez, Secretary, U.S. Department of Housing and Urban 
  Development, Washington, DC....................................    18
    Response to written questions of:
        Senator Shelby...........................................    99
        Senator Reed.............................................   100
        Senator Bunning..........................................   112
        Senator Miller...........................................   113
Franklin D. Raines, Chairman and Chief Executive Officer, Fannie 
  Mae............................................................    42
    Prepared statement...........................................    75
    Response to written questions of:
        Senator Shelby...........................................   113
        Senator Reed.............................................   115
        Senator Hagel............................................   120
        Senator Miller...........................................   126
George D. Gould, Presiding Director, Freddie Mac.................    45
    Prepared statement...........................................    81
Norman B. Rice, President and Chief Executive Officer, Federal 
  Home Loan Bank of Seattle......................................    48
    Preared statement............................................    87

              Additional Material Supplied for the Record

Letter to Robert Ney, a U.S. Representative in Congress from the 
  State of Ohio and Maxine Waters, a U.S. Representative in 
  Congress from the State of California from Franklin D. Raines, 
  Chairman and Chief Executive Officer, Fannie Mae, dated 
  September 12, 2003 submitted by Senator Debbie Stabenow........   128
``Potential Costs Related to the SEC Registration of the FHLB's 
  Stock,'' by the First Manhattan Consulting Group dated October 
  15, 2003 submitted by Senator Richard C. Shelby................   137

                              ----------                              

                       THURSDAY, OCTOBER 23, 2003

                                                                   Page

Opening statement of Chairman Shelby.............................   183

Opening statements, comments, or prepared statements of:
    Senator Sarbanes.............................................   184
    Senator Bunning..............................................   184
    Senator Johnson..............................................   185
    Senator Hagel................................................   186
    Senator Reed.................................................   187
    Senator Bennett..............................................   187
    Senator Corzine..............................................   203
    Senator Allard...............................................   205

                               WITNESSES

John T. Korsmo, Chairman, Federal Housing Finance Board..........   188
    Prepared statement...........................................   223
Armando Falcon, Jr., Director, Office of Federal Housing 
  Enterprise
  Oversight......................................................   189
    Prepared statement...........................................   231
    Response to written questions of:
        Senator Shelby...........................................   249
        Senator Reed.............................................   250
Douglas Holtz-Eakin, Director, Congressional Budget Office.......   192
    Prepared statement...........................................   233
    Response to written questions of:
        Senator Shelby...........................................   253
        Senator Reed.............................................   254
John D. Koch, Executive Vice President and Chief Lending Officer, 
  Charter
One Bank, NA, Cleveland, Ohio, on behalf of America's Community 
  Bankers,
  Washington, DC.................................................   213
    Prepared statement...........................................   238
Dale J. Torpey, President and CEO, Federation Bank, Washington, 
  Iowa,
  on behalf of the Independent Community Bankers of America......   214
    Preared statement............................................   241
    Response to written questions of:
        Senator Shelby...........................................   254
        Senator Hagel............................................   256
        Senator Reed.............................................   256
Allen J. Fishbein, Director for Housing and Credit Policy, 
  Consumer Federation of America, on behalf of National 
  Association of Consumer Advocates, National Community 
  Reinvestment Coalition, National Congress for Community 
  Economic Development, National Fair Housing Alliance, and 
  Consumer Federation of America.................................   216
    Prepared statement...........................................   243
Robert M. Couch, Chairman, Mortgage Bankers Association..........   218
    Prepared statement...........................................   245
    Response to written questions of:
        Senator Shelby...........................................   257
        Senator Hagel............................................   258
Iona C. Harrison, Realty Executives-Main Street, U.S.A., on 
  behalf of the National Association of REALTORS'.....   219
    Prepared statement...........................................   246

                              ----------                              

                       TUESDAY, FEBRUARY 10, 2004

                                                                   Page

Opening statement of Chairman Shelby.............................   261

Opening statements, comments, or prepared statements of:
    Senator Reed.................................................   262
    Senator Sununu...............................................   262
    Senator Crapo................................................   268
    Senator Corzine..............................................   269
    Senator Sarbanes.............................................   273
    Senator Hagel................................................   275
    Senator Carper...............................................   276
    Senator Chaffee..............................................   278
    Senator Bennett..............................................   279
    Senator Dole.................................................   304

                               WITNESSES

David M. Walker, Comptroller General, Accompanied by Tom McCool,
  Managing Director, Financial Markets and Community Investments,
  U.S. General Accounting Office.................................   262
    Prepared statement...........................................   305
Alan L. Beller, Director, Division of Corporation Finance, U.S. 
  Securities
  and Exchange Commission........................................   283
    Prepared statement...........................................   331
    Response to written questions of Senator Reed................   364
Richard S. Carnell, Associate Professor of Law, Fordham 
  University School
  of Law, New York, New York.....................................   287
    Prepared statement...........................................   336
James R. Rayburn, President, National Association of Home 
  Builders                                                          290
    Prepared statement...........................................   352

                              ----------                              

                       TUESDAY, FEBRUARY 24, 2004

                                                                   Page

Opening statement of Chairman Shelby.............................   367

Opening statements, comments, or prepared statements of:
    Senator Allard...............................................   367
    Senator Dole.................................................   368
    Senator Carper...............................................   369
    Senator Bunning..............................................   369
    Senator Reed.................................................   370
    Senator Crapo................................................   371
    Senator Enzi.................................................   372
        Prepared statement.......................................   401
    Senator Sarbanes.............................................   372
    Senator Stabenow.............................................   389
    Senator Sununu...............................................   392

                                WITNESS

  Alan Greenspan, Chairman, Board of Governors of the Federal 
    Reserve System, Washington, DC...............................   373
    Prepared statement...........................................   402
    Response to written questions of:
        Senator Shelby...........................................   407
        Senator Allard...........................................   425
        Senator Reed.............................................   427
        Senator Dole.............................................   435

                              ----------                              

                      WEDNESDAY, FEBRUARY 25, 2004

                                                                   Page

Opening statement of Chairman Shelby.............................   437

Opening statements, comments, or prepared statements of:
    Senator Johnson..............................................   437
    Senator Hagel................................................   439
    Senator Crapo................................................   440
    Senator Stabenow.............................................   441
    Senator Dodd.................................................   454
    Senator Sarbanes.............................................   455
    Senator Bennett..............................................   460
    Senator Carper...............................................   464
    Senator Corzine..............................................   470

                               WITNESSES

Franklin D. Raines, Chairman and Chief Executive Officer, Fannie 
  Mae............................................................   442
    Prepared statement...........................................   485
Richard F. Syron, Chairman and Chief Executive Officer, Freddie 
  Mac............................................................   445
    Prepared statement...........................................   516
    Response to written questions of:
        Senator Hagel............................................   530
        Senator Reed.............................................   530
Norman B. Rice, President and Chief Executive Officer, Federal 
  Home Loan
  Bank of Seattle................................................   448
    Prepared statement...........................................   525
    Response to written questions of Senator Reed................   539











                      PROPOSALS FOR IMPROVING THE
                       REGULATION OF THE HOUSING
                    GOVERNMENT SPONSORED ENTERPRISES

                              ----------                              


                       THURSDAY, OCTOBER 16, 2003

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:12 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order.
    I would first like to welcome Treasury Secretary Snow and 
HUD Secretary Martinez again to the Committee. They are no 
strangers here. It is a pleasure to have both of you back. That 
will be our first panel.
    Our second panel of witnesses will be Franklin Raines, 
Chairman and Chief Executive Officer of Fannie Mae; George D. 
Gould, Director of Freddie Mac; and Norman Rice, President and 
CEO of the Federal Home Loan Bank of Seattle.
    Today's hearing focuses upon a very important topic: 
improving the regulation of the housing Government Sponsored 
Enterprises, or GSE's, as they are commonly known.
    The mission of the housing GSE's is one I strongly support. 
Federal Home Loan Bank advances are a vital link to the capital 
markets for financial institutions nationwide. The secondary 
mortgage market access that Fannie Mae and Freddie Mac provide 
also serves as an important source of liquidity for our 
Nation's mortgage market. By enhancing liquidity, the 
Enterprises make possible the lending activity that is critical 
to economic growth and to expanding homeownership.
    The enterprises are large institutions. Collectively, 
Fannie Mae and Freddie Mac carry $1.6 trillion in assets on 
their balance sheets and have outstanding debt of almost $1.5 
trillion. The Federal Home Loan Bank System is not far behind, 
with combined assets of over $780 billion and outstanding 
advances to member institutions of $495 billion.
    Due to the importance of the housing GSEs' mission and the 
size of the assets, I believe that the Enterprises require a 
strong, credible regulator. I remain concerned that the current 
regulatory structure for the housing GSE's is neither strong 
nor credible.
    In July, this Committee examined OFHEO's oversight of 
Fannie Mae and Freddie Mac and their accounting practices. I 
remain troubled by the fact that OFHEO never detected the 
complete breakdown in the accounting and audit function at 
Freddie Mac. While this breakdown did not directly implicate 
Freddie Mac's financial strength, I believe the integrity of 
financial data is a vital barometer of safety and soundness. 
The breakdown in internal controls that produced Freddie Mac's 
accounting mishap was a managerial failure that, if duplicated 
in a different function, could have had catastrophic 
implications. Sound corporate governance and management is a 
key element of safety and soundness.
    In September, the Subcommittee on Financial Institutions 
held a hearing on the current oversight of the Federal Home 
Loan Bank System, and I want to commend Senator Bennett for his 
leadership and foresight in having that hearing. That hearing 
raised many questions regarding the current oversight of the 
Federal Home Loan Banks. I am hopeful that we will be able to 
expand upon some of those questions today.
    Several Members of this Committee have put forth proposals 
to reform the regulation of the housing enterprises, and I want 
to recognize the efforts of Senators Hagel, Dole, Sununu, and 
Corzine in that regard. Your efforts have given this Committee 
a solid foundation upon which to build. I again want to thank 
all of the witnesses for appearing before the Committee today. 
We look forward to your testimony.
    Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Mr. Chairman, thank you for convening 
this important hearing. We were originally scheduled to hear 
Secretary Snow on this very day with respect to the exchange 
rates and manipulation of currency to gain trade advantage. 
This is, of course, very much a pressing issue now, and the 
President goes to the Far East and will be meeting with 
officials in Japan and China. Of course, the subject of this 
hearing is an important issue as well, and I recognize that the 
Treasury has not yet come forth with its exchange rate report. 
I understand it will come by the end of the month and that you 
have rescheduled a hearing with Secretary Snow for October 30.
    Chairman Shelby. Absolutely, right here.
    Senator Sarbanes. And I look forward to that hearing and 
discussing that subject, in depth with the Secretary.
    I take it we will have the report before that hearing, Mr. 
Secretary?
    Secretary Snow. Senator, I originally intended, to have the 
report with the testimony.
    Senator Sarbanes. All right. So we will have it before or 
at the hearing.
    Secretary Snow. Yes.
    Chairman Shelby. Will it be contemporaneous with the 
hearing?
    Secretary Snow. Contemporaneous with the hearing, right.
    Chairman Shelby. Okay.
    Senator Sarbanes. On today's subject, Mr. Chairman. The 
entities that we are examining--Fannie Mae, Freddie Mac, and 
the Federal Home Loan Banks--together with the Federal Housing 
Administration, have made the American home finance system the 
deepest, most liquid, and most innovative system in the world.
    These GSE's collect capital from around the globe to invest 
in mortgages for homeowners and rental properties here in 
America. They have helped to create the historically high 
homeownership rates we are currently enjoying in this country. 
About two-thirds of all Americans own their homes.
    I might mention, since I see Secretary Martinez at the 
table, I heard the story on the radio this morning of your 
people in Florida. They own their home, but they do not own the 
land on which their home is located. These are these trailer 
homes in Florida.
    Senator Martinez. Yes, sir.
    Senator Sarbanes. Now they are going to redevelop high-cost 
condominiums. These people are being told they have to move 
their trailers, which they have not done in 25 years. 
Apparently they will just fall apart if they try to move them. 
You have a lot of elderly down there. It seems to me it is a 
problem HUD better look at. I hope you are doing that.
    Mr. Chairman, you mentioned the size and complexity of the 
GSE's. I will not repeat those figures, but they obviously make 
the point. That, together with the central role they play in 
the smooth running of our mortgage markets, obviously means 
that we have a special responsibility in this Committee to 
ensure the public that the institutions are well-regulated, 
properly supervised, and thoroughly examined.
    We are fortunate that at least thus far, as best we know, 
the problems at Freddie Mac appear to be governance and 
accounting problems rather than risk management problems. And 
the issues at the Federal Home Loan Banks, some of them, while 
serious, are still relatively small in nature. But it is 
appropriate that we look carefully at these issues.
    I look forward to working with my colleagues to try to 
craft a piece of legislation that provides for strong safety 
and soundness with respect to the GSE's.
    Finally, Mr. Chairman, let me say the Administration has 
requested an additional $7.5 million for OFHEO to conduct 
reviews of accounting practices at the Enterprises it 
regulates. I very strongly support that request, and I hope we 
will be able to work to make sure the appropriators include 
this additional funding in the fiscal year 2004 budget.
    While we are deliberating on creating a new, more effective 
regulatory structure, I think we need to make certain that the 
current regulator is adequately funded in order to address the 
immediate situation which they confront. And I very much hope 
that that appropriation will make its way through the process 
and that the Administration's request will be positively 
addressed.
    Thank you very much.
    Chairman Shelby. Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman. I appreciate your 
holding these hearings. I think they are probably some of the 
more significant hearings we will hold this year, not because 
there is a crisis with respect to Fannie, Freddie, and the 
Federal Home Loan Banks in this area, but because we need to be 
alert to the possibility that a crisis might arise.
    We have to recognize with some significant approval the job 
that Fannie and Freddie have done. The fact that some Federal 
Home Loan Banks want to get into that market more aggressively 
than they have been illustrates how important it is. Markets 
are working. They are working in ways that benefit Americans, 
and as Senator Sarbanes has indicated, Americans have a higher 
degree of homeownership than any other industrialized country. 
And the success of Fannie and Freddie is a large reason why 
that is the case.
    But as they grow, people get nervous. As the numbers get 
into the trillions, even Congress begins to pay attention. And 
it is very appropriate that we air all of the issues as 
thoroughly as this hearing and other hearings will do, and that 
we look at the question of appropriate regulation in as careful 
a manner as we possibly can.
    So, I congratulate you on holding the hearings. I look 
forward to the witnesses. I think it is a demonstration of the 
seriousness of the topic that we have two Cabinet officers as 
our first witnesses and three CEO's as our second panel of 
witnesses. This is not an issue that should be dealt with by 
the second team, and we are very glad that we are getting the 
first team here, both with this panel and the one that will 
follow. And I look forward to hearing what they have to say 
with great interest.
    Chairman Shelby. Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman. I 
appreciate the fact you are holding this very important 
hearing, and I welcome Secretary Martinez and Secretary Snow.
    As we all know, the Government Sponsored Enterprises have 
played an invaluable role in stabilizing and improving the 
availability of funds to support homeownership in our country. 
This has resulted in the United States having one of the 
highest homeownership rates in the world, and strong and 
effective oversight of the GSE's is clearly an important part 
of their long-term success.
    As we begin to delve into how to strengthen our GSE 
regulators, it is increasingly clear how complicated this task 
may be, especially if we decide to change the regulator for the 
Federal Home Loan Banks as well. It is my hope, Mr. Chairman, 
that you intend to hold several more hearings on this matter so 
that we can fully debate the many issues and hear from other 
stakeholders in the housing industry as well as housing experts 
on this matter. For example, proposals such as allowing the new 
regulator to set the minimum capital standard for the GSE's are 
worthy of their own hearing so that this Committee can better 
understand the ramifications of such a change in the housing 
market.
    Needless to say, I look forward to this morning's testimony 
and hope it can help this Committee begin to decide what we can 
do to strengthen the regulation of our housing GSE's.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. I believe Senator Dole was here much 
earlier.

              STATEMENT OF SENATOR ELIZABETH DOLE

    Senator Dole. Thank you, Mr. Chairman.
    First of all, I would like to reiterate something we all 
believe in: Homeownership is a cornerstone in the foundation of 
the American Dream. Each of us here today is committed to 
ensuring that every American can one day own his or her own 
home. Homeownership creates wealth and improves our 
neighborhoods and communities to the greater benefit of us all.
    It is for this reason that we committed to strengthening 
every step in the mortgage process. This past June, when the 
Freddie Mac board removed its three highest executives, we 
learned of violations of generally accepted accounting 
principles at the GSE in order to hide profits so as to 
minimize volatility in earnings. That is an unacceptable 
practice that must never happen again.
    While the uncovering of this scandal will result in the 
eventual restatement of earnings for the past 3 years, I fear 
that the clear lack of oversight could result in a coverup of 
potential future losses. Changes should be made to prevent 
this.
    During the last Congress, the Banking Committee passed the 
Sarbanes-Oxley corporate accountability law to ensure greater 
transparency of our Nation's corporations. It strikes me as 
ironic that the next scandal would occur at a Government 
Sponsored Enterprise.
    Let me be clear: Fannie Mae and Freddie Mac serve very 
important roles in our mortgage finance system by providing 
liquidity in the market. They were given a charter that, in 
2001, the Congressional Budget Office estimated to be worth a 
$10.6 billion annual subsidy. With these built-in advantages, 
Fannie Mae and Freddie Mac have been able to increase 
homeownership, especially for low-income and minority families. 
We all support this goal and will ensure that such efforts 
continue.
    We must take steps to guard against the potential of any 
more scandals and to ensure that these organizations can 
continue their important mission. Because of the recent 
recognition that the current regulator lacks the tools and the 
mandate to adequately regulate these enterprises, I have 
introduced legislation with Senators Hagel and Sununu to create 
a world-class regulator in the Department of the Treasury. A 
consensus has formed in support of this initiative, and I 
strongly urge all of my colleagues to take a look at our 
legislation.
    As we move forward on this issue, it must be remembered 
that the operations of these housing enterprises entail a 
certain degree of risk. Fannie and Freddie do a tremendous 
amount of hedging with derivatives, such as interest rate 
swaps. Together, they held more than $1 trillion worth of these 
interest rate swaps in 2002. A February OFHEO study concluded 
that not only might the GSEs' demand for hedges outstrip supply 
in the near future, but also that a financial problem at one 
GSE could quickly spread to counter-
parties.
    Clearly, this is not a situation we can afford to ignore, 
and we certainly cannot make only half an effort. I want to 
thank Chairman Shelby for scheduling this hearing and, in doing 
so, making this issue a priority. I look forward to working 
with my colleagues as we seek to properly address the need for 
a well-funded, well-equipped, world-class regulator for Fannie 
Mae and Freddie Mac.
    Finally, let me thank Secretaries Snow and Martinez for 
coming here today to discuss this issue. We thank you both for 
your time, your dedicated service, and for your interest in 
working with us on this issue of such importance to all 
Americans.
    Thank you.
    Chairman Shelby. Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman. I appreciate your 
holding this hearing, and I welcome the witnesses. I would 
concur with the view that it obviously speaks to the importance 
of this issue that we have the leaders of the appropriate 
organizations to be here, both in this panel and the next. 
GSE's play an essential role, in my view, in aiding our economy 
and aiding one of those parts of our economy that has been a 
bright spot not only in recent years but also for a very 
extended period of time as our economy has been the strongest 
in the world over a period of history. Homeownership is a 
cornerstone of the American Dream, as Senator Dole mentioned, 
and that is both for individuals and our communities. And the 
size and the complex nature of the structures of the GSE's--and 
they truly are complex within any kind of context of one 
looking at a financial institution--account for billions of 
dollars of mortgage finance dollars. And the critical role they 
play in our housing market does require the oversight by a 
credible, capable regulator that is up to the job of providing 
rigorous oversight.
    In my mind, the current system of supervision has failed to 
meet those standards, and I think the ongoing accounting issues 
at Freddie Mac and those that are now appearing at some of the 
Federal Home Loan Banks attest to that.
    To that end, I introduced legislation several weeks ago 
that I believe evolves the regulatory structure in a way that 
meets the problem without undermining the successful role that 
the GSE's play specifically in the housing market and for our 
economy in general. There are really four key elements to this 
legislation I proposed, actually common with a number of the 
other discussions that others have put forward: Establish a 
new, independent regulator that is credible and capable; 
assuring safe and sound capital; promoting transparency through 
enhanced disclosures; and taking an incremental approach as 
opposed to a one-shot approach to consolidating the supervision 
of the Federal Home Loan Bank System under the regulatory 
framework contained in the bill.
    I do believe we have to be careful here that we do not 
tinker with a system that has actually produced an enormous 
capacity to promote homeownership in this Nation. I think it 
has been absolutely key to that effort. And I understand that 
there are others that have proposals. I look forward to working 
with all on the Committee and certainly you, Mr. Chairman, and 
the Ranking Member. Doing this right is more important than 
doing it immediately. I concur with Senator Bennett that while 
there are serious problems and ones that we need to address, I 
do not think we are dealing with a crisis here. It is one that 
I think needs to be addressed in a way that makes certain that 
our markets continue to have the breadth and depth that these 
two institutions and actually the Federal Home Loan Banks have 
helped fund.
    I will leave the balance of my statement for the record, 
but I have tried to be detailed about the nature of the 
proposal that I have laid down. Hopefully, we will all have 
continuing discussions on this, and I am sure we will.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you.
    Senator Enzi.

              STATEMENT OF SENATOR MICHAEL B. ENZI

    Senator Enzi. Thank you, Mr. Chairman. I appreciate your 
holding this hearing and the Secretaries for being here for it.
    The past decade has brought tremendous change to the 
housing industry. The increase of homeownership for families 
has been one of the great success stories of our economy. In 
Wyoming, the housing market presents many difficulties. Rural 
housing needs are ever increasing, affordable housing in 
atypical places like Jackson are in great demand, and the 
unique challenges of home lending to our Native American tribes 
are but a few of the issues that Wyomingites face.
    In Wyoming, the Government Sponsored Enterprises have 
greatly helped to pull together the necessary financing and 
community backing to make homeownership in these challenging 
environments possible. Fannie Mae, Freddie Mac, and the Federal 
Home Loan Bank of Seattle have worked closely with nearly 50 
community banks in the State to find creative solutions that 
are essential in helping families achieve the American Dream.
    While the Government Sponsored Enterprises have facilitated 
and expanded the homebuying opportunities for families, the 
Enterprises, overall, engage in very complex and intricate 
financial transactions. At this time, the financial stability 
of the housing enterprises does not appear to be in jeopardy. 
However, I believe the regulators of the Enterprises should 
have the tools and resources necessary to oversee the complex 
financial transactions.
    In early August, I sent a letter to Secretary Snow, 
together with Senators Bennett, Johnson, and Schumer, 
supporting the move of the financial oversight responsibilities 
of the Office of the Federal Housing Enterprise Oversight, 
OFHEO, to the Department of the Treasury, providing that the 
new regulator was sufficiently financed. I still support that 
move.
    Since that time, the issues surrounding the move of the 
regulator have become more complex. Recently, there have been 
calls to add the regulator of the Federal Home Loan Bank System 
to the proposed regulator. While I believe that the Federal 
Finance Housing Board needs to improve its financial oversight 
over the Federal Home Loan Banks, I also believe that bringing 
the two regulators together just because they regulate 
Government-sponsored entities is shortsighted.
    Fannie Mae and Freddie Mac operate quite differently than 
the Federal Home Loan Banks. Any proposal to bring the 
regulators together must recognize their unique differences and 
must place sufficient firewalls to keep the regulatory 
oversight of the two systems separate. I strongly encourage 
that we review this matter more thoroughly before rushing to a 
judgment.
    Again, I thank you for being with us today, and I would 
also like to thank the distinguished second panel for being 
with us as well. I look forward to their testimony.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you, Mr. Chairman. I appreciate the 
opportunity to say something here. I will be brief and ask 
unanimous consent that my opening statement be put in the 
record.
    Chairman Shelby. Without objection, your opening statement 
will be made part of the record.
    Senator Schumer. Thank you. And I want to thank the 
Secretary for being here as well.
    I would just make one point here. What is vital to me here 
is that Fannie and Freddie be able to continue in their mission 
to perform--to fill in niches in the market that the private 
sector may not be able to fill in or it takes 10 years to fill 
in afterwards.
    I have found in my State, when we have particular problems 
in suburban areas, for instance, where costs have gone way up 
and policemen, firemen, and teachers cannot afford a home, 
Fannie and Freddie have been the only group to devise policies, 
working with banks, that will fill in those gaps and make it 
easier for those people to live there rather than commute 100 
miles away. Or in our inner city, we have some poor people who 
have--these are Hassidic Jews who have 10 or 12 children and 
are very poor. And they continue to live in the city. It is 
very hard for them to make out.
    Again, Fannie and Freddie have filled in the lurch. If we 
go to a strictly actuarial standard here, I think we will lose 
those things. And so I am deeply concerned, Mr. Secretary, that 
while I have no problem giving Treasury an oversight 
responsibility in terms of safety and soundness--and I want to 
make sure that capital requirements--which, as you may know, I 
have been very much involved with when we wrote the old S&L law 
as a way to strengthen the S&L industry--are strong. I would 
feel very strongly--I would fight very strongly against the 
mission parts of Freddie and Fannie, the approval of new 
products going to Treasury, which has a more actuarial point of 
view, than to HUD--and I love both of you dearly; this has 
nothing to do with either of you--than to HUD, which cares 
about the housing mission. And that will guide much of what I 
do.
    I think you can have both. You do not have to throw out the 
baby with the bath water. You can tighten up the actuarial 
oversight of Fannie and Freddie, given their importance, and 
still maintain the vigor of their mission. And having the 
actuarial part in Treasury and the mission part in HUD makes a 
great deal of sense to me.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Hagel.

                STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you. And welcome to our 
panelists this morning. It is always helpful and a pleasure to 
see the Secretaries of Treasury and HUD with us. And we also 
appreciate the second panel, President Rice, Director Gould, 
and Chairman Raines. We look forward to their testimony.
    As we discuss significant changes to the supervision of 
Fannie Mae, Freddie Mac, and perhaps to Federal Home Loan 
Banks, I think it is important to reflect on why we are here. 
What is our central purpose in the reform we are considering? 
Confidence.
    Confidence in the regulation of Fannie Mae and Freddie Mac 
is critical for the future. The accounting and management 
problems discovered at Freddie Mac earlier this year shed light 
on a problem that some of us have been concerned about for some 
time. We must do a more responsible job of regulating Fannie 
Mae and Freddie Mac, we owe it to the residential mortgage 
market, we owe it to the investors, and we owe it to the 
American taxpayer.
    Congress created Fannie and Freddie and provided them with 
an implied Government backing. Congress must, therefore, 
provide a world-class regulator. Our goal here is to create a 
strong, independent regulator with the tools necessary to 
effectively examine two of the world's largest financial 
institutions and the expertise to minimize the risk to 
investors and the public.
    In introducing the Federal Enterprise Regulatory Reform 
Act, S. 1508, Senators Sununu, Dole, and I offered one model, a 
beginning for an effective new regulator. And I want to 
highlight two principles contained in our bill, and the 
Administration's proposal, which are, in my opinion, essential 
to a credible regulator for Fannie and Freddie.
    First, the new regulator at the Treasury Department must 
have the authority to approve new programs and ensure Fannie 
and Freddie continue to focus on their core missions as defined 
and established by the Congress of the United States. I agree 
with Secretary Martinez that HUD should focus its energies on 
setting and enforcing meaningful, affordable housing goals for 
Fannie and Freddie. Treasury needs the authority to approve the 
new programs.
    Second, an effective regulator must have broad authority 
over capital standards and the ability to adjust them as 
appropriate to balance risk and ensure safety and soundness. I 
am not advocating for immediately increasing the amount of 
capital that Fannie and Freddie must hold, but I strongly favor 
giving the new regulator the ability to do so when it believes 
it is appropriate.
    Some have recently asserted that too much attention on 
safety and soundness will undermine Fannie and Freddie's 
ability to play a leading role in affordable housing. I believe 
just the opposite to be true. The more soundly these companies 
are capitalized, the stronger they will be perceived in the 
marketplace. Higher confidence by investors leads to lower 
interest rates for homebuyers. Mr. Chairman, to be effective, a 
world-class regulator needs these two components.
    Finally, I want to comment on another important aspect of 
the reform we are considering, that is, the inclusion of the 
Federal Home Loan Bank System under the same new regulator that 
we construct for Fannie and Freddie. While I am not opposed to 
including the Federal Home Loan Banks, they differ 
significantly, greatly, as Senator Enzi has just mentioned, 
from Fannie and Freddie. And these differences must be 
addressed and factored into any new regulatory reform we 
consider. Unlike Fannie and Freddie, the banks are 
cooperatives, owned by member institutions in their assigned 
States. They are locally controlled and sensitive to the unique 
and varied financial needs of local communities and issue their 
debt securities through a central Office of Finance, which is 
operated by the 12 Banks collectively.
    While a consensus seems to be forming around inclusion of 
the Federal Home Loan Banks, that does not mean we have to do 
it right away or in the same bill as Fannie and Freddie. This 
is an option. It surely is an option. As with all reform, it is 
more important that we do it right than we do it quickly.
    Again, Mr. Chairman, I appreciate your holding the hearing, 
and I also look forward to our witnesses and working with them 
through this process. Thank you.
    Chairman Shelby. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman. I will be 
brief. I know we want to get to the witnesses.
    I share the concern that has been raised by, I think, all 
of my colleagues with regard to the failure of OFHEO to pick up 
on the problems that have come to light recently and the 
impetus for this hearing. I appreciate the Chairman holding 
this hearing and the important issues that we are dealing with. 
I will just make a couple of brief comments on a couple of the 
issues that have already been raised.
    First, I am very interested in the proposal to include the 
Federal Home Loan Banks in the regulatory system that we are 
considering establishing. I recognize the differences that 
exist and I am very concerned that as we approach this matter, 
we recognize those differences and assure that whatever we 
establish does not overlook the fact that very different 
approaches need to be taken with regard to the regulation and 
oversight of the Federal Home Loan Banks vis-a-vis Fannie and 
Freddie.
    That having been said, I can also see some very significant 
benefits of having them both housed at Treasury and having a 
system where an independent regulator oversees the operations 
of both, because although there are major differences, there 
are also increasing numbers of similarities in the types of 
activities and objectives that both are seeking to address. And 
I am looking forward today very closely to listening to the 
testimony on that issue.
    Second, with regard to the question of where the authority 
over missions and programs of the GSE's should be housed, I 
tend to see the validity, as several of my colleagues, most 
recently just Senator Hagel, have indicated, that the authority 
over the new programs, the new missions, needs to be with the 
financial regulator in Treasury. I will listen very carefully 
to testimony and points brought up on both sides of that issue, 
but it seems to me that we need to be certain that the 
regulatory system we put into place is one in which there is 
fairness, there is that balanced playing field that we always 
talk about in different contexts as we have different types of 
entities being regulated in the same arena, and that we make 
certain that the scope of regulatory authority is sufficient 
for effective regulation and oversight to be accomplished.
    With that, Mr. Chairman, I will withhold the rest of my 
comments and concerns until a later time. Thank you.
    Chairman Shelby. Thank you.
    Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thanks, Mr. Chairman.
    To Secretary Snow, Secretary Martinez, welcome. It is good 
to see you both. We thank you for your presence here and for 
your stewardship, your responsibilities.
    Before I talk just a little bit about some areas where I 
think there seems to be general consensus, and maybe a couple 
of areas where there is not, let me just say that some of you 
may recall hearing the old adage, ``If it ain't broke, do not 
fix it.'' I have said that once or twice. Maybe some of you 
have as well. ``If it ain't broke, do not fix it.'' I think 
what applies here, instead of that approach, is an approach 
that says, ``If it is not perfect, make it better.''
    We have a wonderful ability in this country to generate 
capital and provide that capital for housing, and it is not 
broken. It is not perfect, and we can make it better, and my 
hope is that we will.
    The problems that led to the passage of the Sarbanes-Oxley 
legislation are in many cases created when companies 
understated expenses and they overstated revenues. And they 
were deceitful about it. There was not enough disclosure or 
transparency. They got into trouble and, frankly, created a lot 
of problems for our country and led to the passage of the 
legislation.
    This is not that kind of situation. The problem they had at 
Freddie Mac was a problem, for the most part, where they were 
not overstating revenues, but where they actually were 
understating revenues, and in some cases overstating expenses. 
Quite a different problem. I guess if you are going to have a 
problem, that is the better problem to have. But it is not 
right. It is not the right thing to do.
    I want to mention three or four areas where I think there 
is general consensus for us to go forward, and one of those is 
the idea that we need to create an independent, strong 
regulator, and there seems to be consensus that it should be in 
Treasury. Second is that the regulator should not be subject to 
the annual appropriations process. A third area of general 
consensus, it seems at least to me, is that affordable housing 
goals should remain the purview of HUD. And, finally, the 
housing mission of the GSE's should not be changed. Not 
everybody agrees with those, but I think for the most part 
there is consensus around those points.
    There are a number of areas where there is not a consensus. 
I will mention maybe three. One is the ability of the new 
regulator to set minimum capital standards. Second would be the 
location of program approval authority and the standard for 
those new programs. And last is the inclusion or whether or not 
we should include within this new regulatory scheme Federal 
Home Loan Banks in any kind of approach or the way we change 
business.
    My hope, Mr. Chairman and colleagues, is that what is going 
to flow from these hearings, this hearing today and maybe those 
that follow it, is that some of the items--if you put two 
columns together where there is general consensus and areas 
where there is not consensus, we will be able to move maybe by 
the end of the day some of those items under lack of consensus, 
maybe move a couple of those over to the column where there is 
consensus. And if we can do that with a few of those today, we 
will have done good work.
    Thank you.
    Chairman Shelby. Senator Sununu.

              STATEMENT OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you very much, Mr. Chairman.
    What is the saying? ``Everything has been said, but not 
everyone has had a chance to say it.'' But I will do my best to 
make a couple of additional observations that I do think are 
important as we begin this hearing.
    As Senator Bennett said, we are here because we must be 
alert that a crisis might arise. We are trying to be proactive. 
We are trying to do the right thing in dealing with this 
important regulatory issue for the GSE's.
    We have heard about some significant accounting issues, 
cases where in the Federal Home Loan Banks we have had 
portfolio losses. And I happen to believe that misleading 
investors is always wrong. I do not care whether you understate 
profits or overstate profits or intentionally suggest that 
things are not as good as they really are. That is always 
wrong. And the credibility and reliability of our capital 
markets depend on effective regulation to ensure confidence.
    Let us all agree that the affordable housing issues that 
HUD has traditionally dealt with are very important, and the 
role that the GSE's might play in affordable housing is 
important. And those are issues that we will probably want to 
continue to deal with regardless of the final dispensation of 
this legislation. But let us also understand that the record 
has shown that the GSE's have actually lagged the markets in 
meeting affordable housing targets and goals. And I would ask 
unanimous consent that I be allowed to submit the 
documentation, studies, evaluations put together by HUD to that 
effect.
    Chairman Shelby. Without objection.
    [The information follows:]
    Senator Sununu. That does not mean that they have not done 
important work in affordable housing, but it means that if we 
try to look at it objectively and on a statistical level, they 
have not always provided the kind of leadership that we might 
expect from a Government-chartered institution.
    This is about safety and soundness of the GSE's and 
ultimately the credibility and strength in our capital markets. 
It is about having an effective regulator. And I very much 
appreciate the work and the discussion and dialogue that has 
already taken place, the legislation submitted by Senator 
Corzine, the discussions that I have had with other Members of 
this Committee that have not necessarily signed on to 
legislation but are approaching this in, I think, a very, very 
thoughtful way.
    We have to be careful of a couple things: One, that we not 
allow politics to prevent us from doing the right thing for the 
GSE's themselves, for the taxpayers, and for the housing 
markets; and, second, that we not just accept a bill because we 
want to check it off our list and say we passed legislation 
dealing with the GSE regulation issue and now we can get on to 
something else.
    No bill would be far better than a poorly written bill. I 
believe this very strongly. If we pass legislation that is all 
form and no substance, we will be doing a disservice to the 
consumers, a disservice to investors, a disservice to 
taxpayers, and I think ultimately a disservice to the GSE's 
themselves, Fannie, Freddie, the Federal Home Loan Banks, 
because the employees at those important and fine institutions, 
their leadership, and their management want to operate in an 
environment of credibility, confidence, and certainty, just 
like any other participant in the private sector of the capital 
markets.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Stabenow.

              COMMENTS OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Thank you, Mr. Chairman. I would ask that 
my statement be included in the record.
    Chairman Shelby. Your statement will be made part of the 
record.
    Senator Stabenow. Thank you. I would like to offer a 
slightly different view than my colleague who just spoke in 
that, first of all, I think the secondary mortgage market is 
essential to our housing sector and that, in fact, there has 
been great success, and I welcome the opportunity to in the 
future submit for the record evidence as to why these very 
important GSE's have been so significant in terms of providing 
housing opportunities to people.
    We know that there is a growing interest in strengthening 
our housing finance regulators. I share that. We need a highly 
respected independent regulator for Fannie Mae and Freddie Mac, 
and that the Federal Home Loan Bank, of course, needs to be 
soundly regulated. But I appreciate the Chairman's comments at 
hearings in the past in terms of moving forward in a thoughtful 
manner, as the Chairman and the Ranking Member have done on 
other issues. And I am hopeful that we will move forward in a 
thoughtful manner and address what are legitimate concerns 
without, as they say, throwing the baby out with the bath 
water, because I believe that we have had many great successes 
for the American people through the systems that have been in 
place and providing housing which is so critical to all of us.
    I welcome the Secretaries to be with us today as well. I 
look forward to your testimony.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman, for holding this 
very important meeting. I would also like to thank all of our 
witnesses for testifying today.
    Everyone on this Committee was very troubled at what 
happened at Freddie Mac. Most troubling for me was the fact 
that OFHEO had no idea, until Freddie brought it to their 
attention, what was going on there. No idea.
    While I am happy that Freddie was able to self-police, I 
was astonished by OFHEO's attitude which seemed to come down to 
say, yes, we need more money, but the system worked. OFHEO's 
testimony reminded me of Kevin Bacon's character in ``Animal 
House,'' standing on the corner shouting, ``Remain calm. All is 
well,'' right before he is run over by the mob.
    [Laughter.]
    I am certainly happy that we have all come to the 
conclusion that Freddie and Fannie need to have a new 
regulator. But there are many pitfalls ahead of us. Nobody here 
wants to do anything that would harm our housing market, and 
this new regulatory structure could harm it if we do not do it 
right.
    We should not simply rearrange the deck chairs on the 
Titanic. We should not simply move OFHEO into Treasury and let 
it run the same way. But we also must remember who is affected 
by what we are doing.
    We have few large banks in Kentucky--few. We do not have 
the guys who compete with Fannie and Freddie. We have the guys 
who work with them. They use GSE products to make loans to 
underserved areas so they can bring the dream of homeownership 
to those who otherwise would not be able to afford it.
    They also use GSE products for CRA compliance. They are 
scared to death that this will be harmed by this legislation. I 
want to make sure that they are not.
    I have just one other major concern. On September 9 of this 
year, Assistant Secretary Abernathy was up here. I asked him if 
all GSE's, including the TVA, should have to register with the 
SEC. He said, ``That is our position, yes.'' I have the 
videotape if you would like to see it.
    I understand that someone above his pay grade, which I 
assume is you, Secretary Snow, has said that TVA is not a GSE, 
and so that the statement did not apply. This is very troubling 
to me. If TVA, which was established by the Federal Government, 
runs itself as a quasi-public enterprise and is not a GSE, what 
is it? If the TVA is not Government-sponsored, who sponsors it? 
If it is not an enterprise, what is it?
    Also help me comprehend why the Administration wants the 
Federal Home Loan Banks, which have a regulator and who do not 
sell public stock, to register with the SEC, while at the same 
time it does not call on TVA, which has over $26 billion in 
public traded debt and no regulator, to register with the SEC. 
I cannot comprehend the Administration's position on this.
    I do look forward to further discussions on this question 
very shortly, since I will have a chance to question you in the 
question and answer period. I want to thank you for coming. We 
deeply appreciate your appearance here.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. First of all, Mr. Chairman, I would like to 
thank you for holding this hearing.
    I would like to borrow a cliche from the medical community, 
and that is, ``An ounce of prevention is worth a pound of 
cure.'' And I think that my colleagues Senator Hagel as well as 
Senator Sununu hit upon the keyword, which is ``confidence.'' 
We simply must have confidence in the secondary markets as well 
as the GSE's. The GSE's themselves will benefit with 
confidence. The investors will benefit with confidence. With 
good confidence, the users benefit. Homeowners certainly are 
beneficiaries as well as the taxpayers.
    So, I am delighted that we are having this hearing. Fannie 
Mae and Freddie Mac were chartered by Congress as Government 
Sponsored Enterprises to create a secondary mortgage market 
which has served us well. It is one of the things that has 
separated us from other parts of the world who are struggling 
with housing. We have housing now at an all-time high, and a 
lot of it is due to the fact that we have a very viable 
secondary mortgage market.
    Although they are private companies owned by shareholders, 
the GSE's retain certain Government ties. For example, they 
have access to a line of credit at the Treasury Department and 
are exempted from paying State and local income taxes. In 
exchange for these benefits, they are required to serve all 
markets and must meet certain affordable housing goals. Since 
their creation Fannie Mae and Freddie Mac have been an 
important source of homeownership for all Americans.
    Over the years, the GSE's have evolved into very large, 
very complex financial institutions. Because of their size, 
complexity, and importance to the financial markets, they 
demand the highest levels of oversight and scrutiny. Currently, 
the Office of Federal Housing Enterprise Oversight, referred to 
as OFHEO, is charged with ensuring the financial safety and 
soundness of the GSE's. But recent events have clearly 
demonstrated that OFHEO as currently structured is insufficient 
as a regulator. This causes me great concern due to the 
implications of homeownership, the markets, and because of the 
belief and implied Government backing of the GSE's.
    Accordingly, the Bush Administration proposed creating a 
new regulator for the housing GSE's. The new regulator would be 
an independent agency with the Department of the Treasury, 
similar to other Federal financial regulators, such as the 
Office of the Comptroller of the Currency and the Office of 
Thrift Supervision. I strongly support creation of a new 
regulator within the Treasury Department because they have 
better financial expertise to oversee the complex financial 
transactions in which the GSE's engage.
    In order to be an effective regulator, the new agency must 
have a broad set of powers comparable to other financial 
regulators, including additional enforcement powers and 
litigation authority. I also believe the regulator must have 
the ability to set capital standards for the GSE's. While we 
have found many areas of agreement, there are still many issues 
to be resolved, including mission regulation and inclusion of 
Federal Home Loan Banks. While I believe that we should move 
quickly in this debate, we must do so with care and 
deliberation. We must ensure any changes strengthen oversight 
of the GSE's and work to promote access to housing.
    I would like to welcome our witnesses today, particularly 
Secretary Snow and Secretary Martinez. I know this Committee 
will work closely with you as we continue to address the GSE 
reform.
    Thank you for being with us here today, and I look forward 
to your testimony.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Chafee.

              COMMENT OF SENATOR LINCOLN D. CHAFEE

    Senator Chafee. I just want to thank you, Mr. Chairman for 
holding this important hearing.
    Chairman Shelby. Mr. Secretary, both of you, Secretaries 
Snow and Martinez, we welcome you again to the Committee. Your 
written testimony will be made part of the record in its 
entirety.
    Secretary Snow, you may proceed as you wish.

                   STATEMENT OF JOHN W. SNOW

           SECRETARY, U.S. DEPARTMENT OF THE TREASURY

    Secretary Snow. Thank you very much, Mr. Chairman, Ranking 
Member Sarbanes, and Members of the Committee. I greatly 
appreciate the opportunity to appear before you today with 
Secretary Martinez--can you hear me, Senator?
    Chairman Shelby. Bring it up closer to you.
    Secretary Snow. I greatly appreciate the opportunity to 
appear today before you with Secretary Martinez to address what 
is really a vitally important subject, a subject that raises 
complex and important issues and a subject that touches on 
something that has been mentioned in all of your statements a 
subject that is critically important, and that is homeownership 
in America. It is an important building block of individual 
financial security. It is also a building block for strong 
communities, as has been mentioned. So promoting housing 
opportunities, particularly for lower-income people, is a 
critically important national objective.
    Our national system of housing finance, as has been pointed 
out as well, plays a critical role in doing that. So we need a 
strong, resilient housing finance system. And to have that 
strong, resilient housing finance system, you need a regulator 
with credibility. A strong, credible regulator contributes 
importantly to having a strong, resilient housing finance 
market, which in turn promotes housing opportunities.
    But we have in the GSE's entities which are very large not 
just in terms of housing finance, but are very large in terms 
of the total U.S. financial system. And that is where we run 
into the fundamental issue we have to keep our eye on 
throughout these discussions. And it goes to the issue that 
Senator Hagel mentioned, that Senator Sununu mentioned, that 
others mentioned, of the so-called implied governmental 
guarantee. And that implied governmental guarantee can 
complicate the performance of the entire financial system of 
the United States.
    We need a world-class regulator to watch that issue, to 
watch the soundness and safety of housing finance and the 
relationship of housing finance to the resiliency of our 
financial markets.
    As Senator Allard said--and this is the situation we are 
dealing with here--an ounce of prevention. We do not face, in 
my view, any current crisis, but we never want to get close to 
the point where we would face that problem.
    The best insurance against ever getting there, at the same 
time the best insurance of having a strong, resilient finance 
market which promotes strong homeownership, is a sound 
regulator.
    In my extended testimony, I laid out what I think are the 
elements of a strong regulator. Some of you have mentioned 
them. Senator Hagel mentioned them. First, a sound regulator, 
in the context that I am talking about, a strong regulator who 
is focused both on soundness and safety of housing, but in the 
context of the soundness and resilience of the entire financial 
system, that regulator has to have a say on new products and 
new lines of business. Any strong financial regulator has that. 
Nowhere in the world is there a strong financial regulator who 
does not have an important say on the lines of business of the 
entities that it regulates.
    Second, that strong, effective regulator has to have an 
important say on capital standards, and it has to have the 
ability to adjust the capital standards to whatever the 
circumstances are that dictate a change in those standards. A 
good regulator has flexibility. A good regulator responds to 
the circumstances that that regulator finds call for action. 
And so a second element here would be flexible control over 
capital standards.
    Third, I think the regulator needs to have appropriate 
wind-down authorities; that is, if for some reason one of these 
entities got into difficulty, just like any other private 
sector entity, there needs to be the ability to pay the 
creditors. Wind-down authority, but wind-down authority 
recognizing that you, the Congress, have chartered these 
entities.
    Fourth, I would suggest that the proposal would be stronger 
and better if it did include the Federal Home Loan Banks. They, 
too, are part of this very large housing finance market. They, 
too, have implications for the resiliency and soundness of our 
entire financial system. They are engaged in activities that 
are very similar to those of the other housing GSE's. There are 
some important differences. They would need to be recognized in 
the legislation. I would acknowledge that. But I think if we 
are going to deal with this issue really effectively, we should 
also look at including the Federal Home Loan Banks.
    Finally, there is the question: Where should this new, 
strong regulator be? Our focus is with the strong regulator 
rather than its venue, and I have said in the House that if the 
Congress, if the Senate Banking Committee wants to consider 
Treasury, we are happy to have that discussion. But only if--
and I need to be really clear on this because of the enormous 
problems that can develop otherwise for the financial system in 
the United States--only if the Treasury adds some value and 
avoids the implication that the implied guarantee is being 
reinforced, because in that lies real trouble.
    So we would say if the Congress, if the Banking Committee 
wishes to consider Treasury, we would suggest you only do so if 
you put Treasury in a position to have some real say with the 
new regulator, a real say so that if there is confusion about 
this entity's being in Treasury and thus creating a larger 
governmental hug, a reinforced implied guarantee, we can 
disabuse the markets of that impression.
    Now, how do we do that? We would say that Treasury should 
have a say on new regulations. It should have a say on 
testimony. And it should have a say on budget.
    But let me conclude simply by saying the important issue 
here is a strong regulator. There were suggestions to have that 
strong regulator be an independent body. Wherever you go on 
that path, I would suggest the important thing is to make sure 
the new regulator really has credibility, really can do the 
job, really has the tools that all world-class financial 
regulators have, a say over new products, a say over capital 
standards, and a clear say over wind-down authority.
    I thank you very much.
    Chairman Shelby. Secretary Martinez.

                   STATEMENT OF MEL MARTINEZ

                           SECRETARY

        U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

    Secretary Martinez. Mr. Chairman, thank you very much. 
Ranking Member Sarbanes and distinguished Members of the 
Committee, it is a pleasure to be here today, with my colleague 
Secretary Snow, to talk about this important set of proposals 
of regulations for the Government Sponsored Enterprises.
    Before proceeding to talk about that, I want to just take a 
brief moment to thank the Committee for your support yesterday 
of the American Dream Downpayment Initiative. The President and 
I were in Dinuba, California, yesterday talking about 
homeownership and the importance of downpayment assistance, and 
your move yesterday on that legislation is an important step in 
that direction of creating homeownership opportunities for more 
American families. So we thank the leadership of the Committee 
and all of the Committee Members for your support.
    We believe that Congress, at this point in time, has not 
only an opportunity, but also really an obligation to move 
forward in this area of reform of the regulatory oversight of 
the GSE's. Fannie Mae and Freddie Mac have a vital public role 
to play in providing homeownership opportunities to low- and 
moderate-income families. The fact that we are a Nation of 
homeowners reflects the beneficial impact of the role these 
companies were created to perform, has on American life. The 
Bush Administration is committed to creating opportunities for 
homeownership in America, and that is why we believe it is 
important that these companies fulfill their mission. The best 
way to ensure that they do so is through real and lasting 
reform that enhances their financial regulation, while 
preserving and expanding their commitment to affordable 
housing.
    The Administration is committed to a society where every 
individual has the opportunity to gain the independence and 
dignity that comes from homeownership. This commitment is 
embodied in the President's budget proposals which have 
consistently increased funding for successful initiatives, like 
the HOME Investment Partnership Program, housing counseling, 
and the Self-Help Homeownership Program. The commitment is 
embodied in the President's challenge to the housing industry 
to join with us in creating 5.5 million new minority homeowners 
by the end of the decade. It is embodied in the Blueprint for 
the American Dream Partnership, through which HUD has brought 
together the private, public sector and not-for-profit and the 
Government agencies to meet the President's challenges.
    Fannie Mae and Freddie Mac are founding members of the 
Blueprint Partnership, and we appreciate their pledge to invest 
billions of dollars to lift more families into homeownership.
    The Administration's commitment to homeownership 
opportunities is not confined to our activities at HUD. It 
begins with the President and stretches across the whole of the 
Federal Government, and our proposal today reaffirms that 
commitment.
    Our reform proposal is consistent with this 
Administration's commitment to do everything necessary to 
foster a healthy and vibrant housing industry, which today 
accounts for roughly 14 percent of the Nation's gross domestic 
product. The potential impact of Fannie Mae and Freddie Mac 
upon the economy and housing programs makes it critical that we 
ensure their safety and their soundness.
    To be effective, a regulator charged with overseeing 
prudential operations, including safety and soundness, needs 
the proper tools to do its job. Currently, safety and soundness 
regulation is divided with new program approval authority being 
at HUD and financial oversight of the Office of Federal 
Enterprise Oversight. It is clear to us that both elements of 
safety and soundness regulation need to be consolidated in a 
single regulator. Splitting this regulation between two 
regulators weakens each one.
    The decision of whether to approve or deny any new activity 
is based partly on its effect on the prudence of a company's 
operations. It makes little sense to have one entity deciding 
whether or not to approve a new activity while another 
determines whether that activity meets the prudential operation 
test.
    New activities oftentimes directly impact the housing and 
mortgage markets, and for that reason, the Administration 
believes that HUD should retain a consultative role. Other new 
activities do not involve housing or mortgage market issues and 
are therefore most appropriately addressed by a strengthened 
regulator. As part of its consultative role, HUD will provide 
the benefit of its regulatory experience in such issues, and I 
do not see establishing a new and stronger regulator, 
potentially at the Treasury Department, as something that will 
harm the housing market. I see the opposite result: A 
strengthened housing finance system continuing to provide 
homeownership opportunities for all Americans.
    We are not proposing to alter the Congressional charter of 
Fannie Mae and Freddie Mac, nor do we have any intention of 
stifling innovation in the marketplace. Just as other financial 
institutions are subject to new activity approval, yet have 
been leaders in mortgage innovation, so too can Fannie Mae and 
Freddie Mac thrive under the Administration's proposal. Any new 
business activity that Fannie Mae and Freddie Mac wish to 
undertake will be reviewed with respect to consistency with the 
charter act, with respect to whether it is in the public 
interest and with respect to safety and soundness. The Federal 
Housing Enterprise Financial Safety and Soundness Act 
recognizes the need to take all of these concerns into account 
in the review process.
    While prudential operations, regulation, including safety 
and soundness regulation, should be exercised by a single, 
independent regulator, the Administration strongly supports 
retaining and enhancing the housing goals at HUD.
    Congress established Fannie Mae and Freddie Mac to provide 
market liquidity and to facilitate the financing of affordable 
housing for low- and moderate-income families. Congress also 
mandated that the HUD Secretary set housing goals to ensure 
that those needs are met.
    The affordable housing goals require Fannie Mae and Freddie 
Mac to focus on individuals in those communities most in need. 
This includes very low-income families and low-income families 
in low-income areas, low- and moderate-income families and 
underserved areas, such as central cities and rural areas.
    Today, the low- and moderate-income housing goal requires 
that at least half of all Fannie Mae and Freddie Mac mortgage 
purchases benefit families in this income bracket. As the 
President's budget noted in February, numerous HUD studies and 
independent analyses have shown that the GSE's have 
historically lagged the primary market, instead of led it, with 
respect to funding mortgage loans for low-income and minority 
homebuyers. The GSE's have also accounted for a relatively 
small share of the first-time minority homebuyers.
    The national home purchase goal we have proposed is a tool 
to specifically promote affordable homeownership. As the 
Members know, low interest rates in recent years have led to a 
boom in refinancings. Although Fannie Mae and Freddie Mac 
provide liquidity in refinancing, the share of funding they 
provide for home purchases declines during years in which 
refinancings are high. Our intent is not to saddle Fannie Mae 
and Freddie Mac with a series of stifling mandates as the 
opponents of reform have suggested, but to ensure, through a 
national home purchase goal, that they do not overlook those to 
whom they owe their primary devotion. This goal will certainly 
not unduly limit the ability of Fannie Mae and Freddie Mac to 
serve the refinance market or the multifamily market.
    Allow me to also clarify this proposal for a new goal, as 
some confusion has arisen over it. HUD is not asking for the 
authority to set overall home purchase levels for Fannie Mae 
and Freddie Mac, but instead is asking for the authority to 
ensure that the home purchase activity that takes place be 
equitably distributed among central cities and rural ares, low- 
and moderate-income families, special affordable homebuyers, 
and first-time homebuyers, just as HUD does for the existing 
housing goals. That is why HUD has asked for the authority to 
establish home purchase subgoals corresponding to these four 
categories, similar to the subgoal authority it presently has 
under the three existing goals. HUD is not asking for the 
authority to set home purchase subgoals in individual 
metropolitan and regional markets. HUD seeks only to set 
national subgoals so that Fannie Mae and Freddie Mac's home 
purchase efforts are fairly spread among these four categories. 
HUD also asks that these subgoals be enforceable.
    HUD is the appropriate agency to develop and enforce the 
housing goals. Institutionally, our mission is devoted to 
furthering the goals of affordable housing and homeownership, 
and HUD has the most expertise of any Federal agency in this 
area. Furthermore, the housing industry looks to HUD as the 
agency in which this authority should reside.
    In the Administration's proposal, HUD will not only retain 
authority to set meaningful housing goals, but will also be 
better equipped to ensure that Fannie Mae and Freddie Mac meet 
them. There will be sufficient funding, more accountability for 
Fannie Mae and Freddie Mac, and strengthened housing goals.
    One of the ways in which the Administration proposal has 
proposed strengthening HUD's housing goal authority is by 
creating a new GSE Housing Office within HUD, funded by the 
GSE's, to establish, maintain, and enforce housing goals. We 
also need to improve the Secretary's enforcement authorities 
with respect to these goals and have proposed doing so.
    It is also very important, Mr. Chairman, that fair housing 
requirements and enforcement that pertain to Fannie and Freddie 
remain at HUD, given HUD's expertise in fighting housing 
discrimination. HUD will have full enforcement power for those 
authorities in the same way it enforces the Fair Housing Act.
    A strengthened regulator is in everyone's best interests, 
and we strongly encourage it. The importance of Fannie and 
Freddie in the housing financial system is undeniable, and real 
reform is necessary to ensure the public of the ability of the 
two companies to make low-cost mortgage financing available to 
low- and moderate-income families.
    We look forward to working with the Committee as we develop 
a set of new proposals to have a strong regulator for these 
very important institutions.
    Chairman Shelby. Mr. Secretary, thank you.
    Secretary Snow, assuming that the new GSE regulator were 
placed within the Treasury Department, in terms of 
independence, should the new regulator differ from the OCC or 
OTS model? And, if so, why?
    Secretary Snow. Mr. Chairman, I think there should be some 
differences.
    Chairman Shelby. Why?
    Secretary Snow. Basically, because the OCC regulates 2,000 
national banks and has little risk of what the economists and 
political scientists call regulatory capture. The size of few 
of these entities approaches the size of the two large GSE's.
    Chairman Shelby. But in aggregate, they are larger, are 
they not?
    Secretary Snow. And----
    Chairman Shelby. Wait a minute.
    Secretary Snow. Well, in the aggregate, but there are far 
more than one or two banks. But the more important point is 
they are not issuing debt that is treated as agency debt that 
has a perception of some Government guarantee.
    Now, we do not believe there is any Government guarantee, 
and we go out of our way to say there is not a Government 
guarantee, but yet the market has a perception. I think it is 
terribly important that if the entity is in Treasury, the 
Treasury Department be in a position to continuously avoid the 
confusion, as Treasury is issuing its own debt, that Treasury 
is also party to the debt of an entity which has no Government 
backing. That is the essential distinction here. We need to be 
on guard against this perception. It is a perception. It is 
not, in our view, a reality, but it is a perception of an 
implied guarantee.
    Chairman Shelby. But the trend in financial institutions 
generally dealing with regulation has been to insulate 
regulators from what we call political pressure; that is, like 
OCC and OTS. Why should we buck the trend?
    Secretary Snow. Well, in a number of ways we are doing 
that. We are suggesting that the President forego the ability 
to appoint members of the boards of Fannie and Freddie. We 
think that would be an important way to insulate.
    We are suggesting that the budgets not come before the 
Congress any more. They are not dependent on authorizations and 
appropriations. That insulates it. We are saying that with 
respect to day-to-day operations, supervision, investigations, 
proceedings, the regulator be entirely stand-alone. But with 
respect to policy, we think the Treasury needs to be in a 
position to have a say or else there could be this very 
dangerous thing of a widening of that perception of an implied 
guarantee.
    Chairman Shelby. Mr. Secretary, you also mention in your 
testimony that you would like the new regulator of the GSE's to 
have the same product review authorities as the banking 
regulators have today, but with respect to both OCC and the 
Fed, banks are only required to notify their respective 
regulator after they have engaged in new activity. There is no 
preapproval standard in the bank regulatory world that I know 
of. How do you rationalize that?
    Secretary Snow. Well, I do not think we are asking for a 
prior approval. We just need the ability to weigh in.
    One of the things I have learned about regulatees is if 
they know they are being watched by a regulator, they tend to 
talk to the regulator in advance of doing what they might 
otherwise do. So I think there would be good communications on 
new products and activities.
    Chairman Shelby. But you are not asking for prior approval.
    Secretary Snow. We are not asking for it and do not think 
we need it.
    Chairman Shelby. Secretary Martinez, since we have 13-14 
Senators, I am going to try to enforce the 5-minute rule 
starting with myself. So you will have to be quick.
    Secretary Martinez. All right, sir.
    Chairman Shelby. The mission of Fannie Mae and Freddie Mac 
is expanding homeownership and the housing goals are a 
barometer of that mission.
    Secretary Martinez. That is correct.
    Chairman Shelby. Do you believe that the current housing 
goals are sufficient to fulfill the GSE's mission here?
    Secretary Martinez. No, sir, I think we should have an 
expanded goal of home purchase goal, and that goal would allow 
us to not only have the underserved areas, rural and central 
city, the low- and moderate-income and special affordable 
housing, but also a home purchase goal to ensure that they are 
involved even in refinancing booms with first-time homebuyers.
    Chairman Shelby. How do you see the dividing line between 
encouraging affordable mortgage lending and credit allocation? 
How do we make sure the goals are insulated from the political 
process?
    Secretary Martinez. Well, I believe even now that they are, 
and I think they are set for a 3-year period of time. I think 
we can continue to do that, and I think it is important that we 
have the GSE's sticking to their charter. It is important that 
the mission for which they were chartered is being enforced.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Secretary Snow, I would like to pursue very quickly this 
implied guarantee issue.
    First of all, let me ask you this question. Is it your view 
that Treasury is immune from political pressure?
    [Laughter.]
    Secretary Snow. On a relative scale, absolutely.
    Senator Sarbanes. What does that mean?
    Secretary Snow. Just that; that we live in Washington, DC, 
and I get calls from members of this body and members of other 
bodies, and I listen to them, but basically the Department of 
the Treasury has a long tradition of standing for some very 
important ideas.
    Senator Sarbanes. Why are the OCC and the OTS, which are 
``in the Treasury,'' independent on a whole range of things--
regulation, budget, statements to the Congress? They do not go 
through the Treasury.
    Secretary Snow. You know, they did at one time.
    Senator Sarbanes. I am hearing you are arguing that this 
entity, whatever it is called, should go through the Treasury; 
is that correct?
    Secretary Snow. Yes, very strongly I am recommending that, 
very strongly--not meekly and quietly, but strongly, in full 
voice.
    Senator Sarbanes. What is the rationale on OCC and OTS?
    Secretary Snow. Well, as I suggested earlier in response to 
Chairman Shelby's question, Senator, there is really a very 
different set of circumstances here. One, this is a new 
regulator, and it regulates entities that are very large 
individually relative to the markets. They are entities that 
are perceived--perceived--to enjoy an implied guarantee of the 
full faith and credit of the United States, and the Treasury 
Department is in the business of making the market for the U.S. 
debt. It is important that the integrity of what Treasury does 
is fully protected and that there is no confusion on that 
score.
    Senator Sarbanes. Why would there not be more confusion? 
Why wouldn't locating this regulator in the Treasury, with the 
Treasury having the authority over the GSE's and all of these 
respective areas, heighten the perception that there is an 
implied guarantee? It would seem to me that it is, in fact, 
increasing the likelihood of that perception because of this 
extensive Treasury involvement, an involvement well beyond what 
Treasury has with respect to the OCC and the OTS.
    Secretary Snow. Senator, I think it would do precisely what 
you are saying, unless you establish that new entity in a 
relationship to the Treasury, where Treasury could disabuse the 
markets of that at any opportunity, whenever the risk of that 
misapprehension became visible.
    Senator Sarbanes. What does that mean?
    Secretary Snow. That means the Treasury needs to be in a 
position to articulate the fact that what the role of the GSE's 
is and avoid confusion in the marketplace if, in fact, there is 
a perception that we stand behind their debt instruments.
    Senator Sarbanes. Now, do you agree with Secretary Martinez 
that the goals for the GSE should be set by HUD?
    Secretary Snow. The overall housing goals?
    Senator Sarbanes. The goals, yes.
    Secretary Snow. Yes, absolutely.
    Senator Sarbanes. So, whether it is going to be 50 percent 
or 60 percent or 70 percent, HUD would decide; is that correct?
    Secretary Snow. Yes.
    Senator Sarbanes. Now, why wouldn't the program, the 
programmatic content of the GSE's activities be an appropriate 
thing for HUD to do?
    Secretary Snow. You mean the new lines of business, getting 
into----
    Senator Sarbanes. Yes, the programs that they are going to 
carry out.
    Secretary Snow. Programs, right. Well, I think the 
programs, as I understand what Secretary Martinez said, would 
be with the GSE regulator, they would have the primary say.
    But on the broad program activity that they are engaged in 
today, their goals, that remains under HUD.
    Senator Sarbanes. How about the narrow program activity?
    Secretary Snow. The new program activity, which will be 
narrower than the base they are operating on, should be under 
the strong new regulator, wherever, Senator, that new strong 
regulator is.
    Senator Sarbanes. And why is that?
    Secretary Snow. Why is that?
    Senator Sarbanes. It affects safety and soundness?
    Secretary Snow. It is prudential. It affects not only 
safety and soundness of the housing finance market----
    Senator Sarbanes. Does not the goal set--my time is 
running. That is why I am pushing here--does not the goal 
setting affect safety and soundness?
    Secretary Snow. Goal setting is related to safety and 
soundness, but it is----
    Senator Sarbanes. Well, suppose HUD increases the low- and 
moderate-income requirement from 50 percent to 60 percent, does 
that not have safety and soundness implications, significant 
ones?
    Secretary Snow. It certainly could, and they should be----
    Senator Sarbanes. And that is going to be left with HUD; is 
that correct?
    Secretary Snow. Yes, but then subsequently those would be 
taken into account, Senator, by the new regulator and 
appropriate adjustments made in the risk-based capital 
standards.
    Senator Sarbanes. Well, then the same thing could be done 
with program activity, could it not, if the program activity 
was left with HUD?
    There is considerable concern, and presumably we will have 
another hearing--
    Chairman Shelby. We are going to have another hearing.
    Senator Sarbanes. --to hear from those elements. There is 
considerable concern that Treasury is insensitive to the 
housing objectives, and indeed that there are some within 
Treasury that may be, in fact, antagonistic; that HUD has 
traditionally been the place where concerns for housing goals 
have been reflected, housing objectives, and that moving the 
program approval, which is, in effect, the subcategory to the 
goals, carries with it the possibility of undercutting the 
housing mission, which everyone here keeps saying is so 
important, and where such a good job has been done, and it is 
vital to the functioning of our economy, and we have the 
greatest homeownership rate, and so forth.
    Secretary Snow. Senator, I think everyone has said it is 
important. There have been some questions about how effectively 
it is being carried on, but the housing opportunities remain 
the broad objective, right? To achieve the housing objectives, 
you need a strong, resilient housing finance system. That is 
promoted by a strong regulator, as Senator Hagel was 
suggesting. But the strong resilient housing finance system is 
part of this much bigger thing, of which it is a large part, 
called the U.S. financial system, and we also need to get those 
relationships right and make sure there are not prudential 
risks to the soundness of the U.S. financial system.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    I think Senator Sarbanes has gone directly to the issue 
that probably will cause the most controversy in the Committee 
as we try to draft this bill, and that is the relationship 
between the new regulator in Treasury and HUD. You made a 
statement that I think we would like to clarify. You said there 
will be no prior approval. There is prior approval now. HUD has 
prior approval, and presumably that will stay. The controversy, 
as I understand it, comes from the definition of what requires 
prior approval and the addition of the word ``activities,'' and 
there is a lot of heartburn as to what activities might be 
stretched to mean.
    Can we clarify that?
    Secretary Snow. What we have in mind when we talk about 
approval authority in the strong financial regulator is lines 
of business, is the GSE extending the lines of business that it 
is engaged in. The regulator needs to make sure that those 
extensions of its lines of business are consistent with its 
charter, consistent with the public interest, consistent with 
soundness and safety, and I would also say, Senator, consistent 
with this larger question of the resiliency of the financial 
system as a whole. So it is new lines of business is what I 
primarily have in mind.
    Senator Bennett. Is it not true that HUD currently requires 
prior approval for new lines of business?
    Secretary Martinez. The new lines of business, and I think 
partially going back to the very excellent point that Senator 
Sarbanes was getting at, I think I should add has only, it is a 
sporadic thing. I think in the last decade maybe only six times 
has a new product line been in the approval process, while 
goals are something that has to be followed on a daily basis, 
and I think that is a crucial difference and distinction 
between the two.
    HUD now will require prior approval, does not require prior 
approval, but they must come to us once a product is being 
launched. And so it is an ill-defined system as it currently is 
utilized, quite honestly.
    Senator Bennett. As I understand it, you must affirmatively 
stop the new program.
    Secretary Martinez. Correct. So that is not prior approval.
    Senator Bennett. In other words, if you do not take any 
action. Well, it is prior approval in a sense. You have the 
right to veto it.
    Secretary Martinez. I have the right to come back and say 
stop it. That does not mean that before it is launched they 
come to me and say, ``Here is a product. Please approve it 
before we launch it,'' although that has occurred in the past, 
also.
    Senator Bennett. Have you ever stopped it?
    Secretary Martinez. There has been one that was withdrawn 
and five that were not stopped. That, by the way, largely, 
precedes my time at HUD.
    Senator Bennett. You have said that the GSE's have lagged 
the market rather than led it, which is an interesting 
statement. Can you tell us why? Does anybody have any idea why 
that would be the case? And to the point, does it have anything 
to do with safety and soundness? Usually, people that are a 
little more conservative because they want to be absolutely 
sure they are not taking that much of a risk will lag a market, 
and it is the real risktakers who lead it. Is that an 
indication of what we are dealing with here that we need to pay 
attention to?
    Secretary Martinez. No, sir, I do not think it has to do 
with the market as such. I think part of it could be explained 
in that or is explained by suggesting that they do not deal in 
the subprime market. However, even when including subprime 
numbers, they would still lag the primary markets.
    So, in any event, no matter how you look at it, I am not 
sure I can answer the question of why, and I do not think it 
relates to safety and soundness, but I think it is a very well-
known point that our research would back strongly.
    Senator, I have also been helped and have a little better 
answer for the prior question.
    Senator Bennett. Okay.
    Secretary Martinez. Programs require prior HUD approval; 
products do not.
    Senator Bennett. Okay.
    Secretary Martinez. The real problem comes in 
distinguishing between what is a program and what is a product, 
and the statute currently is too vague for that to make it 
really enforceable.
    Senator Bennett. That is the whole concern here, is the 
vagueness that we try to deal with.
    A final question. Have they ever missed their goals? You 
say they have lagged the market, but have they ever missed 
their goals?
    Secretary Martinez. Yes, they have. From 1993 to 1995, they 
missed their goals. In more recent history, they have met their 
goals.
    Senator Bennett. My time is up. Thank you.
    Chairman Shelby. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    As a preliminary point, Senator Stabenow asked me to submit 
to the record a letter from Fannie Mae.
    Chairman Shelby. Without objection, it is so ordered.
    Senator Reed. Thank you very much, Mr. Chairman.
    [The Fannie Mae letter follows:]
    Senator Reed. Secretary Martinez, you are proposing to put 
together an Oversight Office within HUD that is going to be 
presumably staffed with very skilled individuals with financial 
experience as well as detailed experience in housing. Why could 
not these individuals review the programmatic and product lines 
that are being offered?
    Secretary Martinez. They could. The question really is, is 
that the best way to do this or should safety, soundness, and 
new product lines all be combined in one regulator?
    Right now we have a divided house. OFHEO does certain 
things, HUD does the new program approval. We believe that a 
strong regulator would have all of the ability to do all of 
those particular items, not have it separated. By separating 
it, I think you weaken the regulator.
    Senator Reed. Well, it would seem to me that there has to 
be collaboration between the two entities. Otherwise you would 
be----
    Secretary Martinez. And the bill proposes that 
collaboration. It suggests that Treasury would consult with HUD 
in new program approval.
    Senator Reed. Why could HUD not consult with Treasury with 
respect to safety and soundness? Moreover, I would think, if 
Treasury has the safety and soundness responsibilities, that is 
the trump card in everything. They would be on a daily basis 
dealing with these different GSE's, where you would be dealing 
on a periodic basis, looking at products and programs.
    Secretary Martinez. We would be looking at their goals as 
well.
    Senator Reed. And goals.
    Secretary Martinez. And the Fair Housing goals, too.
    Senator, I believe that one thing that the Secretary and I 
are very firm and very strong in an opinion is that it all 
should be in one place. Again, as he said in his testimony, and 
I think in answer to a direct question, you might debate the 
way that could happen, but inevitably I think it should all be 
under one regulator.
    Senator Reed. Well, but it seems that we are saying that, 
but we are giving you responsibilities, in fact, you are asking 
for enhanced responsibilities with respect to goals----
    Secretary Martinez. Yes.
    Senator Reed. So right away it is not one-stop-shopping; it 
is you have a role, and then Treasury has a role. But, again, I 
do not think there is anything that is chiseled in concrete 
here, and I think we have to look going forward with respect to 
these hearings and evaluation as to whether these functions 
should be in one place or the other because there is going to 
be two centers of gravity for this regulation, both HUD and 
Treasury.
    Secretary Martinez. A regulator of financial institutions 
typically can also deal with their new product lines, and I 
think that is what makes that important distinction is that 
here we are dealing with very important financial institutions 
that from time to time, not on a continuing basis, but from 
time to time, may choose to go into a new product line. As they 
do that, then I think that new regulator should have the 
ability to examine that.
    Senator Reed. Well, this becomes an almost philosophical 
debate. I mean, the question is how do the goals relate to 
programs and products, how do the programs and products relate 
to financial safety and soundness, and that is something we 
will thrash through.
    Secretary Snow, do you believe that this new financial 
regulating entity should have sole discretion to set both the 
risk base and the minimal capital standards?
    Secretary Snow. Yes.
    Senator Reed. What about just simply allowing that entity 
to have responsibility for risk-based capital standards, which 
is usually the measure of the real test for safety and 
soundness?
    Secretary Snow. We think that the regulator should have 
broad flexibility with respect to capital standards, generally, 
the risk-based capital standards, as well as the minimum 
capital standards, and I think that is consistent with good 
regulatory practice.
    I am worried about ``hard-wiring'' capital requirements in 
a statute because of the fact that we just cannot perceive 
fully when we are passing a law the circumstances that the 
entities will find themselves in or the capital requirements 
that will be prudential, given those circumstances.
    So, I think it is better to have a strong, capable 
regulator, sophisticated in what it is doing, who uses good 
flexibility and discretion.
    Senator Reed. Well, I think the flexibility comes in with 
risk-based capital. That is why we have a risk-based capital 
measure and a basic static capital measure sometimes it is 
called. But have you evaluated the impact on the housing market 
and investor markets if you have a complete ability to change 
capital requirements at any time?
    Secretary Snow. Well, a good regulator approaches the 
capital--and we are talking about a good regulator here, a 
strong regulator, an intelligent regulator, a sophisticated 
regulator--that regulator will approach that issue with 
enormous sophistication and care knowing that it is the 
essential ingredient of a financial institution's regulatory 
system. So that strong regulator will approach it with prudence 
and care.
    Senator Reed. Well, we should just pass the statute calling 
for prudence and care.
    [Laughter.]
    Senator Sarbanes. But you would remove the capital standard 
that is now in statute enacted by the Congress; is that 
correct?
    Secretary Snow. That is right. I would. I would. I would 
give the new regulator broad authority over capital, both 
minimum capital and risk-based capital.
    Chairman Shelby. Mr. Secretary, but what if we had a 
regulator that wanted to kill the housing market, for various 
reasons? That could be a dangerous situation.
    Secretary Snow. Senator, it would be a very dangerous 
situation, just as it would be if you had a capital markets 
regulator that wanted to kill the capital markets or a bank 
regulator who wanted to kill banks. I hope we do not confirm 
those sorts of people.
    Chairman Shelby. I hope not too.
    Senator Hagel.
    Senator Hagel. Secretary Snow, following in line with the 
statutory capital structure conversation, you mentioned in your 
testimony I think, Secretary Martinez and others here this 
morning have referenced differences--I mentioned it in my 
statement--differences between the Federal Home Loan Bank 
capital structure versus Fannie and Freddie. You noted, of 
course, as we all are aware, that there are significant 
differences.
    Could you frame up for us, as we are working our way along 
this process, whether obviously one of the questions, once we 
get to a point where we can agree on a new regulator or a new 
process, a new home, all that we have been talking about, the 
question whether Federal Home Loan Banks should be included. 
Obviously, the capital structure is different.
    Secretary Snow. Right.
    Senator Hagel. What are your thoughts about how we could 
address that? Where should we be looking? Can you make this fit 
with one regulator? Would it be too bifurcated, complicated? 
Open it any way you want and take it where you want.
    Secretary Snow. Let me try and address it. I think, as a 
general proposition, it makes sense to have one regulator, but 
the regulator would have probably two divisions. It would have 
a division that, because of the differences that you are 
alluding to, specializes in Fannie and Freddie, and then a 
division which is the division for the Federal Home Loan Banks.
    And there are a lot of issues that would have to be dealt 
with in any legislation. One is the role of the Secretary of 
Housing and Urban Development, who is currently on the board, I 
believe, on the Federal Housing Finance Board. Also, one would 
have to deal with this important issue that under the Federal 
Housing Finance Board is the so-called Office of Finance. And 
the Office of Finance controls the issuance of the Federal Home 
Loan Banks' notes. That would have to be clarified because you 
would not want the new regulatory entity being seen as issuing 
the notes.
    So, I acknowledge there are a number of important issues 
that would have to get dealt with. There are a lot of details 
and policy issues, but I would see it having merit; that is, 
the inclusion in one entity having merit conceptually because 
they are so interrelated and similar in terms of the 
fundamental bottom line of what they do. They are issuing large 
amounts of debt to support the housing market, and they are 
doing so with some notion in a part of the market that maybe 
they are supported in some way by the Government, with a 
Government back stop.
    And that complicated set of issues I think is best dealt 
with in one place rather than bifurcated, but I would see the 
Agency needing to have a division that focused on Fannie and 
Freddie and another division focused on the Federal Home Loan 
Banks just to take into account these differences.
    Senator Hagel. Secretary Martinez, would you have an 
observation, comment, thought on any of this?
    Secretary Martinez. No, sir. I think Secretary Snow pretty 
well covered anything I would have to say on it.
    Senator Hagel. Let me address the obvious tension that is 
always connected, woven into the fabric of agencies like Fannie 
and Freddie, the two different commitments; one being the 
commitment to the affordable housing goals that Secretary 
Martinez referred to, Senator Sarbanes has referenced in his 
questions versus the other commitment of shareholders' equity, 
maximizing that shareholders' equity and profits.
    Do you see any dynamic here, other than a healthy tension 
between the two, any conflict, any issues that you think, as we 
are dealing with possible changes, and enforcement structures?
    Secretary Martinez. I think that is a tension that should 
be recognized, and when I hear commentary that suggests that 
somehow these are Government entities that almost are in the 
grant business or something like that, I mean that is really 
misplaced. These are investor-owned entities chartered by the 
Federal Government to achieve a certain purpose. And one of the 
things I think it is important to note, while recognizing the 
importance and the value of what they have done is the fact 
that they have lagged the market in some very important areas 
that are part of their charter.
    I just believe that should be recognized, there exists that 
tension and that they are investor-owned entities who have a 
fiduciary responsibility to their shareholders.
    Senator Hagel. Secretary Snow, I know my time is up, but if 
the Chairman would indulge me, if you had a comment, I would 
appreciate it.
    Secretary Snow. No, I will associate myself with the 
Secretary's comments.
    Senator Hagel. The Chairman likes that.
    [Laughter.]
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Corzine.
    That is what we do here in the Congress. It works very 
well.
    [Laughter.]
    Senator Corzine. Thank you. Let me start with a couple of 
perceptions. First of all, I concur with the line of 
questioning that I heard from the Chairman and the Ranking 
Member with regard to the implied guarantee. I have a hard time 
understanding how making clearance policy statements through 
the Secretary of the Treasury is a means to protect against the 
misperception in the marketplace that there is an implied 
guarantee.
    I think foregone board appointments or budgets coming to 
Congress is a long way from what I think really gets the market 
to believe that there may be something like an implied 
guarantee, like State taxation exemption, lines of credit, and 
other issues. I do not think this is the heart of the issue, 
and I think we are really talking about, I think you could have 
that independent regulator. I would presume that you would, if 
I asked you the question, Mr. Secretary, whether you think the 
SEC is a world-class regulator, you would, I would hope, come 
to the conclusion that it is and its independence is such 
that--I will not ask you that, so you do not have to answer 
it--but I think the perception issue is not on the subjects 
that we are talking about, and I am not sure exactly, and it 
needs to be explored.
    Second of all, I think all of us are confused--I am more 
confused today than I was when I sat down here--about these 
definitions of mission goal, programs, activities, and which 
ones will fall under the rubric of what the new regulator works 
on, and all of us need to bring real clarity to this so that 
there is not a misperception on that.
    And then I have, I will ask the question on this, I have 
this perception problem that there is not enough emphasis on 
disclosure with respect to the discussion we are having today. 
I actually do not think it should be voluntary that the 1934 
Act is in operation here. I think that there are some standards 
of disclosure that, given the whole arrangements we have seen 
on corporate governance and concerns that have evolved in 
recent days that should be as much a centerpiece of the new 
regimen that we are putting together, and I would be curious 
about that.
    And then I just have to ask the question on Federal Home 
Loan Bank. Do you foresee, under this new formulation, and I 
actually believe one regulator is fine, but are you visualizing 
a demutualization of the Federal Home Loan Bank System at some 
point in this process and more to a shareholder organization?
    Secretary Snow. Senator, let me try and respond quickly to 
each of those four points.
    On the demutualization, no, that is not what is 
contemplated. On the 1934 Act, we agree with you. We are 
pleased that Fannie has gone under it. Freddie has indicated it 
will--the sooner, the better. We are sorry it has gotten 
delayed. We think the Federal Home Loan Banks Board should be 
under the 1934 Act as well.
    Senator Corzine. Disclosure of interest rate risk, credit 
risk, a whole series of these issues.
    Secretary Snow. The whole 1934 Act--yes.
    Then, on the clarity of programs versus activities versus 
lines of business, that is really what we would see the statute 
doing, the new statute. That is our proposal, that the statute 
lay that out so that we know that the regulator has clear 
authority over this, and the HUD Secretary has clear authority 
over that. So we are seeking that clarity.
    And on the first one, the perception issue, I mean, I will 
grant my biggest concern in talking about Treasury as the 
entity where the new regulator is housed as a bureau is that we 
add to the confusion in the marketplace about this perceived or 
implied guarantee. That is troublesome, and it is why I am far 
less focused on having it in Treasury than I am in having that 
strong regulator. And there are some proposals that I have seen 
for an independent regulator like the Federal Reserve Board or 
something, a new regulator.
    My concern is much more with having that strong regulator 
than having it in Treasury, and my comments on Treasury were 
only to indicate the dangers really of putting it in Treasury. 
I think Treasury, because we have some expertise in financial 
markets generally, could bring something to bear on the 
regulator that could be helpful and integrate its activities 
with the overall financial markets, but I also perceive very 
much the risk you are talking about and that others have talked 
about.
    Chairman Shelby. Senator Dole.
    Senator Dole. Secretary Snow, Fannie and Freddie have both 
publicly stated that they want to see legislation with a 
stronger safety and soundness regulator. In your talks with 
them, what initiatives do they advocate that would make their 
regulator stronger?
    Secretary Snow. They seem to be, and they are going to be 
on later so the question may be better to them, but I think 
there is some real agreement that a new strong regulator would 
make sense, would remove some of this volatility in the market, 
and might actually help, in a real way, to improve housing 
finance. And in the discussions I have had, I have pretty much 
laid out, as I did today, what we think should be included in 
that, and I think they better respond as to what parts of that 
they can live with, rather than my trying to interpret it, if 
you do not mind.
    Senator Dole. Secretary Martinez, some have raised 
questions about how the consultative process on GSE programs, 
activities, and products between HUD and Treasury might work. 
Would you describe for the Committee how you believe the 
process would work and any concerns that you might have, would 
you raise those for us.
    Secretary Martinez. HUD must be consulted prior to any 
final determination as to whether the activity is permissible 
or not, and so this process will ensure that any review of a 
new GSE activity and the potential impact that it will have on 
affordable housing or housing goals will be fully considered; 
in other words, will be a participant in the decisionmaking. 
And I think the important considerations of meeting the housing 
goals and the impact on the housing market we think will be 
fully considered through that consultative process that is 
envisioned.
    Senator Dole. Secretary Snow, would you comment on the 
impact of increased capital authority on holders of Fannie and 
Freddie debt and also what capital controls do the major U.S. 
financial regulators have?
    Secretary Snow. All of the major U.S. financial regulators, 
to the best of my knowledge, have broad authority with respect 
to capital adequacy of the financial institutions and, in fact, 
capital adequacy is the principal regulatory tool in the tool 
kit of financial regulators.
    I do not have in mind any precise change in the capital 
adequacy numbers. That, I would leave to a regulator, and the 
regulator may find that the current capital standards are 
perfectly adequate. My only point on capital adequacy standards 
is the regulator should have broad flexibility. I do not enter 
that with any preconception as to what those capital standards 
should be.
    Senator Dole. As you know, our legislation gives the new 
regulator authority to limit nonmission-related assets. Your 
department supplied me with a copy of your suggested language 
to restrict investments if they fail to meet your 12 
operational and managerial standards. I take it that you are 
then in agreement with S. 1508 on this point.
    Secretary Snow. Yes. I would have to say before I give full 
assent, I would like to make sure I have read it, but if the 
Treasury staff gave it to you, and it is based on that, I am 
sure I do agree.
    Senator Dole. Would you share with the Committee the 
reasons why the Treasury believes this authority is necessary.
    Secretary Snow. Yes. This authority is necessary so that 
these entities do not abuse their charters, that they live 
within their charters. A regulator needs to be ever mindful of 
what the charter is, and what the limits of the charter are, so 
that the entities do not go beyond those charter limitations. 
That is the basic point I would make.
    Senator Dole. Secretary Snow, if the regulator is put under 
the Treasury Department and is completely independent, what is 
the advantage to having the regulator at Treasury?
    Secretary Snow. The advantage of having it at Treasury is 
that Treasury is involved in all of the financial markets and 
brings a deep knowledge of the U.S. and world financial 
markets, how they operate, their complexities, and their 
condition. And that would be the value that would be added by 
having this entity at Treasury, if the statute did not block us 
from providing hat value.
    Off-setting that is the risk that we have talked about, 
that being in Treasury might further signal to the market, 
improperly, that the Federal Government stands behind these 
entities, and that is the line we are walking here.
    Senator Dole. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and thank you for 
being here both, Mr. Secretaries.
    First, just a comment. I am concerned, obviously, about the 
legislation that the Administration has suggested, and I do not 
think there is any doubt that there are some in the 
Administration who do not believe in Fannie and Freddie 
altogether. Let the private sector do it. That would be an 
ideological position. And my worry is that we are using the 
recent safety and soundness concerns, particularly with Freddie 
and with a poor regulator, as an excuse or as a straw man to 
curtail Freddie and Fannie's mission.
    I do not see that safety and soundness, which is important 
to every one of us, necessarily requires a regulation by the 
safety and soundness regulator of what Fannie and Freddie does. 
After all, banks decide on their own products, and then it is 
the regulators that decide the capital standards and other 
types of regulation that keep them safe and sound.
    And I could see a Treasury regulator who does not like 
Fannie and Freddie saying you cannot do any new products as the 
marketplace changes and gradually strangling them. So, I worry 
about this. Now, I am not going to ask you to comment on that. 
You have made your point clear, but I think we are using safety 
and soundness or some may be using safety and soundness as an 
excuse to constrict Fannie and Freddie's goal and mission in 
housing because they do not like a GSE to begin with; that they 
would rather just have the private sector do it, but I have 
another question for you.
    It is on a different subject, but you are here, and it is 
an issue of great concern to me, and that is China's currency 
manipulation. I have three questions. I will ask them seriatim 
and ask you for your answers.
    First, I was very, very disturbed, as were many of us, that 
despite the legal requirement that Treasury issue its report on 
exchange policies yesterday, that such a policy was not issued. 
Now, I know we have said we are going to do it October 30, but 
what that leads me to believe is we were afraid to issue a 
report right before the President went to see the Chinese, 
Japanese, Taiwanese, and other leaders and an indication of 
soft-peddling this; that, oh, yes, we will tell the American 
public we care about this, but we do not want to embarrass our 
friends in Asia by issuing a report that says they manipulate 
the currency the day or the week before the President meets 
with them. It is very convenient that it is extended for 15 
days after the trip is over.
    And I just worry about that as an indication of fear, or 
reluctance is a better word, to confront the Chinese, 
particularly, but others as well, on currency manipulation.
    So my first question is why was there the delay?
    Second, let me ask you directly, do you and does Treasury 
now believe that China has engaged in currency manipulation? 
You have probably seen the report already because it was just 
delayed at the last minute.
    And, third, and maybe most importantly, what if China 
continues just to say, no, despite your entreaties? We all read 
how the Chinese said they were not going to change this before 
you even landed on their soil to talk with them. They refused 
the President's entreaties. What should we do? Should we just 
stand here and say, ``Shucks, the Chinese are not doing the 
right thing?''
    Some of us on this Committee, I think there are four of us 
on this Committee, and many others--five of us on this 
Committee, three Republicans, two Democrats--who believe we 
should impose a tariff on China's goods to make up for the 
currency manipulation.
    Yesterday, the Bipartisan Commission on U.S.-China Economic 
Security Review said the following: They said, The Commission 
found that China, in violation of both IMF and WTO obligations, 
is, in fact, manipulating its currency for trade advantage, and 
this is the important point, ``The Commission further urges the 
Congressional leadership to use its legislative powers to force 
action by the U.S. and Chinese Governments to address these 
unfair and mercantilist trade practice.''
    So, A, why was the report delayed; B, do you--yes or no--
believe China manipulates the currency; and, C, what should we 
do if China continues to refuse to do anything in light of the 
thousands, the millions of jobs that we are losing all over 
this country?
    Thank you, and you can have the rest of the time.
    [Laughter.]
    Secretary Snow. I will just answer briefly and look forward 
to a fuller discussion on October 30 when I am up here with the 
report.
    The delay is just straightforward. The GSE legislation was 
scheduled, and I think the report and my testimony should go 
hand-in-hand, so there is no confusion about it. Whether we 
view China as manipulating their currency is the subject of the 
report, which will be released on October 30. In the meantime, 
I have had, as you know, and the President will be having, 
extensive conversations with the Chinese political and economic 
leadership on that question.
    And since my time is up, I will look forward to reviewing 
that with you in detail on October 30.
    Senator Schumer. What about the third question? What should 
we do if the Chinese continue to do nothing?
    Secretary Snow. Well, Senator, this is a discussion, a 
serious discussion that takes some time. We are making 
progress. We are making some real progress. And I think the 
best thing we can do is continue to press hard and come to that 
bridge if we ever come to it, but press hard now for the 
reforms that make sense, and that you have talked about and 
Senator Dole has talked about and other Members of this 
Committee have talked about, including the Chairman.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Secretary, I hope the President does 
better than we did, the two of us, when we went to China and 
Japan.
    Senator Schumer. I hope he does better than I did right 
now.
    [Laughter.]
    Chairman Shelby. Well, you have raised some questions.
    Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    First, as Senator Sarbanes pointed out, we like to do in 
Congress, let me associate myself with the remarks of Senator 
Corzine. You raised some very important points about disclosure 
that he included in his legislation. I apologize to him for not 
delving into those now, but I do want to ensure that we deal 
with these as we move forward with legislation because 
disclosure is an important part of investor confidence, and I 
agree with him very much on those issues.
    Second, there is a lot of discussion about the question of 
affordable housing goals, product and program approval, and I 
want to get into this important issue a little bit more.
    It seems to me that the affordable housing goals and the 
affordable housing mission is extremely important. I believe 
under the Treasury proposal those goals would be set by HUD, as 
they should be. As I said in my opening statement, we should 
look at ways to strengthen and improve the way that those goals 
are set and whether or not HUD needs even more power in dealing 
with affordable housing issues.
    But housing goals are a matter of public policy. There is a 
public policy goal that could be set in statute, but it is a 
matter of public policy. The question of products, activities, 
and business lines are questions of means for attaining those 
public policy goals, and they absolutely do affect safety and 
soundness, in my opinion, and I want to explore some specifics 
of the ways that they might affect safety and soundness.
    I have a list of activities, products, programs, whatever 
we want to call them for the time being, that are offered by 
the GSE's, and I want to list them for you, Mr. Secretary, and 
get some comment here.
    A desktop originator, where a GSE can go directly through 
to mortgage brokers; HomeStore.com, where a GSE engages in a 
direct joint venture with realtors, which raises questions 
about mortgage origination, which is something that the GSE's 
are prohibited from; Home Stay, where a GSE offers, for 
borrowers, credit insurance, two-tiered insurance products, 
where GSE's can take a portion of mortgage insurance risk for a 
portion of the mortgage insurance premium; issuance of retail 
callable bonds; a product called Payment Power, where, in this 
case I believe it is Fannie Mae, can allow borrowers to skip a 
certain number of payments over the life of the mortgage.
    My question is do not these kinds of products, whether they 
are insurance related, consumer related, dealing with 
prepayment issues, do they not affect the risk profile of the 
entities that are engaged in these lines of business?
    Secretary Snow. Senator, I am not an authority on these 
products or the nature of them, but certainly a strong 
regulator would be in a position to evaluate whether extension 
into those products creates risks that require changes in 
capital standards. I am not in a position to do that, but 
certainly there is a relationship between the products you get 
into, the size of your exposures, and the amount of capital 
that is appropriate to those exposures, yes.
    Secretary Martinez. If I may comment, Senator, the proposal 
that we have proposed will do away with the distinction between 
program and product, and instead it would make all new 
activities subject to review by the financial regulator, which 
we think is an important consideration.
    Senator Sununu. I believe that is an important point, and I 
am not prepared to say--I agree with you wholeheartedly, but I 
think the more general point that definitions matter and 
language matter has already been revealed here as to what we 
are defining as a product, what we are defining as a program, 
and I hope, and I expect, that that is something that the 
legislation will try to deal with in a clearer way because it 
does not seem to have been written with the clarity we would 
want.
    To that end, Secretary Martinez, have any of the programs 
that I just read, and I hesitate to call them programs, but 
have any of these required or received clearance from HUD?
    Secretary Martinez. I am being told--I cannot firsthand 
tell you, but I am being told by Mr. Weicher of the Housing 
Commission that the answer is, yes.
    Senator Sununu. They have had to be approved, they have had 
to receive clearance?
    Secretary Martinez. Payment power and Homestay, payment 
power has been approved, and Homestay apparently is under 
review and will be.
    Senator Sununu. Those will be two of the five that you 
mentioned?
    Secretary Martinez. Yes.
    Senator Sununu. Thank you.
    Let me talk about another specific product and, again, one 
that certainly raises concern only in that it certainly seems 
to affect risk profile, and that is the approval for GSE's to 
acquire acquisition, development, and construction loans. This 
would be lending against development properties, perhaps 
against land that could certainly be used for housing, but 
could also be used for projects of a commercial nature.
    This would, one, seem to be a business line that can affect 
the underlying risk profile of the company or the entity that 
is involved in it; and, two, would seem to at least raise 
questions about whether or not it is in keeping with the 
mission.
    I would like each of you to comment on, again, whether this 
is a product line, a program, an activity that affects risk 
profile and issues regarding mission.
    Secretary Martinez. I think it affects risk profile, and I 
think it clearly also affects mission. I think it also should 
be noted this product was approved by HUD in 1992 as a pilot 
program, and then last summer it was approved as a permanent 
program, but I do believe that both areas are affected by the 
product.
    Senator Sununu. I appreciate that, and what we need to get 
at with the legislation is simply to make sure that business 
lines, activities, products, programs, as we hope would be 
clearly defined, the ability to look at these, to consider 
these, as they affect safety and soundness, are included in 
that strong regulator. I cannot think of any other regulator 
that would not have the authority over decisions that so 
directly affect safety and soundness.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    I want to take Secretary Snow back to, even though this is 
a hearing on GSE's relating to housing, but we have got to talk 
about GSE's that are unregulated completely. What would it take 
for this current Administration to call for some regulation of 
the Tennessee Valley Authority--gouging their customers, 
raising rates without any approval? Because they do that if 
they have no regulator whatsoever--they do not have one; having 
$26 billion in debt, publicly traded debt--this is publicly 
traded--which is AAA rated, and guess why it is AAA rated--
because everybody thinks that the Federal Government is backing 
the debt; or are we going to have to wait until something like 
Enron happens in the Tennessee Valley?
    Secretary Snow. Well, Senator, I must confess to you I am 
not an authority on TVA. It is different from Fannie and 
Freddie in the sense that it is wholly owned by the U.S. 
Government.
    Senator Bunning. We own it.
    Secretary Snow. Yes, we own it. We do not own Freddie and 
Fannie. They are publicly owned.
    Senator Bunning. We do not own the Federal Home Loan Banks 
either.
    Secretary Snow. No, we do not. They have a different 
ownership structure, but they are not owned by the Federal 
Government.
    Senator Bunning. They are owned by stockholders, which are 
the banks themselves.
    Secretary Snow. The banks, exactly. So the first 
distinction is TVA is a wholly owned agency, instrumentality of 
the U.S. Government. I agree with you, it sells debt into the 
public markets. The borrowing authority of TVA, if my 
recollection serves me, and I want to confirm this, is treated 
by OMB as budget authority for purposes of the Federal budget. 
So there is that element of oversight on it. It is governed I 
think by three----
    Senator Bunning. Commissioners.
    Secretary Snow. Yes sir, commissioners appointed by the 
President----
    Senator Bunning. The President of the United States.
    Secretary Snow. --confirmed by the Senate, I think.
    Senator Bunning. Yes, but there is a big, big problem here 
because, when OMB tells them to reduce their debt, the $10 or 
$12 billion, they do not pay any attention to OMB.
    So the need for regulator, a regulator, if we are making a 
new regulator to take care of Freddie, and Fannie, and the 
Federal Home Loan Bank, which I do not agree with, but we 
should take a look at some that are totally and completely 
unregulated.
    Secretary Snow. Senator, you have me at an enormous 
intellectual and knowledge-based disadvantage here. Could I 
bone up on this subject and come and talk to you, so I would 
know what I am talking about when I have that discussion?
    Senator Bunning. Yes, you can.
    Secretary Snow. Thank you.
    Senator Bunning. I would be more than happy.
    Let me ask you one more question, then, since my time is 
not up. Why does Treasury call on the Federal Home Loan Banks 
to register with the SEC? Which I agree with, by the way.
    Secretary Snow. We do because there are investors who buy 
their securities; the Federal Home Loan Banks do issue debt, 
and it is important to have disclosure. So you are asking me 
why not TVA, and I told you I am going to get into that.
    Senator Bunning. I am asking you----
    [Laughter.]
    You have answered my question, and I appreciate that very 
much.
    Thank you, Mr. Chairman.
    Chairman Shelby. Since I come from a State where TVA is 
partly represented, I have a lot of questions about it, too, 
but I will save them for another day, though, and probably for 
another Committee.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    I am not sure that I agree entirely with your statement 
that transferring the regulatory provisions from HUD over to 
Treasury implies that there is a greater backing by the Federal 
Government on these loans.
    It seems to me that the issue comes right down to too big 
to fail. Fannie and Freddie have taken over so much of the 
market and have become such big entities, that I think the 
thought is, is that because they have such an impact on our 
economy, the Congress could not allow them to fail. I would be 
interested in hearing your comments on this.
    Secretary Snow. I agree, Senator. It is that if they 
failed, there is a perception that the full faith and credit of 
the United States stands behind them, and that means the U.S. 
Treasury. And the concern would be that if Fannie and Freddie 
came to the U.S. Government, with the perception of ``too big 
to fail,'' or the belief of an implied guarantee or the sense 
that the Federal backing was there, or that the Federal 
Government was a back stop, that perception would be 
heightened. That is what I am saying.
    It is not as large a perception when the entities are in 
HUD because HUD does not have the responsibility of the U.S. 
Treasury to go into the credit markets, with the full faith and 
credit that lies behind it, so that is precisely the issue.
    Senator Allard. Mr. Chairman, I also would now like to 
pursue this idea that you are going to have the expertise there 
to have a top-flight regulatory----
    Secretary Snow. Right.
    Senator Allard. I see Fannie Mae and Freddie Mac standing 
out and using derivatives and some rather unusual financial 
instruments to manage the dollars that they have. When 
regulators manage derivatives, many of them have Ph.D.'s. My 
understanding is that these qualified individuals are sometimes 
difficult to find in Government agencies because there is such 
a demand for them in the private sector.
    Secretary Snow. That is right.
    Senator Allard. Would you explain to me how you are going 
to put together a highly qualified regulatory agency? I think 
OFHEO has the same problem in hiring personnel with the 
expertise necessary to properly regulate Fannie and Freddie, 
whether they can do it top flight. How is Treasury's situation 
different from current OFHEO?
    Secretary Snow. Senator, you put your finger on a very, 
very good issue. What I was talking about is the fact that the 
Treasury Department has people who are deeply knowledgeable 
about the condition of the credit markets, directly involved in 
making the $2-trillion-a-year debt market for U.S. Treasuries, 
and have an awful lot of expertise about financial matters.
    The regulatory agency in Treasury would draw on that 
broader expertise about the condition of financial markets here 
and abroad to address, the whole question of systemic risks. 
But the agency would need to be augmented, with its own 
experts, just as the Fed has a number of experts on 
derivatives. Really, you need people trained in options theory, 
and Black-sholes, and derivative mathematics. You would have to 
attract those people there, clearly. The new regulator would 
need, as the Fed does, to have the authority to attract people 
who are high-powered and financially knowledgeable people. I 
agree with you.
    Senator Allard. How are you going to attract these 
qualified individuals and maybe Secretary Martinez would like 
to comment.
    Secretary Martinez. I just wanted to comment, also, because 
whether the regulator, the Treasury, or the office that we 
envision at HUD for the portion of regulating the HUD will 
continue to have, we also believe that it should be financed, 
as most regulated entities are, by the regulated entity, which 
will give us a little more flexibility in terms of salary, 
compensation packages, and the way in which we could attract a 
competent staff to do this very, very important job, which 
right now what HUD does in this arena, we are not properly 
staffed to do.
    Senator Allard. I have another ``nuts and bolts'' question. 
How are you going to transfer these dollars budgetwise? In 
other words, how are you going to handle the transfer of the 
Agency? Are you going to retain the money that is allocated to 
HUD or will this be transferred over to Treasury? If the 
Director is going to increase his regulatory ability, it seems 
that he will need to request an increased amount of dollars. 
Have you discussed that?
    Secretary Martinez. There is no question that OFHEO, and 
all that goes with it, including its budget, would go to 
Treasury, and there is no dispute or discussion about that. So 
they would have the wherewithal of current OFHEO, to begin 
with.
    In addition to the added authority now from the new law, 
which would permit us to seek, for the regulated entities, to 
finance in fact the regulation.
    Senator Allard. Any comment, Secretary Snow?
    Secretary Snow. No, I agree, Senator. You are putting your 
finger on a very important issue. You have to have 
sophisticated, knowledgeable people. Those people have 
alternatives, and high-paying alternatives. We have to be able 
to attract them. And as Secretary Martinez said, I think taking 
this off the budget and making the Agency self-financing, as we 
have suggested, would give us much greater latitude to attract 
the people that are needed.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Shelby. I have some questions, but since we have a 
second panel, I am going to submit my questions for the record.
    Senator Sarbanes.
    Senator Sarbanes. Mr. Chairman, I will forbear, as well, 
because I know we have people who have been waiting.
    Chairman Shelby. I want to thank both Secretaries for being 
here----
    Senator Carper. Mr. Chairman, I do have just a couple of 
questions I would like to ask. I have not had a chance to ask 
anything, if I could. Thank you.
    I am not going to be here for the second panel. I 
understand that Fannie Mae and Freddie Mac may have a different 
take on whether the GSE's lagged the market on affordable 
housing. I hope, when they speak, that we will hear from them 
about whether they are going to, how they want to respond to 
this charge, and I would look forward to what they have to say 
on that.
    Two questions. Two quick ones.
    Secretary Martinez. Could I comment on that issue, Senator?
    Senator Carper. Sure.
    Secretary Martinez. Business there is one thing that I 
think should be on the record, which is that our research would 
indicate that the GSE's have 42 percent of all loans in the 
mortgage market, of which only 15 to 17 percent go to first-
time minority homebuyers.
    FHA, by contrast, has only 16 percent of loans, of which 34 
percent are for minority and first-time homebuyers.
    Senator Carper. Good. Thanks for that point.
    I know this has been raised, at least indirectly, by 
others, and I want to come back. I have heard from constituents 
in my State, as have my colleagues. They include the home 
builders, they include realtors, they include other affordable 
housing groups, and they are, for the most part, in opposition 
to transferring program approval from HUD to Treasury.
    And I am just going to ask you to take a minute and speak 
to the concerns that have been expressed to us by these groups 
which were that the Treasury would be less sympathetic to 
housing needs than HUD. What do we say to them? How do you go 
about reassuring these people, these constituents, that moving 
program approval to a new agency would not impact Fannie Mae or 
Freddie Mac's ability to design new products, new initiatives, 
to meet unique housing needs in Delaware or in other States.
    Secretary Snow. Well, Senator, I would start----
    Senator Carper. What reassurance can you offer?
    Secretary Snow. Maybe Secretary Martinez should lead on 
this, since this is his area.
    Secretary Martinez. I believe, Senator, that new product 
approval is not essential to the function, day-to-day, of the 
GSE's. It is something that, from time to time, comes up, and 
as it does, it has a very, very direct impact on their safety 
and soundness.
    When those issues would arise, and it is sporadic, it is 
not daily, and they are on very specific market areas that they 
wish to go into, that are new, that they are not today doing, 
so, if they are doing a great job today, only for expansion, 
growth and continued ability to provide a return to their 
investors is a new product necessary. So, for those sporadic 
instances when that will come up, the Treasury is the perfect 
place or the new regulator is the perfect place for that to 
take place.
    HUD would be consulted in that process. So we would have 
our input as it relates to housing needs and, secondarily, as 
it relates to housing goals, we will ensure that they continue 
that vital part of their charter, which has to do with meeting 
low-income, minority homebuyers, first-time homebuyers, and 
underserved areas.
    Secretary Snow. Senator, I work, as Secretary Martinez 
does, for the President of the United States, who is as deeply 
committed to housing, as any President I am aware of. It is a 
matter that comes up regularly. I have heard him say to the 
Secretary, ``How are we doing on those housing goals? Why 
cannot we get there faster?'' And he would not countenance for 
a moment the Treasury Department playing a role which was not 
entirely consistent with his objectives for strengthening 
homeownership in the United States. It is a goal I share.
    You say, well, Administrations come and go, how do you know 
the next one will be that way? I think the Secretary said it 
well. Getting the soundness and safety of the finances of the 
GSE's and the housing markets right helps, not hinders, the 
homeownership objectives. So having a strong regulator in place 
will reassure the markets and should make the markets more 
favorable to housing finance, not less favorable, which should 
help the spreads, help the costs, and help ownership, 
ultimately.
    Senator Carper. Secretary Snow, one last quick question. 
Under the regulatory structure that I understand you are 
proposing, could there be some potential for a conflict of 
interest for Treasury, if Treasury participates in the debt 
markets as a participant, and this potential role as regulator 
of GSE's, who would also be participating in the debt market?
    Secretary Snow. Well, today, there is a consultative 
process. I do not think there would be a serious problem along 
those lines, but today we recognize the need for a consultative 
process, and that consultative process works well.
    Senator Carper. All right. Thanks very much.
    Thanks, Mr. Chairman.
    Chairman Shelby. Thank you.
    I thank both of you, again.
    Our second panel will be Franklin Raines, Chairman and CEO 
of Fannie Mae; George Gould, Director of Freddie Mac; Norman 
Rice, President and Chief Executive Officer, Federal Home Loan 
Bank of Seattle.
    Gentlemen, your written testimony will be made part of the 
record in its entirety. We will start with Mr. Raines. Welcome 
back to the Committee. You have spent a lot of time here, and 
we appreciate it. If you could sum up. I know the day is moving 
on, and we appreciate your patience. This is a very important 
hearing. We are going to have another hearing. We think we 
should hear from the housing people and others and have a 
balanced approach to what we are doing, and perhaps we will 
learn a lot.
    Mr. Raines.

                STATEMENT OF FRANKLIN D. RAINES

        CHAIRMAN AND CHIEF EXECUTIVE OFFICER, FANNIE MAE

    Mr. Raines. Thank you very much, Mr. Chairman, Senator 
Sarbanes, and Members of the Committee, for this opportunity to 
speak with you today. I am delighted to have the chance to 
share my views on strengthening the financial regulation of 
Government-sponsored housing enterprise which Fannie Mae 
supports.
    Fannie Mae supports legislation to create a safety and 
soundness regulator as a bureau in the Treasury Department. I 
believe there is a broad consensus that having a strong, 
credible, well-funded financial regulator is in the best 
interests of the housing finance system, the financial markets, 
and homeowners.
    First, there is a broad consensus that the American housing 
finance system is the best in history and the envy of the 
world, that the housing finance system is critical to the 
economy, that the secondary mortgage market is the backbone of 
the system and that Fannie Mae plays an essential role in the 
system.
    Second, I think there is a broad consensus that the housing 
finance system is, and will continue to be, strong, stable and 
operating at peak performance and that regulatory reform 
efforts do not arise from a need, urgent or otherwise, to ``fix 
the system.''
    Third, there is a broad consensus that thanks to the 
performance of the housing finance system, housing helped to 
boost the economy when the economy needed boosting the most. 
Last year alone, homeowners withdrew about $140 billion of 
their growing equity wealth and plowed $80 billion of it back 
into the economy, boosting consumer confidence and spending.
    All together, housing-related activities accounted for 9.4 
million jobs and contributed $2.3 trillion to gross domestic 
product, which was nearly 22 percent of GDP.
    And, finally, given that the housing finance system is so 
strong, efficient, and essential to the economy, there is also 
broad consensus that any legislation that would affect the 
system should begin and end with two critical goals in mind: 
First, do no harm to housing and homeowners; and, second, 
ensure that any legislation that goes forward serves to 
strengthen the housing finance system.
    We are prepared, and look forward, to working with the 
Congress and the Administration to achieve a broad consensus on 
legislation to ensure that we have a strong, credible, well-
funded financial regulator. But, today, as the Committee 
requested, I wanted to focus these few oral remarks on a couple 
of key issues pertaining to the legislation to move our 
financial regulator to the Treasury.
    First, I believe that a safety and soundness regulator at 
Treasury must have the powers and resources necessary to ensure 
effective oversight. To ensure adequate resources, I believe 
the new Treasury bureau should be funded independent of the 
appropriations process. We do believe, for the sake of funding 
accountability, that Congress should also include some 
transparent review mechanism or process, such as notice and 
comment, to ensure that the assessments levied are reasonable.
    As for the review of regulations and testimony, I believe 
those are questions for the Congress and the Administration to 
resolve.
    Regarding our capital requirements, Fannie Mae supports 
maintaining our minimum capital at the current statutory level, 
but giving the new regulator more flexibility in setting risk-
based capital. The minimum capital requirement established by 
Congress in 1992 is appropriate for a low-risk business model, 
and requiring capital in excess of our risk would reduce the 
flow of mortgage finance to homebuyers and undermine our 
mission.
    That said, we agree with Treasury that our financial 
regulator, like others, should have the authority to 
continuously evaluate the risk we face and adjust our risk-
based capital requirements accordingly.
    Today, our financial regulator has this flexibility through 
the risk-based capital requirement that Congress enacted in 
1992, which is determined by a statutory stress test. This 
test, administered every quarter, computes how much capital we 
would need to survive a severe economic shock and a prolonged 
economic crisis, and Fannie Mae has met this stress test every 
quarter.
    While recognizing the need for stability in capital 
standards, we support Treasury's proposal to provide our 
financial regulator with fuller and more flexible authority to 
ensure that our risk-based capital requirement remains 
consistent with our risk profile.
    On the matter of prompt corrective authority, I believe the 
authority Congress provided in 1992 is appropriate for Fannie 
Mae and Freddie Mac, but at the same time, we would support 
enhancing the enforcement authorities of the new financial 
regulator at Treasury beyond those available to OFHEO. We would 
support granting the new regulator cease and desist powers, the 
ability to levy civil money penalties, and the authority to 
suspend and remove company officers and directors comparable to 
what bank regulators have.
    We also believe that a clear distinction of the separate 
rule and authority of HUD and Treasury would be in the best 
interests of housing and Fannie Mae. Currently, HUD regulates 
our housing mission. OFHEO, an independent bureau of HUD, 
regulates our safety and soundness. These separate regimes are 
mutually supportive and neither undermines the other.
    For example, HUD has the authority to ensure that new 
mortgage programs are consistent with our charter and housing 
mission, and OFHEO has the authority to ensure that new 
mortgage programs do not harm our safety and soundness. This is 
an appropriate distinction and one we believe can, and should, 
continue as our financial regulator moves to become a bureau in 
the Treasury.
    Thus, we agree with most of the housing industry 
organizations that HUD should continue to oversee our housing 
mission and, at the same time, it is critical that a world-
class regulator at Treasury has the authority to review all 
aspects of our operations, including new and ongoing 
activities, and disallow anything that poses a safety and 
soundness risk.
    Whether the Committee chooses to house the mortgage 
approval authority with Treasury or HUD, the standard of 
program approval I believe is crucial. The current standard has 
fostered an unprecedented era of innovation in the mortgage 
industry, and under this authority, HUD is authorized to review 
major new programs to determine whether they come within our 
charter and mission.
    Indeed, on several occasions since 1992, Fannie Mae has 
presented new programs for HUD to review and approve. For 
example, at the urging of Congress, we sought and received 
HUD's approval to invest in energy efficient home loans. The 
current regime does not require HUD to review each and every 
mortgage innovation. This tacit support for innovation has 
allowed us to work with lenders and housing partners to create 
mortgage initiatives, options, and features, all of which are 
consistent with our charter, to fulfill our mission and respond 
to the market and to lender and consumer needs in a timely way.
    In this way, Fannie Mae has led the market in mortgage 
innovation, such as automated underwriting, low downpayment 
mortgages, and creative mortgage initiatives, but we rarely, if 
ever, 
innovate a loan. Behind virtually every new innovation we 
introduce, there is a lender or a housing partner who has asked 
for our investment, and we have responded to them. And we work 
with mortgage bankers, nonprofits and community organizations, 
local housing agencies, minority outreach groups, faith-based 
institutions, and others to help create creative new ways for 
lenders to reach and serve more families.
    Our ability to innovate is crucial to many mortgage 
lenders. They feel free to develop new products to reach 
underserved communities because they know that Fannie Mae will 
purchase their innovative loans in a secondary market, and 
smaller lenders, such as independent community banks, depend on 
our innovations to access the secondary mortgage market and 
build up a competitive mortgage business to serve their unique 
markets.
    With the freedom to innovate, we have been able to respond 
to specific challenges. President Bush challenged the private 
sector to help achieve this minority homeownership initiative, 
to create 5.5 million new homeowners. And Fannie Mae responded 
instantly by boosting our commitment of capital to minority 
families from $420 billion to $700 billion. We have also 
included new initiatives for new Americans and links to 
immigration programs and faith-based organizations.
    As American continues to grow and change, the housing 
industry lenders and homebuyers will need a new generation of 
innovation. We believe the appropriate standard for mortgage 
program review, wherever housed, is that there should be a bias 
for allowing innovation, unless it is clearly contrary to our 
charter.
    One last comment I would make relates to the housing goals. 
Under the 1992 Act, HUD has assigned regulatory affordable 
housing goals for Fannie Mae and has created goals that are 
more 
ambitious than those that are required of most other financial 
companies. They require us to devote a fixed percentage of our 
business in three distinct areas: low- and moderate-income 
families, underserved communities, and special affordable 
housing for very low-income families.
    HUD has considerable flexibility in setting the goals. And 
over the years, they have consistently raised these goals, and 
we have met all of the current goals every year that they have 
been in place. HUD can also use its authority to focus our 
efforts on specific high-priority items, which they have, in 
fact, done.
    In conclusion, as Congress considers legislation to ensure 
a world-class financial regulator for Fannie Mae, I believe 
there is a lot at stake. The U.S. housing finance system is 
indisputably the best in the world, but we have an opportunity 
to make it better.
    There is widespread consensus that housing is crucial to 
the economy and that Fannie Mae is crucial to housing. There is 
also widespread consensus for moving our financial regulator to 
Treasury and providing our regulator with the authority and 
powers to ensure our financial safety and soundness, and Fannie 
Mae stands ready to work with the Congress and the 
Administration to achieve this goal.
    Chairman Shelby. Mr. Gould.

                  STATEMENT OF GEORGE D. GOULD

                PRESIDING DIRECTOR, FREDDIE MAC

    Mr. Gould. Thank you, Mr. Chairman.
    Chairman Shelby, Ranking Member Sarbanes, and Members of 
the Committee, my name is George Gould. I have served on 
Freddie Mac's board since 1990 and am currently the Presiding 
Director and Chairman of the Governance and Finance Committees. 
From 1985 through 1988, I served as Undersecretary for Finance 
at the Department of the Treasury.
    Freddie Mac plays a central role in financing homeownership 
and rental housing for the Nation's families. Given the 
importance of housing to the economy, it is critical that our 
regulatory structure provide world-class supervision. Before 
expressing our views on specific proposals, I just would like 
to say a few words about Freddie Mac.
    The deficiencies in the company's previous accounting and 
disclosure are unacceptable, plain and simple. While the board 
has taken many steps to address these weaknesses, I will be the 
first to acknowledge that more can be done and will be done.
    First, the board is extremely ``hands on'' with regard to 
getting the restatement done and done right. Since March, the 
committee responsible for the restatement has met on a weekly 
basis, and as we announced last month, we expect to release 
restated earnings for prior years in November.
    Second, we are moving aggressively to ensure these problems 
never occur again. We have added highly qualified accounting 
personnel and strengthened our control infrastructure, and we 
have brought in independent experts to review best practices 
and proposed remediation. For example, we have engaged former 
SEC Division of Corporation Finance Chief David Martin to help 
us with disclosure. The board is fully committed to 
implementing the recommendations of independent experts.
    Now, I would like to comment on key aspects of regulatory 
restructuring. I would like to recognize Senators Hagel, 
Corzine, Sununu, and Dole for helping to get these important 
discussions underway.
    Freddie Mac strongly supports the creation of a strong, 
effective regulatory structure. It is good for the GSE's, it is 
good for markets, and it is good for consumers. Difficulties in 
moving legislation forward are regrettable, but not 
insurmountable. We are committed to doing whatever it takes to 
get an effective regulatory structure in place.
    The Committee has requested our views on a number of issues 
starting with regulatory structure and independence. Freddie 
Mac supports the creation of a new regulatory office within 
Treasury. We also support providing both the new regulator and 
HUD authority to assess the GSE's outside of the annual 
appropriations process.
    With regard to independence, we support applying the same 
operational controls as apply to the relationships between 
Treasury, and the OCC and the OTS.
    With regard to capital, we strongly believe the new 
regulatory structure continue to tie its capital to risk. The 
GSE's are subject to both the traditional leverage ratio--our 
so-called regulatory or minimum capital--and a dynamic risk-
based capital stress test that requires us to hold enough 
capital to survive 10 years of severe economic stress. Few 
other institutions could meet such a high standard.
    To ensure that the GSE's remain at the forefront of risk 
and capital management, the new GSE regulator should have 
greater discretion with regard to the risk-based capital 
standard.
    Additional discretion is not needed with regard to GSE 
minimum capital, however. Bank regulators need discretion to 
change capital requirements, given the diversity of the 
business lines banks are engaged in. In contrast, GSE's are 
restricted to one line of business, residential mortgages. 
Compared to commercial lending or loans to foreign governments, 
long-term, fixed-rate mortgages are one of the safest financial 
assets around. Even comparing mortgages alone, Freddie Mac's 
mortgage credit losses are consistently lower than those for 
banks.
    Given this low-risk profile, regulatory discretion to 
change minimum capital is unwarranted. Raising minimum capital 
would not increase the safety of the housing finance system; 
rather, it would hamper our ability to serve housing markets 
and raise costs for homeowners.
    With regard to new program approval, we believe HUD should 
retain its authority to approve new programs in keeping with 
its housing mission. At the same time, however, we believe the 
new regulator within Treasury should have authority to review 
and veto any new program that raises safety and soundness 
concerns.
    We also urge the Committee to maintain a new program 
standard, not a new activity standard. In saying that, based on 
earlier discussion, I note that there seems to be a little 
confusion about the definition of those terms, but I think 
there is some precedent to indicate what programs HUD dealt 
with in the past. Requiring the regulator to provide advance 
approval of each and every new activity significantly exceeds 
the standard required of banks and could chill innovation and 
mortgage lending.
    Freddie Mac supports parity of supervisory and enforcement 
powers among financial institutions. Although an array of 
powers currently exist, we would support providing the new 
regulator additional authority, such as new removal and 
suspension authority and new authority to assist civil money 
and criminal penalties.
    Now, let me say a few words about mission oversight. In 
1992, Congress established three GSE affordable housing goals: 
An income goal, a geographic goal, and a special goal for unmet 
needs as determined by HUD.
    HUD has significant discretion to establish and adjust 
these goals and has raised them markedly over the years. Today, 
50 percent of our mortgage purchases must be dedicated to 
meeting these needs. The GSE affordable housing goals are the 
toughest of any financial institution. Additional statutory 
goals could simply balkanize the mortgage market.
    And I may say, departing slightly from my written and oral 
comments, that within Freddie Mac, at least, our Economic 
Department would disagree with Secretary Martinez' conclusion 
that we are lagging the market. If you compare apples-to-apples 
and oranges-to-oranges, we do not believe we are. FHA has a 
different mission. Therefore, its percentage would obviously be 
different from ours, and we are limited statutorily, and by 
safety and soundness standards, to certain parts of the market 
which, when you put it all together, makes us look like we are 
lagging, but within our universe, we do not feel we are.
    HUD also has significant enforcement powers. Not only can 
HUD require the submission of a housing plan should we ever 
fail to meet one of our goals, but it can also require a 
housing plan if it determines there is a good chance that we 
might miss a goal. By contrast, bank regulators cannot bring 
enforcement proceedings against an institution failing to meet 
its CRA obligations.
    Considering that we consistently have met the goals since 
they have become permanent, and that existing powers already 
are the industry's toughest, we respectfully suggest no 
additional powers are needed.
    In summary, Freddie Mac is prepared to embrace significant 
enhancements which will make our regulatory structure stronger. 
Building these enhancements into existing law would give the 
new regulator supervisory and enforcement powers comparable to 
those of bank regulators. The new structure would also maintain 
the tougher GSE regulatory requirements, including program 
approval standards and a risk-based capital stress test.
    Our mission regulator would continue to oversee the most 
challenging, quantitatively affordable housing goals in the 
industry, with more than adequate powers to enforce them. Taken 
together, this enhanced GSE regulatory structure would be 
strong, solid, and credible. It is essential to maintaining the 
confidence of the Congress and the public.
    I would look forward to working with Chairman Shelby, 
Ranking Member Sarbanes, and other Members of this Committee as 
you move forward to address these issues, and I will be 
obviously happy to answer any questions the Committee may have.
    Chairman Shelby. Thank you.
    Mr. Rice.

                  STATEMENT OF NORMAN B. RICE

             PRESIDENT AND CHIEF EXECUTIVE OFFICER

               FEDERAL HOME LOAN BANK OF SEATTLE

    Mr. Rice. Thank you. Good afternoon, Chairman Shelby, and 
Ranking Member Sarbanes, and Members of the Committee. I am 
Norman Rice, President and Chief Executive Officer of the 
Federal Home Loan Bank of Seattle, and I would like to thank 
you for the opportunity to speak today on behalf of the Council 
of Federal Home Loan Banks.
    I will just start this afternoon by commending Congress for 
the process now underway regarding regulatory restructuring of 
the housing GSE's. It is also important to note that the Bank 
System continues to work toward voluntary SEC registration, 
pending resolution of some critical accounting and reporting 
accommodations. For example, the Seattle Bank's Board of 
Directors, at our September 2003 meeting, adopted a resolution 
calling for SEC registration, and we are now moving to make 
that happen. The bottom-line goal for our 12 banks is to 
provide complete and transparent financial disclosures that are 
considered no less than best in class.
    While there remain differences of opinion within our system 
on the matter of regulatory reform, we have reached consensus 
on four principles that we believe must serve as a framework 
for specific action and represent our bottom-line concerns as 
Congress moves forward on legislation.
    Principle No. 1: Preserve and reaffirm our mission. We 
strongly believe any legislation should accomplish the 
following regarding the mission of the Bank System: Provide 
cost-effective funding to members for use in housing finance 
and community development; preserve our regional affordable 
housing programs; support housing finance through advances and 
mortgage programs; and allow for innovative new business 
activities that advance our mission.
    Principle No. 2: Create a strong and independent regulator. 
Safety and soundness of the Bank System is our number one 
concern. This is neither a partisan nor an ideologically driven 
endeavor. It is for this reason we ask that Congress protect 
the Bank System through the creation of a strong and 
independent regulator. This is absolutely consistent with the 
role of other bank regulatory agencies in which the regulator 
responsible for safety and soundness has free and unfettered 
authority to determine policy, rulemaking, adjudicative, and 
budget matters.
    We strongly believe that a regulator lacking true 
independence may eventually find itself pursuing other agendas, 
not the will of Congress, nor what is demanded to ensure safety 
and soundness.
    Principle No. 3: Preserve the Bank System funding. It is 
critical that we ensure that nothing is done to any of the 
housing GSE's that would increase their cost of funds and, 
correspondingly, increase costs for financial institutions and 
consumers. Therefore, any legislation must: Preserve the role 
and function of the Office of Finance, which issues our 
system's debt; It must ensure that neither the U.S. Treasury, 
nor the independent GSE regulatory unit, has the ability to 
impede or limit our access to the capital markets without 
cause; And it must not limit the financial management tools 
available to the GSE's to prudently manage risk.
    Principle No. 4: Recognize and reaffirm the unique nature 
of the Bank System. We believe any legislation must preserve 
the cooperative ownership of the Bank System, joint and several 
liability, and the regional structure that assures we are 
locally controlled and responsive to the needs of our 
communities.
    Regardless of the regulatory structure established by 
Congress, we believe these principles must be considered as you 
move forward in your policymaking. So, in closing, I would like 
to put forward some ideas that reflect my own thinking on these 
matters.
    I believe there are two threshold issues that could help 
Congress attain its goal of protecting the public interest in 
the housing GSE's.
    First, there is much that separates the Federal Home Loan 
Banks from the two other housing GSE's: Our mission is broader, 
incorporating economic and community development. We have 
different capital requirements; The Bank System is 
cooperatively owned and capitalized by our members, while the 
other housing GSE's must meet the earnings expectations of Wall 
Street; The other two housing GSE's pay Federal income tax, but 
the Federal Home Loan Banks pay special taxes, equivalent to a 
Federal corporate income tax rate of 26 percent.
    These are not inconsequential differences. Yet, despite 
these differences, we increasingly have more in common. All 
three housing GSE's are managing increasingly complex sets of 
financial, operating, and accounting risks. And in my view, all 
three would benefit from more rigorous oversight of these 
activities.
    Second, the choices you make on regulatory reform must be 
based on the underlying philosophy about the housing GSE's. In 
your judgment, is the public interest best advanced by 
encouraging competition or encouraging market domination? In 
the end, I believe the Nation's home lenders will better serve 
the Nation's homebuyers if there are choices and competition in 
the secondary mortgage market. Full-fledged competition among 
GSE's is a way to more prudently manage growth and disburse 
risk among more investors.
    As one of 12 Federal Home Loan Bank presidents, my 
responsibility is to protect and enhance this cooperative and 
the overall public interests invested in our Bank System--the 
same process that each of you bring to this process.
    I would like to thank you for your time this afternoon, and 
I would be also happy to answer any of your questions you may 
have regarding my testimony.
    Chairman Shelby. Thank you very much.
    Mr. Raines, the minimum capital threshold of 2.5 percent 
that Fannie Mae and Freddie Mac are subject to is often 
compared, as we know, to the 4-percent-minimum capital standard 
the banks and thrifts must meet. Do you believe that is a fair 
comparison?
    Mr. Raines. I do not believe it is a fair comparison, for 
several reasons.
    First, the minimum capital requirement that we have applies 
not just the 2.5-percent on-balance sheet, but also there is a 
45 basis for off-balance sheet items, which banks do no count 
off-balance sheet items in the calculation of their so-called 
minimum capital.
    But more importantly, banks are in a far more risky 
business than we are.
    Chairman Shelby. Elaborate on that for the record. We 
basically know that a first mortgage on a home is probably one 
of the safe investments. I mean, it is not perfect, but it is 
pretty safe. Would you compare it to some of the other risks 
that banks take.
    Mr. Raines. Yes, sir. I think the simple comparison is to 
compare capital to losses. If you compare our capital to our 
losses on an annual basis, we have 450 times more in minimum 
capital than in our annual losses. A typical bank has 15 times.
    Chairman Shelby. Four hundred fifty times?
    Mr. Raines. Four hundred and fifty times as much minimum 
capital as our losses, a typical bank 15 times, a typical large 
bank, 12 times.
    Chairman Shelby. And how long is this 450? Is this this 
year or what about the last----
    Mr. Raines. It has been maintained for many, many years.
    Chairman Shelby. It remains constant.
    Mr. Raines. And, indeed, even if you just look at banks' 
residential mortgages, banks lose 30 times as much on their 
residential mortgages as we do. So, even if we do not count 
their investments overseas, their investments in leases, their 
investments in a wide range of riskier things, if we just look 
at residential mortgages, they have 30 times the losses that 
Fannie Mae has.
    Chairman Shelby. You do not make credit card loans, do you?
    Mr. Raines. We do not do that. Indeed, if we were to turn 
the equation around and say maybe banks should have the same 
level of capital that we have compared to losses, it gives you 
an idea of how high bank capital would have to go, even on 
their mortgages, if they had to have 30 times the capital that 
they have today.
    So that is why it is very important to relate capital to 
risk. The most dangerous thing I think you can do in the 
financial system is require excess capital for the risk that is 
being taken because what that does is it diminishes the flow of 
capital into the marketplace. And so what you need to do, I 
believe, is to match capital with risk, and Fannie Mae and 
Freddie Mac, throughout our entire history, have had far lower 
risk profiles than comparable banks.
    Chairman Shelby. Both you and Mr. Gould have expressed your 
opposition clearly to a change in statutory minimum capital 
guidelines, but at the same time, you have generally expressed 
support for strengthening the authority of the new regulator 
using bank regulators as a model.
    Why would it not make sense to allow the new regulator, if 
we create one, to have more discretion over the minimum capital 
standard?
    Mr. Raines. The major reason, I believe, is that the 
minimum capital standard is this capital standard relates to 
our mission, and it is saying how much it is that you think 
Fannie Mae should do. If you double the minimum capital 
standard, without any change in risk, you are saying Fannie Mae 
can do half as much, and I believe that should stay with 
Congress.
    But where it comes to risk, we believe that a regulator 
should have extensive ability to change the capital standard. 
Indeed, I have to say to you, and I am a very trusting person, 
but I have to say to you I wonder what would be the reason to 
raise our minimum capital standard if our risk has not gone up? 
What would be the reason? And the only reason I can think of is 
that the regulator will just have a different view of how 
active we should be in the housing market.
    Chairman Shelby. But, on the contrary, if the risk were not 
there, could a regulator not lower the risk capital?
    Mr. Raines. In theory, the regulator could lower it. We are 
not asking for it to be increased, and we are not asking for it 
to decrease. We are asking for our capital to be related to 
risk.
    Chairman Shelby. And if you could quantify your capital, 
just Fannie Mae, and I will ask Mr. Gould, what is this 2.5 
percent? How many billions of dollars are you talking about?
    Mr. Raines. It is about $30 billion currently.
    Chairman Shelby. This is Fannie Mae.
    Mr. Raines. This is Fannie Mae. But on top of that, we have 
also pledged to issue another 1.5 percent against our assets in 
subordinated debt. So, if you calculate all of the capital, all 
of the risk-bearing capital that we have, we have 4 percent 
capital--2.5 percent that is equity and another 1.5 percent 
which is subordinated debt, which if we were a bank would be 
counted as part of the overall capital calculation.
    We have 4-percent capital if you are talking about risk 
bearing.
    Chairman Shelby. For a lot less risk, you are saying.
    Mr. Raines. For a lot less risk, and it is important to 
remember that, when everyone talks about the risk to others, 
remember the first people who lose their money are the Fannie 
Mae shareholders. They have $30 billion as the first line----
    Chairman Shelby. Well, that is the way it should be, is it 
not?
    Mr. Raines. Exactly. That is why they keep me on my toes.
    Chairman Shelby. Mr. Rice, uniform capital standards for 
housing GSE's. You state that it is your view the capital 
requirements be standardized for all three housing GSE's. Are 
you proposing a 4-percent minimum, a 2.5-percent or regulatory 
discretion? What are you really saying?
    Mr. Rice. I believe in regulatory discretion, but I do want 
to state that the Federal Home Loan Banks have had zero credit 
losses--zero--ever, and we are required to hold 4 percent 
minimum capital.
    So, I would hope, with the discretion of an independent 
regulator, they would understand that there is some imbalance 
in the minimum capital standards, and maybe they would lower it 
to a level closer to the other housing GSE's.
    Chairman Shelby. On the other hand, the Federal Home Loan 
Banks can make advances based on collateral beyond mortgage-
related assets; is that correct?
    Mr. Rice. That is correct.
    Chairman Shelby. Would that not argue that the capital 
standard for the Federal Home Loan Banks should be different 
and perhaps more rigorous? In other words, you have got more 
risk than----
    Mr. Rice. Well, Congress allowed us to have expanded 
collateral for other loans to be made to rural farmers and the 
like.
    Chairman Shelby. But that does not mean you do not have 
more risk.
    Mr. Rice. No, I am not saying that, but I am saying that 
the collateral standards and the management of that credit is 
as important in managing that risk.
    All I am saying is that we have a different minimum 
standard, and I think it would be important for the new 
regulator to evaluate those standards and make some 
determination rather than the status quo.
    Chairman Shelby. Mr. Rice, your written statement notes 
that the Bank System is working toward voluntary SEC 
registration, pending resolution of critical accounting and 
reporting issues.
    I am also familiar with the study completed by First 
Manhattan which indicates that there may be significant costs 
associated with registration, and I want to enter that study 
into the record and share it with my colleagues.
    [The First Manhattan study follows:]
    Mr. Rice. I would appreciate it.
    Chairman Shelby. What factors do you believe that we need 
to consider, if we agree with the need for disclosure, which I 
think we do, yet want to be mindful of any structural factors 
unique to the Federal Home Loan Bank System?
    Mr. Rice. The Federal Home Loan Banks have always, by 
statute, been jointly and severally liable for each other's 
debt. Under SEC registration, it appears that this situation 
could give rise to the need for each Federal Home Loan Bank to 
create an additional on-balance sheet liability. Additionally, 
Federal Home Loan Bank stock would be characterized, under 
current regulations, as being mandatory or redeemable. Those 
have real consequences on our balance sheet for our members, 
and we want to get clarification of those issues.
    So the issue is not about not disclosing, it is how we 
disclose, and then the impact of those disclosures on our 
members. Our board has directed us to move quickly on this 
issue, but we do think there are areas of differences we would 
like to resolve with the SEC.
    Chairman Shelby. But the key to disclosure is how you 
disclose.
    Mr. Rice. Exactly.
    Chairman Shelby. So, in other words, what do you disclose, 
and if you have transparency, that is going to be better for 
the regulator, it is going to be better for your members, is it 
not?
    Because you are looking for the truth of your financial 
condition.
    Mr. Rice. Well, transparency is what we all believe in.
    Chairman Shelby. And disclosure.
    Mr. Rice. And disclosure, and there is no doubt about it. 
There are unintended consequences for the way we are structured 
from other publicly held corporations, and all we want to do is 
to talk to SEC about those differences and recognize them.
    Chairman Shelby. Thank you for your indulgence.
    Mr. Gould. Mr. Chairman, might I comment on capital from a 
slightly different point of view, but I think an important one 
for what this Committee is considering?
    Chairman Shelby. Yes.
    Mr. Gould. I think capital has often been a shorthand way 
of looking at protecting the overall risk which Secretary Snow 
commented on to the financial system a number of times when he 
was here, and that is of course true. That is the first capital 
to be lost if there is a problem, and risk-based capital, 
trying to relate it to the risk nature of where you are buying 
loans or holding assets, but I think there is another very 
important aspect of it, a subtlety to the risk aspect, which 
is, to me, the most important thing the regulator must look at 
is how well the companies themselves control the risk of what 
they are doing, how well does Freddie Mac control its interest 
rate risk exposure in terms of its retained portfolio and how 
well do we evaluate and monitor the credit risk of our 
securitized portfolio because there the numbers are very large.
    This is a very important factor, as we go forward and try 
to provide more minority housing and fulfill our low-income 
mission, so a strong regulator, in my mind, is defined in other 
ways, besides other ways, as someone who is able to evaluate 
the risks of how we manage ourselves internally because that, 
in the end to me, involves much larger numbers than merely the 
amount of capital.
    Chairman Shelby. How much of our portfolio do you keep and 
you do not secure? Do you securitize everything?
    Mr. Gould. No, sir.
    Chairman Shelby. I thought you kept a lot of stuff.
    Mr. Gould. Yes, we do.
    Chairman Shelby. That is where the risk comes, is it not?
    Mr. Gould. Well, a different type of risk.
    Chairman Shelby. It is risk.
    Mr. Gould. They are the same securities. Yes, sir, it is 
risk, but the retained mortgages and the ones we securitize are 
the same product. In securitizing them, we have taken the risk 
in our guarantee of those securities that they are good in a 
credit sense. For the same type of mortgage that we retain, our 
risk is that we do not finance properly or do not hedge 
properly the interest rate risk of having to finance those 
retained mortgages in the market and yet have those mortgages a 
fixed rate of return financed in a fluctuating or volatile 
public market, which we do, and we believe very successfully 
and safely, with a certain amount of derivatives.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Mr. Gould, your comment just now about a 
strong regulator evaluating the internal controls of the 
entities that he is regulating, that is the point you are 
making.
    Mr. Gould. Yes, the economic controls within the company.
    Senator Sarbanes. I take it that is, in effect, a fairly 
strong criticism of OFHEO in terms of its oversight over 
Freddie Mac.
    We would not be here today, I do not think, but for the 
Freddie Mac experience.
    Mr. Gould. I would not, personally, characterize it as a 
strong criticism because their prime mission is safety and 
soundness, and there is no question, before or during the 
accounting problem or now, of Freddie Mac's safety and 
soundness. Indeed, I think anyone will testify that our safety 
and soundness, in terms of economic risk, and hedging and 
credit risk, is first rate, best in class.
    Senator Sarbanes. If you are not reporting accurately, does 
that not carry with it a huge potential to impact on the 
perception of your safety and soundness?
    Mr. Gould. Certainly, the perception I would not argue with 
you, Senator, and perceptions in markets are extremely 
important. And Freddie Mac, what the Freddie Mac issue is 
really about is the timing of the recognition of income. When 
you get right down to the core issue, that is what it is. 
Should these earnings have been recognized in earlier years or 
should they have been amortized over certain assets into future 
years? And basically that is what you are getting to.
    And the answer of our new auditor, in particular, is we 
should have recognized that income in earlier years, but that 
is a long way from safety and soundness and a long way from the 
systems we built to control our economic risk. And, very 
frankly, Freddie Mac simply did not build its accounting, both 
its accounting abilities, both in a technical sense and in a 
personnel sense, in the same way that fortunately it built all 
of its economic risk organization.
    Senator Sarbanes. Mr. Rice, if a new regulator is developed 
for Fannie and Freddie that carries with it the message that 
they are under enhanced safety and soundness regime, and the 
Federal Home Loan Banks are not part of that new regime, with I 
think a growing perception that the regulator of the Federal 
Home Loan Banks is really not up to standard, what would the 
impact of that be on the Federal Home Loan Banks?
    Mr. Rice. You started your question with ``perception,'' 
and if that perception moves to the Street, then it could have 
consequences on the cost of funds. There could be a difference, 
and you might be able to feel it.
    I think that is one of the reasons why a large number of 
banks have said, if you are going to move in this direction, 
here are the principles we want, and we would like to be 
included based on that framework.
    Senator Sarbanes. I guess it is the concern about that 
development that has led at least some of Federal Home Loan 
Banks to now be in favor, on certain terms, of being included 
with the other GSE's in this regulatory arrangement; is that 
correct?
    Mr. Rice. There are those concerns, yes.
    Senator Sarbanes. So from the point of view of the Federal 
Home Loan Banks, or at least some of them as they analyze it, 
being left out has a potential of a significant downside to it; 
is that correct?
    Mr. Rice. The more people talk that way the more momentum 
is create but there is nothing quantifiable at this point.
    Senator Sarbanes. I am not talking that way. I am just 
asking.
    Mr. Rice. There is nothing quantifiable that could show you 
those kind of metrics. But I do believe that the cost of funds 
might be affected, but I have no proof or empirical data to 
show you that.
    Senator Sarbanes. Then let me ask this question of all of 
the panel members. Fannie and Freddie have been under the same 
regulator. They do the same line of work. The issues are all 
co-terminus, so to speak. The Federal Home Loan Banks are 
somewhat different. They do some things that Fannie and Freddie 
do, and they do other things that Fannie and Freddie do not do. 
Fannie and Freddie would not be permitted to do some of those 
activities.
    Now if you are all brought in under one regulatory 
structure, it seems to me you confront a problem of how do you 
harmonize this situation. So, I would be interested in hearing 
from each of you what you think the problems of harmonization 
would be and how they might be resolved. Mr. Rice, why don't I 
start with you and we will just go across the panel?
    Mr. Rice. I think the best way was the one that was 
articulated by Secretary Snow, even though I would like an 
independent regulator--he said, have two deputies to view the 
functions of the two structures, because they are different. I 
think to recognize the difference within the organization and 
let the regulator then lead would be the best way to do it.
    Senator Sarbanes. Mr. Gould.
    Mr. Gould. I think you would have to have a pretty good-
sized staff in order to harmonize it because you are, as you 
suggest, Senator, looking at certain different activities and a 
regulator would have to come to conclusions as to the safety 
and soundness of each of those different missions. I think, 
however, there is a common denominator which is the safety and 
soundness of how they finance themselves and how they manage 
risk; interest rate risk or core credit risk. So the Treasury 
does have, certainly, expertise in that area, but I think it 
would have to be staffed more broadly than just the two GSE's 
because of the different level of opportunities they have to 
make loans.
    Senator Sarbanes. Mr. Raines.
    Mr. Raines. Senator, I think the problem is broader than 
that of my compatriots here. I think that there would need to 
be a very clear standard that similar activities would be 
regulated in a similar way. Otherwise it raises the question, 
which regulatory scheme is really the best one? That raises a 
number of issues I think would have to be resolved.
    First of all, the question of mission. If you look back in 
1992, Fannie Mae had 87 percent of its assets were owning 
single family mortgages and the rest were liquidity primarily. 
If you look today, 90 percent of our assets are owning single 
family mortgages but we have had an extensive debate about 
whether Fannie Mae has been in new businesses or not.
    If you look at the same thing with the Federal Home Loan 
Banks, for some of the Federal Home Loan Banks in 1992, 100 
percent of their assets were either advances or investment 
securities. Today, in at least one of the banks, advances are a 
minority of what they do. So there would have to be a question 
first on mission. What do we mean by mission? And could Fannie 
Mae, if we were to harmonize, does that mean Fannie Mae could 
go wholly into an entirely new business that is completely 
different from the holding of mortgages, if the harmonization 
were to go that way? I would think that would not be the 
interest because there has been so much concern that we have 
already gone into things that are far beyond our charter.
    The second point that comes up is on capital. We had a 
discussion on capital, and I have to correct myself. We only 
have 357 times as much capital as our losses, not 450.
    But on the question that Norm Rice brought up on capital. 
The capital that the Federal Home Loan Banks have today would 
not count as capital for Fannie Mae because it would be 
considered a kind of puttable preferred. It would not count at 
all as being acceptable capital for Fannie Mae. That is a big 
difference. The Federal Home Loan Banks believe they have an 
enormous amount of capital but under our capital standard it 
would count for zero. Someone would have to resolve, what does 
that mean?
    Similarly with regard to housing goals. Today, Fannie Mae 
has housing goals which are percentage of business goals and we 
invest more money in low-income housing tax credits than the 
entire Federal Home Loan Bank System invests in their 
affordable housing program. And we pay Federal income taxes. So 
we do all three and the Federal Home Loan Banks do one. Now 
which way are you going to harmonize?
    Mr. Rice. That is why you need two.
    Mr. Raines. I think the problem is, if we are both going to 
be in the business of providing a secondary market and owning 
and guaranteeing the mortgages, then presumably we would have 
the same standards apply. I think these are tough questions. I 
think that before we embark on this you would want to either 
have the Congress answer them, or certainly empower the 
regulator to insist that the same standards be applied if you 
are in the same business. Certainly within this small group of 
GSE's that should not be too much to ask for.
    So, I think there are some very profound issues and I do 
not want to presume to say, doing it our way is the best way or 
their way is the best way. But there are very different 
standards that are being applied now and I would think that we 
would want to pick one to apply to all these entities, at least 
as far as it goes to the owning of mortgages.
    Mr. Rice. I would just come back to the whole question that 
because we are a cooperative and because our members are on our 
board and we service our members, if our members are desirous 
of a product, we have that product approved by our regulator 
and we are providing the type of product that our members want.
    I would call it mission leap rather than mission creep and 
I do believe we can do it and we have managed it well. In the 
short term, $1.75 million from this new activity has gone to 
our affordable housing programs and created almost 385 units of 
housing. So we are still providing the mission that we were 
chartered, and I think we are moving in a way that really makes 
a difference.
    Advances are a product. I have no problem if Fannie Mae 
wants to move into advances. I just think that the regulator 
ought not to be so overburdened with restrictions at the 
beginning. These are things that I think an independent 
regulator has to come to grips with. But I do think that there 
is a way to manage this in a way that maintains the character 
of the system that we have and recognizes the differences, 
because that is what is at risk is the differences. So by 
having a single regulator with maybe two divisions under it 
still maintains the integrity of what the Federal Home Loan 
Banks is and allows I think for good regulation.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you very much, Mr. Chairman. The 
more I sit here, the more I realize I need to sit here.
    [Laughter.]
    First, I asked a question of the previous panel, have they 
ever missed their goals? Mr. Gould, you came back fairly 
strongly and said you disagree and that you have not missed 
your goals. Mr. Raines, do you also disagree that you have not 
missed your goals?
    Mr. Gould. I have said that there is disagreement with the 
study that Mr. Martinez was citing as to our not leading, but 
lagging. In terms of meeting our goals, as my testimony says, 
since those goals have been permanent we have met them every 
time. There were some temporary goals in the early to mid-
1990's that we did not meet.
    Senator Bennett. That was the period of time that he cited, 
1993 to 1995.
    Mr. Gould. Yes, sir, that is correct.
    Senator Bennett. Mr. Raines, do you have a comment on that?
    Mr. Raines. Yes. The current goal structure we have met 
every year. In the first year that they established the goals, 
they had a different goal called a central cities goal, in the 
very first year, which we did not meet nor, I believe, did 
Freddie Mac meet. But that goal was then eliminated. So when we 
are talking about, have we met our goals, if you look at the 
goals that we have had over this period we have met them every 
year.
    But I agree with George Gould on the question of leading 
the market, that we believe the data clearly shows that we do 
lead the market. But let us be clear of what that means.
    Senator Bennett. I wanted to get more clarification on 
that.
    Mr. Raines. What leading the market means is that we are 
acquiring a greater share of a type of loan than the market 
creates. Now that may sound like an easy thing to do, but we 
are in the business of buying loans that other people have 
originated and which they have voluntarily decided to sell. So 
leading the market is not just simply our opening up the doors 
and saying, give us the loans you have. Indeed, if you look at 
our major lenders, if we only relied on our single family 
lenders we could not even meet the HUD goals, let alone lead 
the market.
    But also, this Committee has instructed other lenders, 
particularly depositories, that they are to lead the market. So 
when they acquire loans that may fit our goals, if they decide 
to hold them then they are leading the market and we are unable 
to lead the market. So the fact that we lead the market is a 
big deal. It is not a small thing.
    This debate, I hope you understand, between us and HUD on 
the statistics, which we can go over with your staff with the 
statistics, is a question of, they believe we might be behind 
the market by 1 percent, and we believe we might be ahead of 
the market by 1 percent. So this is not a question of wholly 
failing. This is a difference between 41 percent and 42 
percent.
    But the important thing is the fact that Fannie Mae and 
Freddie Mac can even come close to the market on this kind of a 
detail is an indication of the kind of effort we make because 
we can only buy loans that people voluntarily want to sell to 
us. We cannot make them sell them to us. Indeed, we have to 
induce them to originate the loans. Then we have to induce them 
to sell them. And then we have to induce them to sell them to 
us. All of which goes into leading the market.
    So when we say we lead the market, it is not as though we 
just opened up the doors and business came in. It is a very 
hard thing to do when you do not originate the loans yourself.
    Senator Bennett. So everybody has to lead the market. It is 
a little like Lake Woebegone where everybody is above average.
    Mr. Raines. Yes.
    Senator Bennett. Let me ask about the cost of funding. 
GSE's are successful largely due to their access to relatively 
low-cost funding. So how would the different issues relating to 
creating a new regulator and possibly moving program 
authority--these are the two fundamental issues I keep hearing 
over and over again; what role is HUD going to have? What role 
is the regulator going to have? I think there is general 
agreement agreeing with Senator Carper, here is the list of 
things that we all agree on, and there is general agreement 
that there needs to be stronger regulation; a higher class, 
world class--whatever that means--regulator for everybody. And 
there is general agreement that that, for the GSE's at least, 
should be in Treasury. Mr. Rice is not quite sure he is ready 
to move in that direction yet. I can understand that.
    But how would the different issues related to creating a 
new regulator and then moving the program authority out of HUD 
affect your access to low-cost funding?
    Mr. Raines. I think the impact on funding is not nearly 
what has been spoken about. I think that is an issue of 
mission. I think it is far more important, in terms of the 
balance between safety and soundness and mission, to get the 
program approval right. Because if you freeze Fannie Mae or if 
you had frozen us 10 years ago and said that innovation is now 
going to be subject to a bureaucratic procedure, we never could 
have done all the refinances that were done last year when 10 
million loans went through our automated underwriting system, 
and giving people loan approvals in two minutes rather than 2 
weeks. We could never have done what we have done in the last 
couple of years. It just would not have happened.
    I think it goes to the mission and our capability to serve 
the market. But I do not believe that moving our regulator to 
Treasury is going to increase our access to the market. I do 
not believe it will harden in any sense the implied guarantee, 
which I never quite understood what an implied guarantee is. 
Nor do I think it would be harmful, whether or not the Federal 
Home Loan Banks were in or out of the Treasury apparatus. I 
think the most important thing is that we have a strong and 
safe and sound--strong regulator so that the investors believe 
that their interests are being taken care of.
    I view this as a continuum. Before 1992, we essentially did 
not have a safety and soundness regulator. In 1992, this 
Committee led the way in creating one. Now here we are 11 years 
later to improve on it. So, I view this as more of a continuum 
than an abrupt change that is going to change the market's 
perception of Fannie Mae, Freddie Mac or of the Federal Home 
Loan Banks.
    Senator Bennett. Mr. Rice, do you want to comment?
    Mr. Rice. The only thing I would add is that the System has 
had zero credit losses--and we are regulated for safety and 
soundness by the Finance Board, we have had an exemplary 
activity and a record in this whole area because we have had a 
very good safety and soundness regulator. I do believe that I 
share some of the same opinions that Mr. Raines has, and that 
is that it is the performance and the examination and the 
supervision of our activities that really does resonate with 
the Street.
    The Street does not really ask you, who is your regulator? 
They really look at your financial statements and the condition 
of how you run your operations and that is the measure of your 
success. We think we have a good success record as we exist 
today. I think that is the reason some of the banks are 
questioning whether this new configuration as something that is 
necessary.
    But I do think that all of us are realists. If you are 
going to create a new regulatory structure, we would like to 
see if maybe there could be some consistency. But I do not 
believe we all need to be the same. One size does not fit all, 
especially for the Federal Home Loan Banks, and especially for 
the cooperative nature in which it operates. So when you try to 
make these distinctions to bring this all together in one lump 
sum, I think that is not something that legislation can really 
do. You are going to have to rely on the independent regulator, 
who should be outside of Treasury, making those determinations 
which will allow you to get the accountability that Congress 
needs.
    Senator Bennett. Thank you. Thank you very much.
    Chairman Shelby. Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman. Welcome to each of 
you. Mr. Raines, I very much appreciate, one, the time you have 
spent on this issue. You have spent time with me. Your staff 
has been very generous with my staff and that is very helpful. 
I think everyone on the Committee understands how important 
these issues are to you as businessmen and your employees, but 
also how important they are to the capital markets. So thank 
you for that.
    I also very much appreciate the emphasis you place on the 
definition and the language that is going to be used by any 
regulator regarding products, programs, and activities. I very 
much agree with that. We want to be, first and foremost, as 
clear as possible. We may end up with language that is not 
exactly the way you would write the statute. No surprise. But I 
very much agree that language is important, more important than 
exactly where the regulator overseeing those new business lines 
are. We want to get that right so that you can innovate, so 
that you can respond to changes in the market and new 
technologies. So, I want to emphasize that I very much agree 
with you there.
    Certainly, as you well know, the legislation that Senator 
Hagel, Senator Dole, and I have introduced I think largely 
agrees with the perspective that you place on enforcement--you 
talked about that in your testimony--on independence, which you 
have talked about and emphasized in your testimony, and a 
number of other issues. So, I think we can all appreciate that 
there is a good deal of consensus here.
    Mr. Gould, I think you suggested that the accounting issues 
do not affect safety and soundness. The misstatements of 
accounting, profits, do not affect safety and soundness; is 
that correct?
    Mr. Gould. I have said the accounting issues we have had do 
not affect safety and soundness. I am not making a 
generalization of that statement.
    Senator Sununu. Sure. I want to explore that a little bit 
because I think a $3 billion misstatement of profit does affect 
safety and soundness. I would imagine it affects your access to 
the capital markets, and it certainly affects the interest rate 
at which you can borrow and the expectation of investors. Would 
that not be part and parcel of affecting safety and soundness?
    Mr. Gould. It might ultimately. I do not think it has 
affected our safety and soundness now. I do not know what tense 
we are speaking in, Senator. Are we talking about present 
tense, future tense, or past tense?
    Senator Sununu. We are talking about past tense in terms of 
accounting misstatements that have occurred, a $3 or $4 billion 
misstatement of the timing of profits earned by Freddie Mac----
    Mr. Gould. Have not affected our safety and soundness.
    Senator Sununu. And whether or not that accounting issue in 
particular or that type of accounting issue would affect safety 
and soundness.
    Mr. Gould. It has not affected our safety and soundness in 
a past tense or in a current tense. Could it affect our safety 
and soundness in a future tense? Absolutely. That is why we 
have a number of steps of remediation to try to prevent 
anything like that happening again. In a sense this is, as 
someone said earlier, a high class problem. It happens to be 
more earnings. But it is also possible, in theory, if steps 
were not taken to correct it, that it might go the other way 
sometime and that certainly affect the perception and the 
reality of safety and soundness. So it is something that must 
be corrected.
    Senator Sununu. I appreciate that, although I will qualify 
my own reaction as I did earlier, the fact that it was an 
understatement of earnings does not make it any better, any 
more acceptable, does not denigrate the fundamental problems 
than if it were an overstatement.
    Mr. Gould. I agree with you totally. I might say though, 
since you are on that subject and we are talking about 
accounting, and I think that this is very important for this 
Committee to understand. I am not passing judgment on whether 
it is good or bad, the new accounting rules under GAAP, but the 
fact is it introduces, particularly for someone like Freddie 
and Fannie, a high degree of volatility in earnings, quarterly 
earnings and yearly earnings, high degree compared to the past 
which, again since we have discussed perceptions, is something 
that we are both going to have to work on trying to explain the 
realities of the underlying economics of our companies rather 
than merely GAAP.
    Because Freddie's transgression here has been not following 
GAAP. Part of the problem has been the fact that we do not 
think GAAP is the best explanation of the nature of our 
economics. But we must follow GAAP. Those are the rules. But in 
an accounting sense, the future will look different from the 
past even with all the accounting corrected.
    Senator Sununu. I appreciate your concern with the 
accounting standards and I understand in concept, in principle, 
your concern. But this is usually the part of the hearing when 
we all run for cover behind Senator Enzi. If we start getting 
into FASB and GAAP standards then most all of us are out of our 
element. But your points are very well taken. Also I want to be 
clear, I very much understand that you are more sensitive than 
anyone else in this room to the issues created by the past 
misstatements.
    Mr. Raines, you stated that you, Fannie Mae, or the GSE's, 
are asking for capital to be related to risk. I totally agree. 
But I do not see how moving regulatory authority for a minimum 
capital standard to be inconsistent with ensuring that capital 
is related to risk. Those are not mutually exclusive, are they?
    Mr. Raines. I think that there is a concern that if you 
have a risk-based capital standard that you are setting gauged 
risk; why did you move the minimum capital standard? Our 
minimum capital serves a very different purpose than minimum 
capital in banks. Banks do not have an effective risk-based 
capital standard. What they call risk-based capital is simply a 
leverage requirement applied asset class by asset class. But it 
does not go up and down with changes in the economy. It does 
not go up and down with changes in interest rates. It has no 
stress test involved in it. So in their case, the only lever 
they have to move is the minimum capital in order to be able to 
affect the bank.
    Senator Sununu. I appreciate that. I appreciate the 
differences between banks, and your testimony about the 
differences in portfolios and business activities; very 
important and very well taken. But it just would seem to me, 
and I suppose most people looking at this from a common sense 
perspective would say, whatever capital standards exist in 
order to ensure and match with safety and soundness should be 
the responsibility of whatever new regulator is envisioned by 
this Committee.
    Again, I can understand your point that there are 
differences between banks and that banks may not have the risk-
based capital standard. But whether we are talking about 
minimum capital or risk-based capital, it would seem to me to 
make sense that the new regulator have responsibility.
    Mr. Raines. Then, Senator, if that is the Committee's view 
then my recommendation would be, abolish the minimum capital 
standard and simply have a risk-based capital standard, which 
would be entirely based on risk and we would not have to have 
the discussion about whether minimum goes up or down. Because 
in our case, minimum capital is in some ways an anomaly, as to 
why you even have a minimum capital standard if you have got a 
risk-based capital standard. So there is another way to avoid 
the confusion, which is to eliminate the minimum capital 
standard.
    Senator Sununu. Are you recommending that?
    Mr. Raines. No. My recommendation is to leave the capital 
standard that Congress has created in law and leave it the way 
it is and allow the regulator great flexibility in changing 
risk-based capital. I am not proposing a big change. I am 
trying to have as few changes as possible so we can actually 
get something done. But based on your logic, there is an 
alternative solution. Rather than giving the regulator 
authority to move it around, get rid of it and have the entire 
focus based on risk-based capital.
    Senator Sununu. My logic is that whatever capital standards 
exist should be the responsibility of the new regulator. Your 
logic is that nobody else has a minimum capital standard, and 
therefore, we ought not to deal with it.
    With regard to the Federal Home Loan Banks, if they are 
included in the legislation, are you recommending that we 
include your proposal to tax them?
    Mr. Raines. What I recommend is that if the Committee is 
going to include the Federal Home Loan Banks, that the 
Committee address these substantive issues as to whether or not 
they should be--as it relates to their mortgage programs, not 
to their advances, but as it relates to their mortgage 
programs--operating under the same rules that we do.
    Senator Sununu. Which would be a significant change to 
their charter.
    Mr. Raines. Absolutely. But they have moved into a 
significantly new business. Just as if we moved into a 
significantly new business I think you would want to revisit 
our charter.
    Senator Sununu. But moving them to a new regulatory 
authority does not mean they are moving into a new business.
    Mr. Raines. Some of them have already moved----
    Senator Sununu. The question is, if we move them into a new 
regulatory authority, should we tax them? You seem to say, yes, 
because we should revisit the charter issues associated with 
the Federal Home Loan Banks because we are moving them into 
this new regulatory authority.
    Mr. Raines. No, because the Congress of the United States, 
I do not believe, is going to take up this issue again any time 
soon. If you move them into a new regulator you are essentially 
saying that you are comfortable with the Federal Home Loan 
Banks having $100 billion today, and potentially $500 billion 
in a few years, owning of mortgages under an entirely different 
scheme than you have established for Fannie and Freddie.
    Senator Sununu. So by extension, should we revisit the 
issue of the tax status with regard to State and local taxes 
for the GSE's, and the Treasury line of credit as well?
    Mr. Raines. If we move into a different business.
    Senator Sununu. If we move Fannie and Freddie into a new 
regulator?
    Mr. Raines. No. If we moved into a new business I think you 
should revisit our charter. But we cannot move into a new 
business under our charter. They have moved into a new business 
that is entirely different from the business that they were in 
the last time Congress reviewed their charter.
    Senator Sununu. So your point seems to be that you want to 
revisit these issues of charter and taxation because they have 
moved into new businesses, not because we are considering 
including them in a new regulator.
    Mr. Raines. Both.
    Senator Sununu. There is an important distinction to be 
made here.
    Mr. Raines. It is both of those. But I agree with you. If 
the Congress was not taking up this issue, then I would not 
come up here and say, I would like you to take up the issue. 
But if Congress does take up the issue of the Federal Home Loan 
Banks, I think this is the one time you are going to deal with 
it for the next 5 or 10 years, and I think if you do not deal 
with it now it will never be dealt with.
    Senator Sununu. But this same exact argument could be made, 
by someone that wanted to make it, that for those very reasons, 
because we are talking about these issues, that we should have 
on the table Treasury line of credit for the GSE's, that we 
should have on the table applicability of State and local 
taxes. As you well know, in approaching this I think many 
people, including me, have said that maybe those ought not to 
be addressed specifically in this legislation.
    Mr. Raines. There has been no hesitancy in this town for 
people to raise those issues about Fannie Mae and Freddie Mac. 
If we were to move into a new business I would expect them to 
raise them, and I would expect Congress to address them. But 
nothing has changed in terms of our business since 1992. 
Congress addressed that issue in 1992. There has been no new 
argument made with regard to them since 1992. That is why I am 
saying, I do not see a need for Congress to go into that.
    A lot has changed with the Federal Home Loan Banks since 
1992; a lot has changed. And a lot has changed since the last 
time Congress legislated a few years ago with regard to this 
issue. And the Banks are proud of the change. So this is not 
hidden. The only question I am raising, a change has occurred. 
If you are going to now legislate on the Federal Home Loan 
Banks, it seems to me that change should be addressed.
    Senator Sununu. I want to salute Mr. Rice for his 
discipline at the other end of the table and make note that----
    [Laughter.]
    Mr. Raines. It is a Seattle characteristic.
    Senator Sununu. I do not think the Chairman would have 
moved on without giving you an opportunity to respond.
    Mr. Gould. And you noticed, I tried to stay out of the 
argument.
    Mr. Rice. I was trying to. I have a hole in my tongue.
    The Fifth Circuit Court of Appeals confirmed the System 
moving into this mortgage purchase area. They said it was 
consistent with the mission, and the System's housing mission. 
And the Finance Board authorized us to move into this area. So 
it was not as if somehow we just moved into this area. We had a 
lot of people giving us scrutiny, and that precedent is there.
    As a matter of fact, it is interesting, this is the hard 
part with the regulatory structure. Some people want things 
left as they are as we move forward into the new regulatory 
structure and some people want them changed. I do not think 
that you can have it both ways.
    I think at the end of the day we are in a business that our 
members wanted and that is what we respond to.
    I would just say that we do have taxes, we pay RefCorp, 
which is a percentage of our income. And we have AHP, our 
Affordable Housing Program, 10 percent of our net income that 
is mandatory. And we have no tax shelters.
    Chairman Shelby. I think you used the phrase earlier 
creeping mission or something like that.
    Mr. Rice. Mission leap.
    Chairman Shelby. Mission leap. Well, we hope you are not 
leaping, any of you leaping toward the taxpayers. That is what 
we worry about, as you know, and that is why we need strong 
regulators and strong standards.
    Mr. Raines, you have indicated that you support such a 
change, but there is a need for stability in capital standards. 
How would you define stability in capital standards?
    Mr. Raines. I think the stability that we would look for is 
to simply leave it to the regulator to decide when it would be 
necessary to change the risk-based capital standards. They just 
became effective this year. I would hate to see the Committee, 
or the Congress, mandate that the regulator make a change. And 
so I would leave it to the judgment of the regulator as to how 
rapidly they would want to make a future change.
    But there was some discussion at some points about 
mandating, that they throw out the existing standard and create 
a wholly new one. And having just gotten it, after 10 years, we 
think that would be precipitous.
    Chairman Shelby. You would have to be careful in doing 
that.
    Mr. Raines. You would have to be careful, but we are not 
looking for any limitation on the ability of the regulator to 
make a change. We just do not want there to be a mandate that 
by some date they have to come up with a brand new standard 
that we would then have to adjust to.
    Chairman Shelby. So basically, would you be comfortable, 
whatever that comfort level might be, with language on risk-
based capital similar to that accorded to the bank regulators?
    Mr. Raines. In terms of how they set the risk-based 
capital?
    Chairman Shelby. Yes.
    Mr. Raines. We are comfortable--I hesitate on the bank 
regulator because we have some many examples. But we are 
comfortable that they have broad authority to do that.
    Chairman Shelby. We know you are different, your mission is 
different.
    Mr. Raines. Yes, we believe that they should have broad 
authority, keeping in mind the best practices that have been 
developed over time, and that they apply their best judgment to 
that. So we are in favor of a lot of latitude on risk-based 
capital because it has to evolve and change as the risk posture 
changes.
    Chairman Shelby. Senator Bennett, would you like to ask any 
more questions?
    Senator Bennett. Thank you, Mr. Chairman, and I thank 
Senator Sununu for his diligence and his penetration in his 
questioning. I just have one quick comment, more or less to get 
it off my chest than to discover anything.
    Mr. Gould, I believe that accounting is an art, not a 
science. I believe accounting is a philosophy, not an exact 
procedure. And the assumption everywhere is exactly the 
reverse. The assumption is that you count the number of beans 
in the jar and they are what they are, and any statement of a 
different number of beans in the jar is dishonest. And 
accounting is very, very clear and straightforward.
    What people who have not run businesses do not realize is 
that there are a whole bunch of jars sitting on the shelf and 
you put a bean in the wrong jar, many times because your 
auditor tells you the second jar is where that bean belongs 
even though you want to put it in the first jar.
    And my understanding of what happened at Freddie Mac was 
that your auditor, who was Arthur Andersen that no longer 
exists, was telling you that proper accounting required you to 
report what you reported. And then when Arthur Andersen, who 
made some very, very serious accounting mistakes in their 
advice to Enron, ceased to exist, your new accountant said no, 
they are in the wrong and let us put it here. And this is not a 
matter of misleading anybody. It is simply a matter of making a 
philosophical choice as to which jar the bean goes into that 
turned out to be the wrong choice.
    Now I do not want to lead you, but is that----
    Mr. Gould. Well, that would apply to a good bit of all that 
is wrong, Senator. I can say that with absolute certainty.
    There are probably some other instances of transactions 
where on reflection, with the help of our new auditor, our 
people internally would say gosh, we were following the wrong 
policy, albeit that a number of those may have been passed upon 
by Arthur Andersen. I am not trying to exonerate everything or 
whitewash what had been done. But I will just give you one 
example.
    We changed auditors and Price Waterhouse comes in and looks 
at 140 accounting policies and decides to change 130 of them. 
Now that is not saying that 130 of them are necessarily dead 
wrong. That is saying they felt best practice and the proper 
way to do it was to change 130, and that is one of the reasons 
this restatement has taken so long.
    But you are absolutely correct, there is subjectivity in 
accounting rules. There is no bright line, often. Sometimes 
there is a bright line and sometimes Freddie Mac went over that 
bright line.
    But the fact is that there was a lot of subjectivity to it, 
a lot of art form. In fact, sometime if we had a lot of time, 
perhaps you and I could have a philosophical discussion of what 
are earnings? What reflects the underlying economics of a 
business best? And that is not an easy question to answer. So 
you are correct certainly, sir, in that respect.
    Senator Bennett. Well, I just simply, in this discussion, 
want to make it very clear that there is a difference, and it 
is a very significant difference, between the Enrons where 
people are greedy and stupid--and usually those two go 
together--and deliberately cooked the books to achieve a result 
that was not sustainable from the economics. And then 
accounting challenges that come because of philosophical 
differences between accountants.
    And this is one of the challenges that a regulator is going 
to have to deal with, because the regulator is going to have to 
decide how the books should be kept, in many instances.
    Mr. Gould. Again, I want to be very careful that I am not 
exaggerating here. Freddie Mac made some errors and that is 
undeniable, particularly as to whether or not certain things 
conformed with GAAP or the business purpose of certain things. 
A lot of it was, as suggested, differences of opinions. But 
there were some mistakes made and those mistakes have been 
corrected and the remediation has included not only correcting 
those mistakes but also ensuring it will not happen again by 
changes in personnel and systems.
    Senator Bennett. That is why I raised the question, because 
I wanted to be clear to what extent it was just you were 
following the advice of your auditor, and what extent you made 
mistakes. And you have made it clear that there was both.
    Mr. Gould. I wish I could say it was entirely someone 
else's fault, but that would not be an honest statement.
    Senator Bennett. Thank you. I appreciate that.
    Chairman Shelby. Mr. Gould, is that restatement date, is 
that in November now?
    Mr. Gould. Yes, sir.
    Chairman Shelby. I know it slipped.
    Mr. Gould. It has been a moving target, but it is now 
November.
    Chairman Shelby. Are you going to make it? I think the 
world would like to know.
    Mr. Gould. I certainly do not want to perjure myself in any 
way here. No, yes. I feel a very high degree of confidence that 
we will have it completed. The last glitch has been largely a 
systems----
    Chairman Shelby. Sure, we know you have to go back and do a 
lot of things.
    Mr. Gould. Yes, we had to go back to 1998 and review some 
numbers because of a systems glitch. But the fact is that I am 
quite confident that it will be November, yes, sir.
    Chairman Shelby. Thank you.
    Senator Bennett. If I could just interject, Mr. Chairman, 
you have announced your intention to register with the SEC, as 
Fannie Mae has already done. Is your registration with the SEC 
delayed by your ability or inability to meet these deadlines?
    Mr. Gould. Yes, sir. Our ability to register with the SEC 
is contingent upon having current financials and we do not have 
those, and will not have current financials for probably the 
middle of next year.
    Senator Bennett. So your registration is not a lack of will 
or a dragging of the feet, it is simply the mechanics of 
getting numbers.
    Mr. Gould. Precisely. We thought we would have been there 
by now.
    Senator Bennett. I see. Thank you.
    Chairman Shelby. Sir, do you anticipate November, if you 
meet the deadline, the news is going to be upward and out and 
good news as far as----
    Mr. Gould. Well, I expect it will be really----
    Chairman Shelby. I know you are not going to say what.
    Mr. Gould. The news that we have already tried to announce 
to the public in several releases, we have given a range of our 
expectations.
    Chairman Shelby. It is going to be a gain, not a loss?
    Mr. Gould. Oh, yes. It is going to be----
    Chairman Shelby. It is going to be a substantial----
    Mr. Gould. There are few things I am totally sure of, but I 
am totally sure of that.
    Chairman Shelby. Would it be a substantial one?
    Mr. Gould. Yes, sir. I think we have said it would be 
something, a $4.5 billion after tax number, or maybe somewhat 
higher, I believe, was the nature of our public announcements.
    Chairman Shelby. Senator Crapo, I know you have been gone 
and busy.
    Senator Crapo. Since I have not been here, maybe you should 
let Senator Sununu go ahead.
    Senator Sununu. Thank you. If we were to extend Senator 
Bennett's line of questioning, I am afraid the next question 
would be when is an economic hedge not an economic hedge? And I 
think my friend Peter would be the only person who would enjoy 
that discussion. So, I am going to change the subject.
    Mr. Gould, is the prepayment rate in the mortgage-backed 
security portfolio that Freddie Mac holds different than the 
prepayment rate associated with the mortgage-backed securities 
that are sold into the secondary market?
    Mr. Gould. Not intentionally, but there has been a period 
here, which I believe has now been almost entirely corrected, 
when it appeared that that actually occurred. And to the best 
of my knowledge, the research internally that we undertook to 
see why that was happening, it had to do in particular with a 
number--or several, not a number, several people who were very 
large sellers of mortgages to us. And we happened to securitize 
those. And it would appear that, for whatever reasons in their 
initiation of those mortgages, they had a population that 
prepaid earlier. But there was a differential, that is correct.
    Senator Sununu. There were unusual demographics in two 
distinct blocks of mortgages that were rolled into a mortgage-
backed security? Is that correct?
    Mr. Gould. There were.
    Senator Sununu. Was it coincidence that you had this type 
of a prepayment demographic rolled into one security? Or was it 
good fortune?
    Mr. Gould. You have to look at, to answer that question 
properly, our pattern of mortgages purchases. We have steady 
customers who sell us mortgages on a regular basis. And 
occasionally we have large financial institutions who originate 
mortgages that will sell us a large bundle of mortgages.
    You can get as technical as you wish, but the fact is that 
in a very steep yield curve, a lot of these banks find it more 
profitable to hold mortgages than they did with a flatter 
curve, so they accumulate mortgages and hold for a while 
because it is economic to them. And then they might crawl up 
and say how would you like $20 billion of mortgages?
    So there are periods when you buy a large pool of mortgages 
and then you turn around with those mortgages and either retain 
some of them for your own portfolio, or you securitize some of 
them. So it is not a steady, even pattern. So once in a while 
you can have instances where there may be difference of 
demographics or geography that particular affects some issue of 
mortgage-backed securities. Yes, sir.
    Senator Sununu. A final question. Mr. Raines, you talked 
about in your testimony the assessment fees or the fees that 
are used to finance a new regulator. I did not see in your 
testimony a final number. How much? How much do you think we 
should provide for the new regulator? How much is enough for 
them to do a good job?
    Mr. Raines. I think that should be left up to the 
regulator, with some supervision by some outside entity that 
would simply have a reasonableness test or simply have them 
announce publicly what it is going to be and give an 
opportunity for people to comment.
    But I do not think that there should be any artificial 
limitation on their resources, but I just worry. Having been a 
former budget director, I worry a little bit about when you 
have an unlimited source of money, that you have an unlimited 
need.
    Senator Sununu. Fannie Mae does not represent an unlimited 
source of money. That is a slight exaggeration.
    Mr. Raines. I think that some believe that to be true, and 
I just hope it is not our regulator who has that belief.
    Senator Sununu. Let me ask it a slightly different way. The 
$30 million that is currently appropriated for OFHEO, is that 
enough?
    Mr. Raines. Well, they have asked for more. And we have had 
a policy of never commenting in the appropriations process on 
what their appropriations should be. So we have never taken a 
position one way or another. We have left it up to the 
appropriators to pick the right number.
    Senator Sununu. Thank you. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Let me first apologize to the members of the panel. I had 
other obligations that took me away, and so I was not able to 
be here when you made your presentations, although I have read 
your testimony and am familiar with it.
    I want to use my time here talking to Mr. Rice about the 
Federal Home Loan Bank issue. You thought you were going to get 
off the seat.
    Mr. Rice. I sure did.
    Senator Crapo. I apologize if these things have already 
been addressed by others, but it is my understanding that there 
is not consensus among the Federal Home Loan Banks as to 
whether they support the establishment of a new independent 
regulator, as you do. Could you tell me why there is that lack 
of consensus?
    Mr. Rice. First of all, as I said earlier in my testimony, 
there is consensus around the four principles that I laid out. 
And that is clear. Three banks have no desire to be under 
Treasury and believe that the status quo is fine.
    I think if you asked any individual bank president, no one 
would say that we have something broke that needs to be fixed. 
But if we are talking about the future and where we are going 
to go, I think there are more presidents who say if you are 
going to make a change this is the way you should do it. And 
that is where we are moving.
    I think that if Congress were to create an independent 
regulatory agency outside of Treasury, there may be more banks 
who would work to be supportive. I think the big issue is to 
get consensus over the idea of whether it is an independent 
regulatory agent under Treasury.
    Senator Crapo. So independence really is the critical 
issue?
    Mr. Rice. Yes, it is. And I think it is important, no 
matter how you shape it, regulator should have independence. 
And I think also having the flexibility to make changes to 
consider who we are and move in that direction. Because you are 
going to have a strong regulator.
    Senator Crapo. We have had some testimony, or actually some 
comments that were made earlier by some of the members of the 
panel, of the Senate panel here, to the effect that there are 
differences between Fannie and Freddie and the Federal Home 
Loan Banks. How would you--and I know you probably went into 
this some--but how would you propose that this independent 
regulator approach those differences?
    Mr. Rice. Well, one of the things I believe is, first of 
all, to recognize that there are differences and therefore 
shape the organization of the agency in a way that recognizes 
how we do our business and how we move forward.
    There are some people who want to say that maybe we could 
have consistency across all the housing GSE's. I do not think 
you can because the cooperative nature of the Federal Home Loan 
Banks lends itself to a different type of structure. And I 
think that we want to have a regulator who understands that.
    So, I would see something along the lines of where there 
would be a regulator with divisions. One would deal with the 
Federal Home Loan Bank and the other would deal with the Fannie 
and Freddie. I think there will be some things that they will 
have to look at across those three GSE's, but I still think it 
is the regulator that would have to shape that.
    Senator Crapo. So there would be a benefit to having the 
single regulator, but that there should be divisions among that 
regulator's focus?
    Mr. Rice. I think so.
    Senator Crapo. Can you just tell me briefly, for a minute, 
how the Federal Home Loan Banks accomplish their affordable 
housing mission?
    Mr. Rice. By statute, 10 percent of our net income goes 
toward affordable housing. And that was crafted by Congress, to 
achieve those objectives. We use our affordable housing 
allocation to target households and neighborhoods with incomes 
lower than those that qualify even under the housing goals for 
HUD.
    Each bank has an advisory committee that sets standards and 
objectives within that 10 percent affordable housing goal and 
then we allocate along those lines. We have about 50 percent of 
our affordable grants go for multifamily and 50 percent go for 
single family, but under those guidelines.
    Basically, the banks are collectively the largest source of 
private funding for affordable housing, and we probably are the 
largest contributor to Habitat for Humanity.
    So we are consistent in this area and we like the 10 
percent that we have. I do not know what would happen if you 
move us into a new regulatory agency. Would we go under HUD's 
goal? Or would you keep the 10 percent affordable housing goal 
that we have? I think it is cleaner and easier to manage with 
our 10 percent.
    Senator Crapo. All right. Thank you very much.
    I have other questions for each member of the panel, and 
perhaps the Chairman would allow us to submit questions.
    Chairman Shelby. We will. We are going to keep the record 
open. Senator Sarbanes and I have a number of questions.
    Senator Crapo. And again, Mr. Chairman, I appreciate your 
cooperation here. I had to leave for an extended period of time 
and I appreciate the fact that you were still going when I got 
back so I could ask some of my questions.
    Chairman Shelby. Important hearings.
    Senator Crapo. Thank you.
    Chairman Shelby. Thank you.
    As I said earlier, we are going to continue some hearings. 
We want to hear from the housing end of this because I think 
the mission of Fannie Mae and Freddie Mac and the Federal Home 
Loan Bank are very important. We know they are different. We 
believe, I think most people believe here, that a strong 
regulator is important, a regulator that knows what is going 
on, that has the means to know what is going on.
    But I think we have to balance this. I think Senator Reed 
said it fairly well earlier. We might have two centers of 
gravity here. We are all interested in housing, from the 
President of the United States to every Member of Congress. And 
we realize how important that is, not only socially but also to 
our economy. So we have to balance this.
    I think we can do this. We know it is difficult to do but 
we are trying to make sure that we are not part of the problem 
down the road. I think all of you recognize this.
    We thank you for your patience, and the hearing is 
adjourned.
    [Whereupon, at 2:03 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
            PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER
    Thank you Mr. Chairman, Ranking Member Sarbanes, and our 
distinguished panel. Thank you for coming. This is an important 
subject, one of the most important topics before our Committee in some 
time. I have only a brief statement to make.
    You know there is an old expression, ``if it ain't broke, don't fix 
it.'' I think some of us here in the Senate believe that when we try to 
fix things that are not really broken, we can end up doing more harm 
than good.
    In today's hearing we are considering potential large-scale changes 
in one of the few areas that is working in our economy--housing. It is 
a critical area to get right for the country, and it is an area where 
Fannie Mae and Freddie Mac play a vital role.
    We had an accounting issue at Freddie Mac--but we should note that 
it was a problem some of us would love to have, they had understated 
their earnings! I agree we need to address the issue of the best 
regulation of Fannie Mae and Freddie Mac for all the stakeholders 
involved. But I have not heard why that should lead us down the path of 
potentially changing capital standards or changing the method and 
authority for approving the kinds of business Fannie and Freddie can 
engage in or potentially politicizing the management of the GSE's. That 
seems to be going too far--to run the risk of fixing what is not 
broken.
    It seems that instead of treading carefully, if we rush to 
judgement now we could be opening the door to all sorts of changes 
unrelated to the specific problem at hand, and going down a path that 
may not be where we want to head.
    So, I will be very interested to hear Treasury's specific evidence 
that the capital standards at the GSE's--minimum and risk based 
capital--are too low or too high. I hope they will share that data with 
us today or in the future. I did not see it in Secretary Snow's 
testimony.
    I am also very interested in whether Treasury can give us a report 
or findings that show where the current ``new program approval'' 
authority, which is today at HUD, has consistently broken down or hurt 
the economy.
    I am also curious to hear the level of capital that Fannie or 
Freddie would be required to hold under the Basel I and the proposed 
Basel II Accords. Are their current capital amounts too high or too low 
versus these standards? I am assuming Treasury has done that analysis 
or will do that analysis shortly.
    We are all also very sensitive to the impact of that a change in 
capital could have to the GSE's ability to fulfill their vital housing 
mission and to their stock prices. They are after all publicly held 
companies.
    So, I hope Treasury will walk us through an analysis of what a 
potential change in minimum capital standards, some have suggested 
these levels should double, would mean in terms of Fannie's and 
Freddie's ability to fulfill their housing mission.
    For example, how many units of housing could be impacted if they 
need to hold funds in reserve and not put them into the housing market? 
And what would be the impact on the stock prices, since any capital 
reserves would come out of the companies earnings?
    Again, I am assuming Treasury has done all this analysis--it seems 
critical to the decisions we need to make. But to date I have not seen 
it.
    Mr. Chairman, if we do not have that data and have fully aired 
those findings--and they are but a few examples of the consideration 
needed to carefully address these issues--I wonder how we can know 
whether or not we have a problem or whether or not we should make 
changes. If we do not have any data to look at--if it is all simply 
conjecture--one opinion versus another--do we risk making some enormous 
and potentially damaging mistakes?
    It seems like a dangerous way to make public policy in one of the 
few areas that is working in the economy.
    Mr. Chairman, you and Ranking Member Sarbanes, have always chosen a 
careful and considered approach, and I trust you will lead us in that 
direction again. I look forward to future hearings on this important 
subject.
                               ----------
             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
    Thank you, Mr. Chairman. Today's hearing is an important 
opportunity to re-examine the regulatory structure in place for Fannie 
Mae, Freddie Mac, and the Federal Home Loan Bank System.
    Ever since accounting problems were reported at Freddie Mac earlier 
this year, there has been a growing interest in strengthening our 
housing finance regulators. I agree that there is room for improvement, 
but I also think that it is extremely important that we move 
deliberatively and cautiously. The secondary mortgage market is so 
essential to our housing sector and to our greater economy that it 
would be inappropriate to make sweeping changes without extensive study 
and broad consensus.
    Mr. Chairman, when I raised this caution at our first hearing on 
accounting at Freddie Mac, you were quick to agree that we must move 
cautiously and judiciously and I very much appreciate that we are of 
the same mind on this.
    I want to see Fannie Mae and Freddie Mac with a highly respected, 
independent regulator. I want the Federal Home Loan Banks to be soundly 
regulated, too. And, I think there are several things that we can do to 
achieve that end. And, that is part of what today's hearing is all 
about.
    I appreciate that Secretary Martinez and Secretary Snow have agreed 
to come up and share their thoughts on this issue. And, I appreciate 
our second panel for appearing before us today as well.
    I want to work with all of my colleagues to come to a bipartisan 
consensus on what legislative changes if any are needed in the housing 
finance regulatory system.
    The Chairman, from FCRA to the American Dream Downpayment Act, has 
shown that he is a consensus-builder and that he listens to everyone on 
this panel. I know that he will want to move forward on regulatory 
reform in the same way we have on so many other important issues under 
his leadership.
    While we may not be able to move on legislation this year, it is 
more important that we begin a discussion and a debate. And, we let the 
GSE's, the regulators, the markets, and the public know that while 
there is no explosive financial disaster before us today, this 
Committee is working together to ensure that our GSE's and the Federal 
Home Loan Banks will always be safe and sound and fulfill the missions 
with which they are tasked. Thank you, Mr. Chairman.
                               ----------
                   PREPARED STATEMENT OF JOHN W. SNOW
               Secretary, U.S. Department of the Treasury
                            October 16, 2003
    Thank you Chairman Shelby, Ranking Member Sarbanes, and Members of 
the Committee for inviting Secretary Martinez and me to appear before 
you today.
    Homeownership is an important building block of individual 
financial security as well as strong communities. Our national system 
of housing finance plays a key role in promoting homeownership. We 
might call it one of the economic wonders of the world. Playing a 
prominent role in the vitality of our housing finance system are the 
Government Sponsored Enterprises (GSE's): Fannie Mae, Freddie Mac, and 
the Federal Home Loan Banks. They need to be strong and healthy so that 
they can play that important role today and be here to continue that 
important role in the future. That is why Secretary Martinez and I are 
here today.
    As the President has made clear, one of the great strengths of 
America is that everyone has an opportunity to gain the independence 
and dignity that come from homeownership. And, Secretary Martinez and I 
share the commitment made by the President to expand homeownership to 
5.5 million more minority homeowners by the end of the decade.
    There is a general recognition that the existing supervisory system 
for these enterprises does not have the tools, stature, authority, or 
resources to reach that goal. The regulatory structure is ill-equipped 
to deal effectively with the current size, complexity, and importance 
of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. As we 
attempt to remedy this situation, we must be mindful that we have two 
core objectives that should guide us: A sound and resilient financial 
system, and increased homeownership opportunities for less advantaged 
Americans.
    To serve both of these objectives we need to devote careful 
attention to the resilience of our system of housing finance. These 
enterprises play such a major role in our housing finance system and 
housing finance is so important to our national economy that we need a 
strong, world-class regulatory agency to oversee their prudential 
operations, including safety and soundness, consistent with maintaining 
healthy national markets for housing finance.
    On September 10, in testimony before the House Financial Services 
Committee, we called upon Congress to create a new and stronger 
regulatory system for Fannie Mae, Freddie Mac, and ideally the Federal 
Home Loan Banks. At that time, I outlined the Administration's 
recommendations for the essential, minimum requirements for a credible 
regulator for these enterprises. At that same hearing, Secretary 
Martinez outlined measures that the Administration would desire to 
increase homeownership opportunities. Today, I renew that request, and 
I will highlight some of the key elements that the Administration 
believes are essential to reform of the supervision of these important 
housing Government Sponsored Enterprises. Without these reforms, any 
new regulatory system would be little improved from the inadequate 
system we have today. In doing so, I must emphasize that we are not 
presenting a wish list of reforms that we would like to see enacted. We 
are presenting the minimum elements that are needed in a credible 
regulatory structure, a structure that can ensure that our housing 
finance system remains a strong and vibrant source of funding for 
expanding homeownership opportunities in America. There may be 
additional reforms worthy of consideration, and I look forward to 
discussing them, but the reforms that Secretary Martinez and I are 
presenting today are the foundation for an enduring program of housing 
finance to help provide an effective regulatory system for Fannie Mae, 
Freddie Mac, and the Federal Home Loan Banks.
Essential Elements of Regulatory Reform
    To begin with, we must make sure that we keep our eye on the 
crucial task of getting the regulatory structure right. In general, the 
legislative objective should be to create a strong, credible, and well-
resourced regulator with all of the powers, authority, and stature 
needed to do its job. In this regard, the new agency's powers should be 
comparable in scope and force to those of other world-class financial 
regulators, fully sufficient to carry out the agency' mandate, with 
accountability to avoid dominance by the entities it regulates. This 
means that the new agency should have general regulatory, supervisory, 
and enforcement powers with respect to the Enterprises. In my September 
10 testimony, I outlined the broad parameters of the new agency's 
powers and presented a list of specific items that should be included.
    Each of these reforms should be placed in context. The 
Administration wants Fannie Mae, Freddie Mac, and the Federal Home Loan 
Banks to be models of the highest corporate governance standards, 
rather than exceptions to the rule. The Administration is committed to 
make sure that corporate governance and oversight remain strong and 
effective. That requires that there be great clarity that the people 
running large companies are there to serve the interests of the 
shareholders and that their incentives and loyalties be clearly aligned 
in this way. One man cannot serve two masters. Fannie Mae and Freddie 
Mac are large, experienced, publicly traded enterprises that have grown 
significantly and taken important places in our capital markets. The 
Administration is committed to make sure that the directors of publicly 
traded corporations like Fannie Mae and Freddie Mac are elected by 
their shareholders, rather than selected by the President.
Location of the Agency
    While in my statement on September 10, the Administration did not 
make a request that the new regulatory agency be made a bureau of the 
Treasury Department, I did say that such a recommendation could be 
contemplated and would be supportable if the new agency were 
established with adequate elements of policy accountability to the 
Secretary of the Treasury. The necessary arrangement would allow the 
agency to draw upon the resources of the department for depth of policy 
guidance, stature, and authority, assuring that the regulated 
enterprises remain focused on their important housing duties, operating 
within prudent bounds that will ensure sustained financial vigor to 
continue to fulfill their housing finance roles.
    To allow the Treasury Department to provide real value to the new 
regulatory agency, at a minimum, the new agency should be required to 
clear new regulations through the Department. The existing independent 
regulator for Fannie Mae and Freddie Mac currently clears its new 
regulations through the Office of Management and Budget (OMB), so it 
would not be novel for the new agency as a bureau of the Treasury to 
clear its new regulations with the Treasury Secretary as well as OMB. 
The Treasury Department should also have review authority over the new 
agency's budget to ensure that resources are being properly allocated. 
And to ensure policy consistency, a new Treasury bureau should clear 
its policy statements to the Congress through the Department. 
Nevertheless, in any such arrangement, the new 
supervisory agency should have independent responsibility over specific 
matters of supervision, enforcement, and access to the Federal courts.
    The direct involvement of the Treasury Department in providing 
policy guidance to the new regulatory agency is important for a number 
of reasons.
    First, unlike the Treasury Department's other financial institution 
regulatory bureaus, the new regulatory agency would only be responsible 
for regulating a very limited number of very large financial 
institutions, ranging in size from more than $30 billion in assets to 
more than $700 billion in assets. This increases the possibility of 
regulatory capture, and makes the oversight of overall policy 
development by the Treasury Department vital.
    Second, even though the obligations of Fannie Mae, Freddie Mac, and 
the Federal Home Loan Banks are not backed by the full faith and credit 
of the U.S. Government, market participants have come to believe that 
some sort of implied guarantee exists, weakening market discipline of 
the Enterprises. Market discipline is an essential element of any 
regulatory oversight regime, the first line of regulation of commercial 
banks and thrifts. A weakening of market discipline is inconsistent 
with our goal of a resilient housing finance system, particularly if it 
weakens the sensitivity of Fannie Mae, Freddie Mac, and the Federal 
Home Loan Banks to the demands of the housing markets. Therefore, it is 
vitally important that the Treasury Department be able to monitor the 
new regulator's policies to ensure that such policies are not 
reinforcing any such market misperception of an implied guarantee.
    The Administration's proposal strengthens the Department of Housing 
and Urban Development's oversight of the GSE's' housing goals. However, 
we need a credible, single regulator to do the important job of overall 
prudential supervision of Fannie Mae, Freddie Mac, and the Federal Home 
Loan Banks, one that will help ensure that the Enterprises are healthy 
today and strong tomorrow. We need a regulator that has all of the 
tools and stature and resources to do the job, that is independent with 
regard to supervision and enforcement, but that has accountability in 
the formulation of policy.
New Activities Approval
    The Administration has proposed that the authority for approving 
new activities of the housing enterprises be transferred from HUD to 
the new regulatory agency. This proposal is consistent with 
availability of one of the central tools that every effective financial 
regulator has--the ability to say ``no'' to new activities that are 
inconsistent with the charter of the regulated institutions, 
inconsistent with their prudential operation, or inconsistent with the 
public interest.
    The Federal Reserve has this kind of authority for bank holding 
companies, the Comptroller of the Currency has comparable authority for 
national banks, and the Office of Thrift Supervision has similar 
authority for savings associations. The current financial regulator for 
Fannie Mae and Freddie Mac lacks that authority, one of its most 
serious weaknesses. If we are serious about creating an effective, 
credible financial regulator, it must have the authority, in 
consultation with the Secretary of HUD, to review new activities as 
well as to review their ongoing activities.
    Innovation has been fostered and encouraged under the review 
authorities that our Nation's banking regulators have, and we see no 
reason why providing similar authority to the new regulatory agency 
would stifle innovation by Fannie Mae, Freddie Mac, and the Federal 
Home Loan Banks.
Capital Requirements
    While we are not recommending a statutory change to the current 
capital requirements, we believe that the regulator should have broad 
authority with regard to setting the capital requirements of the 
Enterprises, both with respect to risk-based 
capital and minimum capital. Authority for setting capital standards 
needs to be flexible enough to employ the best regulatory thinking, 
conscious of the Enterprises' own measures of risk, so that the 
regulator can direct Fannie Mae, Freddie Mac, and the Federal Home Loan 
Banks to each maintain capital and reserves sufficient to support the 
risks that arise or exist in its business. We want the regulator to 
have the authority to increase minimum and risk-based capital 
requirements if warranted. Providing the new regulatory agency 
flexibility in regard to setting risk-based capital requirements would 
be an important and necessary improvement over the current awkward 
risk-based capital regime that applies to Fannie Mae and Freddie Mac.
Receivership/Conservatorship
    Should sufficiently troubling circumstances require it, the new 
regulatory agency should have more than the powers associated with 
conservatorship. It should have all receivership authority necessary to 
direct the orderly liquidation of assets and otherwise to direct an 
orderly wind down of an enterprise, in full recognition that Congress 
has retained to itself, in the case of Fannie Mae and Freddie Mac, the 
power to revoke a charter. Providing the new regulatory agency the 
ability to complete an orderly wind down of a troubled regulated entity 
also encourages greater market discipline, which is consistent with our 
goal of a resilient housing finance system that responds to the needs 
of customers in the housing markets.
Federal Home Loan Bank System
    The importance of our housing finance markets requires that all of 
the housing enterprises be included in a single program of world-class 
supervision. We see the need for this for the Federal Home Loan Banks 
just as we see it for Fannie Mae and Freddie Mac. While including the 
Federal Home Loan Banks in a program of world-class supervision 
presents some significant issues of policy and important details that 
must not be glossed over, that does not mean that their inclusion 
should be avoided at this time. This does not require that the 
supervisory structure of the housing GSE's be identical in all 
respects, but it does require that the new regulator have the same 
caliber of authorities, stature, powers, and resources for enforcement 
and supervision of all of its regulated entities.
    Since September 10, when Secretary Martinez and I testified on this 
subject before the House Financial Services Committee, tremendous 
progress has occurred in developing a consensus. There now appears to 
be an emerging consensus for providing a new supervisory structure for 
the Federal Home Loan Banks. Today, we are very encouraged that this 
can be achieved, as part of a new regulatory system for Fannie Mae and 
Freddie Mac.
Conclusion
    In conclusion, let us consider once again our purpose here this 
morning. It is to consider how best to promote the strength and 
resilience of our housing finance markets, in order to continue our 
progress in advancing homeownership throughout the Nation. The housing-
related Government Sponsored Enterprises were created by Congress to 
assist in achieving that goal. Our aim must be to give them the first 
class quality of supervision that the importance of their charge 
requires. To accomplish that purpose, the fundamental elements that the 
Administration has proposed are essential.
                              ------------
                PREPARED STATEMENT OF FRANKLIN D. RAINES
                      Chairman and CEO, Fannie Mae
                            October 16, 2003
    Chairman Shelby, Senator Sarbanes, and Members of the Committee, 
thank you for inviting me here today to share my views on legislation 
to strengthen the safety and soundness regulation of Fannie Mae.
    A strong safety and soundness regulator is in the best interest of 
Fannie Mae, homeowners, and the financial system. I am here to voice 
support for legislation that creates a new world-class safety and 
soundness regulator within the Department of the Treasury. There is a 
strong and growing community of support for legislation that focuses on 
strengthened financial regulation and does not directly or 
indirectly change our mission, status, or charter.
    The impact of what you do here can be enormous, for the economy as 
a whole and for expanding affordable homeownership and affordable 
rental housing in particular. First, as you know, the home mortgage 
refinance wave of the last 2 years has allowed millions of families to 
increase their savings or raise their standard of living. Federal 
Reserve Chairman Alan Greenspan has noted that last year close to 10 
million households ``cashed out'' almost $200 billion of their 
accumulated home equity, using as much as half of that amount for 
consumption. Home mortgage refinance provided the single largest 
stimulus to the economy last year, and it made difficult economic times 
more manageable for families across the Nation. Our ability to use 
technology and to draw private capital into the home mortgage market 
was critical to ensuring that lenders were able to meet refinance 
demands effectively and efficiently.
    Second, we as a society have a long-held commitment to 
homeownership. Congress has reflected that commitment by making 
homeownership a public policy priority, in tax policy, in policy 
affecting Government Sponsored Enterprises, and in the commitment to 
FHA and other Government programs. Recent public policy commitments 
have reaffirmed the importance of homeownership. Just this month, the 
House of Representatives overwhelmingly passed legislation to provide 
downpayment assistance to cash-strapped families.
    President Bush has made expanding homeownership a priority for his 
Administration. Last summer, he called on the private sector to partner 
with Government to create 5.5 million new minority homeowners this 
decade. Fannie Mae stepped up to the plate to meet that challenge. We 
committed $700 billion in financing for minority borrowers, and are 
forming partnerships in communities across the Nation to bring mortgage 
financing to underserved minority communities.
    Enacting legislation that will strengthen safety and soundness 
regulation of Fannie Mae and Freddie Mac can enhance our role in 
promoting a smooth functioning mortgage finance industry. Ultimately 
that leads to more homeownership opportunities for more Americans.
    Since I testified before the House Financial Services Committee on 
this issue on September 25, the debate over changing our regulatory 
framework has moved on from general principles to specific issues. 
Rather than repeat my recent testimony, I would like to specifically 
address the questions posed by the Committee in its invitation 
requesting my appearance here today.
The Structure and Mission of the New Regulator
    Safety and soundness regulation of privately capitalized, privately 
managed companies has a singular mission. That mission is to ensure 
that institutions have the ability to manage the risks they face. As 
long as a company is managing risk properly, safety and soundness 
regulation should not dictate day-to-day business 
operations or routine management decisions. Private companies thrive 
when management is allowed to innovate and experiment, and even to see 
a new innovation fail, as long as that failure does not put the 
Enterprise at risk. Companies that take no risks and do not innovate 
cannot evolve to meet the demands of consumers and improve living 
standards for all Americans.
    This distinction between supervision and management is the 
foundation of commercial regulation throughout the marketplace. In the 
financial services sector, our public policy has found the right 
balance between private management and public supervision. And the 
Federal Housing Enterprises Financial Safety and Soundness Act of 1992 
struck the right balance between private management of Fannie Mae and 
Freddie Mac and public supervision to ensure that management does not 
put the companies at risk of failure.
    The financial services industry has evolved dramatically over the 
last 11 years, as financial institutions have merged and broadened 
their lines of business. The housing finance industry has evolved as 
well, developing products and technology that have given both 
homebuyers and mortgage investors more choices at lower costs. It is 
appropriate that, 11 years later, Congress reexamine the safety and 
soundness regime it built in 1992 to see if that balance is still 
correct.
    Striking the right balance between appropriate and effective safety 
and soundness oversight and avoidance of micromanagement is important 
when considering the powers of the new regulator. The new Treasury 
bureau should be charged with the full authority to ensure that the 
Enterprises are operating in a safe and sound manner, and that they 
remain adequately capitalized. World-class safety and soundness 
regulation is designed to help ensure that financial institutions do 
not mismanage the risks they face in a way that threaten the financial 
viability of the companies.
    At the same time, Congress should not open the door for the 
regulator to prescribe, outside the necessities of safety and soundness 
oversight, how the Enterprises conduct their businesses--whether it be 
the management of credit and counterparty risk, management of interest 
rate exposure, issuance of subordinated debt, or adequacy of liquidity 
and reserves, to name just some of the issues the Enterprises must 
manage. The modern best-practices regulatory approach to these issues, 
as reflected in the practices of the OCC and OTS, for example, is for 
the regulator to issue guidelines ensuring that the regulated financial 
institutions have adequate policies and procedures addressing these 
prudential matters. The regulated entities are then examined against 
these standards. This approach not only avoids micromanagement, but 
also ensures necessary flexibility for examination staff. In fashioning 
the new regulator's duties and responsibilities, Congress should follow 
the evolving best practices used by regulators for the rest of the 
industry.
Funding
    To ensure adequate resources, a new Treasury bureau should be 
funded independent of the appropriations process. Over the last 11 
years, OFHEO has steadily increased its budget and grown its 
examination staff. Today, OFHEO has a staff of 40 examiners, or 20 per 
institution. This is comparable to the size of the typical on-site OCC 
exam team dedicated to any of the largest OCC-regulated banks. OFHEO's 
current budget includes a plan to expand to 66 examiners over the next 
year.
    While independent funding will ensure that the new regulator has 
the necessary resources to do its job, there must be some review of 
that independent assessment, to ensure that the regulator does not 
assess the companies in an arbitrary way. In the banking system, the 
ability of any bank at any time to change charters engenders a 
regulatory competition that prevents excessive assessments. Fannie Mae 
and Freddie Mac will not have an option to move to a different charter, 
and therefore some other mechanism must be developed.
    There are many different ways to achieve this objective. 
Fundamentally, it should involve some wider review within the 
Administration of the new agency's budget. Congress could mandate 
transparency for the new agency's funding by requiring it to release 
for notice and comment a proposed budget and resulting assessment. This 
would be similar to the approach used by the National Credit Union 
Administration. Or the increase from year to year could be based on an 
objective index. Of course, we would support the agency's ability to 
obtain additional funding mid-year if necessary.
    Currently, OMB authority to apportion agency funds is an important 
check in ensuring the most effective and economical use of resources. 
Their authority covers agencies funded both through the appropriations 
process and outside of it, and we believe it would be an important 
level of review that should be adopted for the new safety and soundness 
regulator.
    A new regulator must not only have necessary resources, but those 
resources must also be spent appropriately. Today, the OCC and the OTS 
devote more than three quarters of their budgets to examination and 
supervision. This emphasis in their budgets is evidence of these 
agencies' focus on examination and supervision to monitor continuously 
the safety and soundness of the regulated enterprises. A new regulator 
for the Fannie Mae and Freddie Mac should have a similarly clear focus 
on examination and supervision, with a similar division of resources to 
ensure the regulator's priority remains on on-site, daily oversight of 
the safety and soundness of the operations of the regulated companies.
Independence
    The independence of the new regulator is also an issue of 
discussion in the current legislative debate. In particular, 
policymakers today differ over the independence of the new regulator 
with respect to funding, testimony, and regulation. As I stated 
earlier, we do believe that there must be some review of the 
assessments the regulator levies on the company, to ensure the budget 
fully funds the regulatory mission of the agency but does not include 
arbitrary assessments. Because we cannot change regulators the way 
banks can, we favor outside review of the new regulator's budget.
    With regard to the issuance of regulations, currently OFHEO's 
regulations are reviewed by OMB. That practice does afford broader 
policy input into any proposed regulation, and we believe that broader 
input has value. The third issue, review of testimony, raises important 
questions that Congress and the Administration will have to address 
directly and resolve.
The Powers of a New Regulator
    The new regulator must have the powers necessary to carry out its 
role. The current debate over these powers has focused on capital, 
prompt corrective action, and new program approval. Let me take up each 
of those issues separately.
The Appropriate Capital Regime
    Capital requirements are a fundamental part of financial 
regulation. The approach Treasury put forward in testimony before the 
House Financial Services Committee focuses on ways to give the 
regulator more flexibility in aligning capital 
requirements with the risks Fannie Mae takes on, while ensuring that we 
can continue to fulfill our mission. It is this balance that Congress 
struck in 1992, and it is a balance Congress should maintain in any 
proposed legislation.
    As you know, Fannie Mae has two capital standards, a minimum 
capital (or leverage) requirement, and a risk-based capital 
requirement. The minimum capital requirement sets a floor and also 
incorporates the indefinable, non-quantifiable risk present with any 
institution. Fannie Mae must hold the greater of the minimum capital 
requirement or the risk-based capital requirement.
    Minimum capital is defined as the sum of 2.50 percent of on-balance 
sheet assets and 0.45 percent of mortgage-backed securities guaranteed 
by, but not owned by, Fannie Mae. Including capital for off-balance 
sheet obligations distinguishes Fannie Mae's minimum standard from the 
bank leverage ratio, which requires that banks hold capital only 
against on-balance sheet assets.
    Calculated in the same manner as the bank leverage ratio, Fannie 
Mae's core capital was 3.3 percent of on-balance sheet assets, or $30.7 
billion, as of June 30, 2003. Furthermore, beginning in 2001, Fannie 
Mae has issued subordinated debt as a supplement to our equity capital. 
Subordinated debt can act as a risk-absorbing layer on top of core 
capital and can serve as a market signal of a corporation's credit 
risk. Fannie Mae's subordinated debt outstanding totaled $11.5 billion 
at June 30, 2003, or 1.2 percent of on-balance sheet assets. Thus the 
sum of core capital and outstanding subordinated debt represented 4.5 
percent of on-balance sheet assets at the end of the second quarter, or 
$42.2 billion.
    Fannie Mae's minimum capital requirement should be viewed in the 
context of the limited business in which we operate. By law, we invest 
only in residential mortgages, which are less risky than many bank 
investments such as consumer debt, commercial real estate, or foreign 
debt. Furthermore, our book of business is more geographically diverse 
than most banks, and we are required to have loss-sharing agreements on 
higher-risk loans.
    As a result, Fannie Mae has far lower losses than other lenders. 
For instance, Fannie Mae's credit losses in 2002 were 0.5 basis points 
of our total single-family mortgages. That compares with bank credit 
losses on mortgages of 15 basis points in 2002. Furthermore, while 
Fannie Mae's losses have trended sharply lower in the last 5 years, 
banks' losses on mortgages have not followed a similar pattern.
    The further an institution moves away from specialization in 
mortgages, the greater the level of losses relative to capital. 
Reflective of our low level of risk, Fannie Mae's capital was 357 times 
its credit losses for the first two quarters of 2003. The thrift 
industry, which also specializes in mortgages, had a comparable ratio 
of 47:1, less than one-seventh the capital coverage that Fannie Mae 
had. Large commercial banks, on the other hand, had a capital coverage 
ratio of only 15:1, with the entire banking industry at 18:1.
    The question for policymakers is not how to eliminate credit risk 
from the system. That is not possible. The question is how do 
institutions manage this risk, and what capital is necessary to cover 
the risk. In the event of a credit crisis, Fannie Mae is in a much 
stronger position to survive than are the other potential holders of 
mortgage credit risk. If credit losses were to increase by a factor of 
20, Fannie Mae would have sufficient capital to cover the resulting 
losses. The average bank wouldn't.
    For these reasons, Fannie Mae's minimum capital requirement should 
remain set in statute at 2.5 percent for on-balance-sheet assets and 
0.45 percent for off-balance-sheet assets. Doing so supports Fannie 
Mae's mission of bringing low-cost capital to housing. Increasing 
minimum capital absent any increase in risk raises the cost of capital 
to housing and undercuts our ability to fulfill our mission of 
constantly providing liquidity in all markets and through all economic 
conditions. Quite simply, if you raise capital requirements for the 
same level of risk, you will substantially reduce the impact Fannie Mae 
can have in fulfilling its mission.
    Of course, a key responsibility of a safety and soundness regulator 
is to evaluate continuously the risks the company faces and adjust 
capital requirements accordingly. Financial regulators achieve this 
goal through a risk-based capital standard. In Fannie Mae's case, this 
requirement is determined by a statutory ``stress test,'' computing the 
capital needed to survive a prolonged adverse economic environment, 
assuming no new business and adding a 30 percent capital cushion for 
operations risk. The regulation that implements this standard has been 
in place for one year, after 10 years of development. Fannie Mae has 
met the requirements of that rule every quarter.
    A world-class regulator must have the ability to adjust this risk-
based capital requirement to reflect both changes in the economy and in 
the risks facing an institution. Under the current statute, our 
regulator has considerable flexibility to adjust the standard. The 
Administration has asked for additional flexibility in this area. We 
support giving the regulator more flexible authority in this area, 
while recognizing that there is a need for stability in capital 
standards, which should not be subject to frequent change. Additional 
flexibility in altering the risk-based capital standard will ensure 
that the regulator can require the companies to hold appropriate levels 
of capital consistent with the risks they take.
Location and Standard for New Program Approval
    To carry out our mission effectively, Fannie Mae must be able to 
harness the innovation and efficiency of the private sector to promote 
affordable housing as a clearly articulated public policy goal. The 
standard Congress created in 1992 has fostered an environment of 
unprecedented innovation in the mortgage industry over the last 10 
years.
    In a constantly changing interest rate environment and faced with 
unprecedented volumes of business, Fannie Mae and the mortgage finance 
industry have created a revolution in underwriting, product innovation, 
and streamlined technology processes, to produce significant gains in 
lending to low- and moderate-income and other traditionally underserved 
borrowers. We have automated our underwriting, reducing mortgage 
origination costs by an average of $800, and enabling applicants to get 
an answer from a mortgage lender in minutes rather than weeks. Our 
improved credit analysis has helped us to develop mortgage products for 
credit-impaired borrowers who previously had little access to 
conventional mortgages. We have worked with lenders to develop low-
downpayment loans, bringing homeownership within reach of Americans who 
can afford a monthly mortgage payment but do not have savings for a 20 
percent downpayment. Much of this innovation is driven by our lender 
customers, who routinely challenge us to add features to match their 
offerings, and to partner with them to increase access and efficiency.
    Some of our competitors have decried innovation as somehow outside 
our charter. But the facts are these: In 1992, when our charter was 
last revised, mortgages made up 86 percent of Fannie Mae's total 
assets. Another 11 percent was devoted to maintaining necessary 
liquidity and the remaining 3 percent consisted of other assets. In 
2002, mortgages made up 90 percent of Fannie Mae's total assets. 
Another 7 percent was devoted to our liquidity portfolio and--just as 
in 1992--only 3 percent consisted of other assets. Clearly, our 
devotion to our mission has not changed. The 
innovations we have pioneered or adopted from others are not only 
within our charter; but they are also necessary to meet our charter 
obligations. We cannot serve our mission of making homeownership more 
affordable unless we can innovate continuously to create products and 
processes that better serve the industry and homebuyers.
    The mortgage market today provides consumers with a wider variety 
of products than ever before, and therefore is better poised to meet 
the individual financing needs of a broader range of homebuyers. This 
has been possible because the program approval requirements in the 1992 
law respect the need for innovation. Lenders have felt free to innovate 
and develop new products to reach underserved 
communities because we have been able to review the products and, 
whenever possible, assure them that we will purchase these loans in the 
secondary market. Without that secondary market outlet, lenders would 
have to assume more risk and expense in developing innovative mortgage 
products that are vital for reaching new markets.
    There is a consensus in the housing industry that innovation is 
best protected by maintaining HUD's role as mission regulator for 
Fannie Mae and Freddie Mac. Many of our lender partners and leaders in 
the housing industry, such as the National Association of Home 
Builders, the National Association of Realtors, the Independent 
Community Bankers of America, the Enterprise Foundation, LISC, and 
Self-Help Credit Union, fear that moving program approval authority 
away from HUD could diminish housing as a public policy priority, and 
create a barrier to innovation that hinders us from achieving our 
mission within our charter. We share those concerns, and as a result we 
support maintaining HUD's authority to review new programs.
    The current debate over whether program approval authority should 
be housed at HUD or at the new Treasury bureau misses a critical point. 
Maintaining HUD's role as mission regulator to review new programs does 
not diminish the power and authority of the safety and soundness 
regulator on matters of financial risk. In our view, a world-class 
financial regulator must have the ability to address any issues that 
pose a risk to safety and soundness. The new regulator will have on-
site examination staffs continually reviewing and assessing programs, 
products and business processes at Fannie Mae. Just like a bank 
regulator, the new bureau could examine any activity in detail at any 
time, and address any activity it found to pose a safety and soundness 
risk, even if it has been approved by HUD for charter compliance.
    Wherever Congress decides to locate the program approval authority, 
our greatest concern is that the process and standard allow Fannie Mae 
the freedom to work with lenders to create innovative mortgage products 
that meet consumers' needs. Lenders eager to reach underserved 
communities have developed mortgage features that make homeownership 
more affordable to these communities. Before they make these innovative 
mortgages available, they want to know that Fannie Mae will purchase 
them in the secondary market.
    If new legislation creates a bureaucratic process in which every 
new mortgage ``product'' or ``activity'' must be formally approved 
before we can tell a lender we will buy it, or every process innovation 
to improve efficiency must first be vetted by some third party, then 
innovation to address tough housing problems will come to a screeching 
halt. Without a secondary market partner, lenders will be less able to 
pursue the creative partnerships that are critical to meeting Congress' 
public policy goal of bringing homeownership opportunities to 
underserved communities. Any new program approval regulatory regime 
must ensure Fannie Mae's continued freedom to work with lenders, non-
profits, community organizations and local governments to develop new 
products and new business processes without intrusive regulation that 
seeks to replace business judgment with the government's judgment.
Prompt Corrective Action Authority
    In determining the appropriate and necessary powers to ensure a 
world-class regulator for Fannie Mae, there has also been some debate 
over what prompt corrective action, or PCA, powers a new regulator 
should have.
    Congress created a PCA regime for OFHEO one year after creating a 
PCA regime for bank regulators, purposely altering the bank regime to 
make it appropriate to Fannie Mae and Freddie Mac. Because Fannie Mae 
and Freddie Mac differ from banks, Congress crafted a prompt corrective 
action regime for OFHEO that focuses specifically on how Fannie Mae and 
Freddie Mac operate in the secondary market without importing those 
wholly inapplicable aspects of the bank-like PCA regime.
    Interestingly, prompt corrective action is not the preferred method 
of supervisory enforcement by banking regulators. In fact, capital 
deterioration is seen as a lagging indicator of problems at banks. 
Thus, bank regulators often take action pursuant to their cease and 
desist, civil money penalty, and suspension and removal authority long 
before a bank would be subject to PCA. As reflected in its enforcement 
regulations and as we have seen by the recent actions it has taken, 
OFHEO has considerable enforcement authority. Fannie Mae supports the 
enhancement of these authorities by giving the new regulator cease and 
desist and civil money penalty authority consistent with the authority 
of bank regulators. Fannie Mae also supports the addition of express 
authority for the new regulator to suspend and remove personnel from 
the Enterprise for violations of laws, regulations, final cease and 
desist orders and written agreements.
    As part of our PCA regime, Congress specifically provided for the 
authority of our regulator to appoint a conservator should an 
enterprise become significantly or critically undercapitalized. By 
providing for a conservatorship process in the 1992 Act, Congress, and 
in particular this Committee, made clear its preference that an 
enterprise be privately recapitalized rather than liquidated in order 
for the important mission of the Enterprise to be protected. Moreover, 
Congress reserved, as Fannie Mae and Freddie Mac's chartering body, the 
right to extinguish those charters.
    We welcome Congress' discussion of potential enhancement of the 
conservatorship powers enumerated in the 1992 Act. Certainly, we 
believe a conservator for an enterprise should be able to take such 
actions as may be necessary to put the Enterprise in a sound and 
solvent condition as well as those that are appropriate to carry on the 
business of the Enterprise and preserve and conserve the Enterprise's 
assets and property.
HUD's Continuing Oversight Role
    Finally, the Committee has asked for our thoughts on HUD's role in 
the oversight of the Fannie Mae and Freddie Mac. As I stated earlier, I 
support maintaining HUD's authority to review new programs for charter 
compliance, and I share the concerns of the housing industry that 
moving this authority from HUD to the Treasury Department could 
diminish the overall public policy commitment to homeownership as a 
national priority.
    Let me comment on legislative proposals regarding HUD's authority 
with regard to housing goals. HUD sets housing goals as a regulatory 
requirement to ensure that Fannie Mae focuses particular attention on 
low- and moderate-income borrowers and underserved areas. We have 
consistently exceeded those goals every year since 1994. The agency is 
currently developing proposed goals for next year and beyond.
    Over the years, HUD has sought to establish goals that require the 
company to stretch beyond levels we might otherwise achieve, without 
threatening our safety and soundness or jeopardizing the liquidity of 
the mortgage finance system. HUD relies on predictions of market size 
to establish these goals. This kind of forecasting is not easy and 
predictions are likely to be inexact. The record-breaking refinance 
boom of the last 2 years, for instance, has resulted in a dramatically 
different mortgage market from the one envisioned when the current 
goals were set in 2000, substantially increasing the difficulty we face 
in meeting them.
    Setting goals in the midst of changing markets requires 
flexibility--for HUD in setting the goals and for Fannie Mae in meeting 
them. HUD's recasting of the goals in 2000 is an example of the 
flexibility it has under current law. The Department increased all 
three housing goals. The goal for Fannie Mae's purchase of loans to 
low- and moderate-income borrowers, for instance, was increased from 42 
percent in 1999 to 50 percent in 2001. In addition, the new goals 
created bonuses that gave Fannie Mae the incentive to pay special 
attention to financing small multi-family properties and owner-occupied 
2-4 unit properties, which HUD identified as having particular value to 
underserved groups and which it believed would benefit from increased 
participation by Fannie Mae and Freddie Mac.
    Fannie Mae also has flexibility under the current structure. We 
must meet three national goals through a combination of our single-
family and multi-family businesses, including all types of business--
both refinances and purchase money mortgages--that we engage in. And we 
must pursue this focus on affordable lending while serving the broader 
market. Under the current framework, Fannie Mae has been able to 
achieve both objectives, though it has been very difficult in some 
years.
    Going forward, it is critical that Congress not change the 
structure of housing goals in a way that would fragment the market 
Fannie Mae serves. The mortgage market in the United States is a 
national market, with mortgage rates essentially the same in every 
community in America. Indeed, Fannie Mae and Freddie Mac were founded 
to, among other things, provide stability in the secondary market for 
residential mortgages and promote access to capital throughout the 
Nation by increasing the liquidity of mortgage investment and improving 
the distribution of investment capital. A series of regional goals, as 
some have suggested, could disrupt the free flow of capital into 
certain areas in favor of others and place these founding principles at 
risk. In addition, the proliferation of national goals would similarly 
begin to fragment the market among a number of competing credit 
priorities and weaken our ability to bring efficiencies to the market.
    Therefore, it is essential that our affordable housing requirements 
drive us to expand access to underserved communities without 
undermining our support for the broader market. The Administration's 
proposal, which appears to establish a series of home purchase goals 
and give the Secretary open-ended authority to set or amend additional 
national goals would, we believe, undermine our ability to support the 
broader market.
Conclusion
    I have tried to respond to the specific issues that have been at 
the center of the legislative debate over the last few weeks. I am sure 
there are other issues I have not addressed, and I look forward to 
discussing these topics with you as well.
    We as a society have long made homeownership a national policy 
priority. And the work of the Congress to address that priority has 
been an unprecedented success. We have the most effective and efficient 
home mortgage market in the world, continually working to make 
homeownership affordable to an ever larger number of Americans.
    I have attached the testimony delivered to the House Financial 
Services Committee last month, which lays out the steps Congress has 
taken and the steps we have taken that together have expanded 
homeownership opportunities for millions of America's families. I 
believe Congress has an opportunity this year to build on this success, 
by creating a new financial regulator that will ensure the continued 
health of the mortgage finance market and enable us to continue 
bringing low-cost financing to millions of American homeowners.
                               ----------
                 PREPARED STATEMENT OF GEORGE D. GOULD
                    Presiding Director, Freddie Mac
                            October 16, 2003
    Thank you, Chairman Shelby, Ranking Member Sarbanes, and Members of 
the Committee. Good morning. It is a pleasure to be here today. My name 
is George Gould.
    I have served on Freddie Mac's board since 1990 and am currently 
the Presiding Director and Chairman of the Governance and Finance 
Committees. I am also Vice Chairman of Klingenstein, Fields & Company, 
a firm that manages individual assets and estates. Prior to joining 
this firm, I served as Undersecretary for Finance at the Department of 
the Treasury from 1985 to 1988. At the request of President Reagan, I 
chaired the Working Group on Financial Markets to examine the effect of 
the October 19, 1987 stock market crash.
    I welcome the opportunity to be here today to discuss key aspects 
of a strengthened regulatory structure for Freddie Mac and Fannie Mae. 
Freddie Mac plays a central role in financing homeownership and rental 
housing for the Nation's families. Our job is to attract global capital 
to finance America's housing. Given the importance of housing to our 
economy, and the importance of housing finance to global capital 
markets, it is critically important that our regulatory structure 
provide world-class supervision. Hence, I would like to recognize 
Senators Hagel, Corzine, Sununu, and Dole for their legislative efforts 
in this regard. We commend them for helping to get these important 
discussions off the ground.
    Before expressing our views on specific proposals, I would like to 
say a few words about the resolution of Freddie Mac's accounting issues 
and steps we are taking to ensure these problems never occur again. I 
would also like to recount Freddie Mac's long track record supporting 
strong, credible regulatory oversight.
Resolution of Accounting Issues
    On January 22, 2003, Freddie Mac announced, in conjunction with our 
new independent auditor, PricewaterhouseCoopers, the need to restate 
earnings for 2000, 2001, and 2002. In our June 25, 2003 press release, 
we described the major factors leading to the need to restate earnings, 
a copy of which is provided for the record. In stark contrast to other 
recent corporate restatements, we expect Freddie Mac's restatement to 
show a large cumulative increase in earnings for the prior years. As we 
announced last month, we expect to release restated earnings for prior 
years in November. We deeply regret this delay, which was largely due 
to a systems error uncovered during the final validation of results.
    While the restatement will represent an important milestone, we 
remain determined to bring our financials completely up to date as 
quickly as possible. Once we resume timely reporting of our financials 
next year, we will proceed with our commitment to complete the process 
of voluntarily registering our common stock with the Securities and 
Exchange Commission (SEC) under the Securities Exchange Act of 1934 so 
that we become a reporting company under that Act. We are irrevocably 
committed to the voluntary agreement we announced last summer to submit 
to the periodic financial disclosure reporting requirements that apply 
to registrants. Freddie Mac reaffirmed this commitment in a letter to 
Treasury Secretary John Snow on July 14, 2003.
    I would like to briefly mention steps we are taking to ensure 
problems like these never happen again. While the Board has taken many 
important steps to date, I will be the first to acknowledge that more 
can be done--and will be done.
    First, the Board is extremely ``hands on'' with regard to getting 
the restatement done--and getting it done right. The committee 
responsible for overseeing the restatement has met weekly since March, 
and the Board is in constant communication with management. We are also 
overseeing the implementation of a comprehensive remediation plan.
    Second, we are moving aggressively to address weaknesses in our 
disclosures and related processes. We have added highly qualified 
accounting personnel and we are working to strengthen our control 
infrastructure. In addition, we have brought in independent experts to 
review best practices and propose remediation. For example, we have 
engaged former SEC Division of Corporation Finance chief David Martin 
to help us with disclosure. The Board is fully committed to 
implementing his recommendations, as well as those of other independent 
experts.
Regulatory Oversight Structure
    Freddie Mac has long supported strong regulatory oversight. In 
October 2000, Freddie Mac and Fannie Mae announced a set of public 
commitments to ensure that the two GSE's remain at the leading edge of 
financial risk management and risk disclosure. These commitments, which 
I will describe in greater detail below, continue to represent a high 
standard that few other financial institutions can meet.
    In May 2001, we appeared before a Senate Subcommittee and announced 
we had implemented five of the six commitments, with the sixth being 
implemented the following month. In June 2001, we testified before a 
House Subcommittee that a strong regulator is essential to maintaining 
the confidence of the Congress and the public that we can meet our 
mission. We outlined key principles for effective regulatory oversight 
and pledged to work with the Congress in that regard. Those principles 
are as follows:

 First, the regulator must be highly credible. We continue to 
    firmly believe that the GSE regulator must have supervisory 
    expertise, be adequately funded and be independent in its 
    judgments. Credibility is absolutely fundamental to the continued 
    confidence of the Congress, the public and the markets.
 Second, the regulator must support housing. Not only is 
    housing an important public policy objective, but it has also been 
    an economic powerhouse for the past several years. The necessity of 
    expanding affordable housing opportunities is more urgent than 
    ever. Over the next 10 years, America's families will need an 
    additional $8 trillion to fund their mortgages. By innovating new 
    mortgage products and new mortgage investment vehicles, Freddie Mac 
    will open doors for the homebuyer of the future, who is more likely 
    to be a low-income, minority, or immigrant family, eager to realize 
    the American Dream. We continue to work diligently to fulfill our 
    commitment to President Bush to significantly expand the number of 
    minority homeowners by the end of the decade.
 Third, and very importantly, the regulator must enjoy strong 
    bipartisan support. In this regard, I would like to commend 
    Chairmen Shelby and Oxley for the joint statement they recently 
    issued. In the statement, they pledged to seek a timely bipartisan 
    resolution of questions relating to regulatory restructuring.

    With these principles in mind, today I will comment briefly on key 
aspects of the regulatory structure under consideration in this 
Committee. The Committee has requested our views on a number of issues, 
starting with regulatory structure and independence.
Structure and Independence
    Freddie Mac would strongly support the creation of a new regulatory 
office within the Department of the Treasury, if Congress were to 
determine that this would enhance our safety and soundness oversight. 
We recommend that the new regulator have a Director appointed by the 
President, with the advice and consent of the Senate, for a 5-year term 
of office.
    To ensure that the new regulator is able to exercise independent 
judgment, we would support applying the same operational controls as 
apply to the relationships between the Secretary of the Treasury and 
the Office of the Comptroller of the Currency and the Office of Thrift 
Supervision.\1\ It is difficult to justify why the GSE regulatory 
structure should differ so strikingly from other regulators--at the 
risk of politicizing our mission and the critical role we play in 
global financial markets.
---------------------------------------------------------------------------
    \1\ See 12 U.S.C. Sec. Sec. 1, 250, 1462a(b)(2), (3), and (4).
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Funding of New Oversight Offices
    We also are prepared to support providing both the new regulator 
and the Secretary of HUD authority to assess Freddie Mac outside the 
annual appropriations process to pay for the costs and expenses of 
carrying out their respective responsibilities vis-a-vis the GSE's. 
Additionally, we recommend that the General Accounting Office regularly 
report to the Congress on the efficacy of the new regulatory structure 
and the reasonableness of the costs relative to other world-class 
financial regulators so that neither unnecessarily raise the cost of 
homeownership.
Capital Adequacy
    Adequate capital is the touchstone of investor confidence and is 
key to our ability to attract low-cost funds to finance homeownership 
in America. Freddie Mac's regulatory capital requirements incorporate 
two different measures: A traditional (leverage) capital requirement 
and a risk-based capital stress test that requires Freddie Mac to hold 
capital sufficient to survive 10 years of severe economic conditions. 
Freddie Mac consistently has exceeded both stringent capital standards.
    Freddie Mac's capital requirements were developed in keeping with 
our charter, which restricts us to lower-risk assets than banks. Since 
1994, charge-off losses at the five largest banks have been, on 
average, 17 times larger each year than charge-offs at Freddie Mac. 
Even in these banks' best year, charge-offs were more than five times 
higher than Freddie Mac's worst year.\2\ Limiting the comparison to 
mortgage assets, the residential mortgages found in bank portfolios 
typically entail greater risk than those in Freddie Mac's portfolio. 
Banks tend to hold a higher proportion of second mortgages, adjustable 
rate mortgages, subprime mortgages, and uninsured mortgages with high 
loan-to-value ratios. These historically present greater risk than the 
fixed-rate conforming loans that are the core of Freddie Mac's 
business. In 2002, FDIC-insured institutions had an average charge-off 
rate of 11 basis points on their mortgage portfolios, compared to 1 
basis point for Freddie Mac.\3\
---------------------------------------------------------------------------
    \2\ Federal Financial Institutions Examination Council, 
Consolidated Reports of Condition and Income and Freddie Mac annual 
reports for 1994 to 2001. For 2002 Freddie Mac credit information, see 
http://www.freddiemac.com/news/archives/investors/2003/4qer02.html.
    \3\ Federal Financial Institutions Examination Council, 
Consolidated Reports of Condition and Income and Freddie Mac. See 
http://www.freddiemac.com/news/archives/investors/2003/4qer02.html.
---------------------------------------------------------------------------
    In addition to our low exposure to mortgage credit risk, Freddie 
Mac maintains an extremely low interest-rate risk profile. Our risk 
management framework has performed exceptionally well through a number 
of challenging interest-rate cycles--and recent months are no 
exception. Despite the most turbulent market environment in 8 years, 
our average monthly duration gap was just one month in July. 
Maintaining a low-risk profile that is durable through time is the 
hallmark of Freddie Mac's disciplined approach to managing interest-
rate risk.
    Given this lower risk exposure relative to banks, we agree with 
Secretary Snow's testimony before the House last month that the GSE 
minimum capital requirement is adequate and need not be changed. The 
GSE's' minimum capital requirements are commensurate with our lower 
risk profile and the limitations of our charter. In addition, our 
rigorous risk-based capital stress test ensures that our risks remain 
low throughout a sustained period of severe economic conditions. 
According to an analysis prepared by L. William Seidman, former 
Chairman of the FDIC, the stringent risk-based capital standard 
applicable to Freddie Mac could be extremely challenging if applied to 
most other financial institutions.\4\ More recently, the CapAnalysis 
Group, LLC, concluded that the risk-based capital stress test is ``a 
much more stringent test for judging the safety and soundness of a 
financial institution than is a traditional capital-requirements 
test.'' \5\
---------------------------------------------------------------------------
    \4\ L. William Seidman, et al., Memorandum to Freddie Mac, March 
29, 2000.
    \5\ The CapAnalysis Group, LLC, OFHEO Risk-Based Capital Stress 
Test Applied to U.S. Thrift Industry (March 17, 2003), p.1.
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Regulator Discretion on Risk-Based Capital
    Conclusions about appropriate capital determinations will continue 
to evolve in the years ahead. Accordingly, our regulator must have 
adequate discretion to ensure that Freddie Mac's capital standard keeps 
pace with these developments. Although the basic parameters of the 
risk-based capital stress test are set in law, our present regulator 
has significant discretion in adjusting the risk-based capital 
requirements. Additional discretion, such as provided to Federal 
banking agencies, could help ensure the GSE risk-based capital standard 
remains at the forefront of financial sophistication, while continuing 
to tie capital to risk.
    Discretion must be balanced with continuity, however. A key 
component of a stable financial market is a stable regulatory 
environment. Unnecessarily changing the risk-based capital standard 
harms those who made investment decisions based on a particular set of 
rules, only to find later that the rules were changed. This sort of 
``regulatory risk'' increases costs that are ultimately borne by 
mortgage borrowers. Therefore, until such time as an overhaul of the 
risk-based capital stress test appears warranted, the regulator should 
be encouraged to continue to apply the existing risk-based capital 
rule. The rule has been in effect for less than one year and has yet to 
show signs of need for reform.
    We also believe the new regulator should be encouraged to gather 
information over the entire business cycle before making changes. This 
could be accomplished by requiring that the current rule remain in 
place for a period of time and expressing Congressional intent to this 
effect. When a new rule appears warranted, policymakers should ensure 
that certain fundamental principles remain firmly intact. Any future 
capital standard must continue to:

 Tie capital levels to risk;
 Be based on an analysis of historical mortgage market data;
 Remain operationally workable and as transparent as possible; 
    and
 Accommodate innovation so the GSE's can carry out their 
    missions.

    It is imperative that any changes to the rule be accomplished 
through notice-and-comment rulemaking, with an adequate comment period 
for all interested parties to express their views, followed by an 
adequate transition period for the GSE's to make any necessary 
adjustments to comply with new requirements.
    In summary, Freddie Mac supports granting the regulator greater 
discretion to set risk-based capital levels that accurately reflect the 
risks we undertake. However, changing risk-based capital standards 
unnecessarily, capriciously or frequently will reduce the amount of 
mortgage business the GSE's can do, resulting in higher costs for 
homeowners and renters.
Mission Oversight and New Program Approval
    We believe that the HUD Secretary should retain all existing GSE 
mission-related authority consistent with HUD's mission to expand 
homeownership and increase access to affordable housing. Specifically, 
HUD should retain authority to ensure that the purposes of the GSE's' 
charters are accomplished and continue to have regulatory, reporting, 
and enforcement responsibility for the affordable housing goals, just 
as under current law. Additionally, HUD should retain existing fair 
housing authority.
    We also believe that, in keeping with its housing mission, HUD 
should retain its authority to approve any new programs of Freddie Mac 
and Fannie Mac. HUD alone has the expertise to determine whether new 
mortgage programs are in keeping with our charter and statutory 
purposes. In this vein, we also urge the Committee to maintain a new 
program standard--not a new activity standard. Requiring the regulator 
to provide advance approval of each and every new activity 
significantly 
exceeds the standard required of banks and would chill innovation in 
mortgage lending. Our ability to lower housing costs for homeowners and 
renters is directly linked to our expertise in managing mortgage credit 
risk and our distinguished record of bringing innovative products and 
services to market.
Supervisory and Enforcement Parity
    The current legislative structure provides our safety and soundness 
regulator an array of supervisory and enforcement authorities to ensure 
that Freddie Mac is adequately capitalized and operating safely.\6\ If 
Congress were to deem it appropriate, we would support providing the 
GSE safety and soundness regulator authorities similar to those 
accorded to the Federal banking agencies. These enhanced powers would 
include broadening the individuals against whom the regulator could 
initiate cease-and-desist proceedings; new authority to initiate 
administrative enforcement proceedings for engaging in unsafe and 
unsound practices; new removal and suspension authority and authority 
to impose industry-wide prohibitions; and new authority to assess civil 
money and criminal penalties.
---------------------------------------------------------------------------
    \6\ ``Comparison of Financial Institution Regulators' Enforcement 
and Prompt Corrective Action Authorities,'' GAO-01-322R, January 31, 
2001.
---------------------------------------------------------------------------
Conservatorship
    In the unlikely event of extreme financial distress, we believe 
conservatorship is the right approach. Although we believe that current 
law provides ample convervatorship powers, we would be willing to 
consider whether additional authorities could enhance Congress' and the 
public's confidence in our safe and sound operation. We agree with 
Secretary Snow's testimony before the House that steps 
beyond potential enhancements to conservatorship would appropriately be 
left to the Congress and not to the GSE regulator.
Market Discipline Commitments
    In October 2000, Freddie Mac and Fannie Mae announced a set of six 
public 
commitments to ensure the GSE's adhere to a high standard of financial 
risk management. Excluding the commitment to adhere to an interim risk-
based capital standard (which was rendered obsolete with the completion 
of the current risk-based capital stress test) these commitments are as 
follows:

 Periodic issuance of publicly traded and externally rated 
    subordinated debt on a semiannual basis and in an amount such that 
    the sum of core capital and outstanding subordinated debt will 
    equal or exceed approximately 4 percent of on-balance-sheet assets. 
    Because subordinated debt is unsecured and paid to the holders only 
    after all other debt instruments are paid, the yield at which our 
    subordinated debt trades provides a direct and quantitative market-
    based indication of our financial strength.
 Maintenance of at least 5 percent of on-balance sheet assets 
    in liquid, marketable, non-mortgage securities and compliance with 
    the Basel Committee on Banking Supervision Principles of Sound 
    Liquidity Management, which requires at least 3 months' worth of 
    liquidity, assuming no access to new issue public debt markets. 
    Because of the critical importance of liquidity to the achievement 
    of our mission--and the importance of non-mortgage assets to this 
    liquidity--the GSE's' non-mortgage assets should not be singled out 
    for onerous regulatory treatment.
 Public disclosure of interest-rate risk sensitivity results on 
    a monthly basis. The test assumes both a 50 basis-point shift in 
    interest rates and a 25 basis-point shift in the slope of the 
    Treasury yield curve--representing an abrupt change in our exposure 
    to interest-rate risk.
 Public disclosure of credit risk sensitivity results on a 
    quarterly basis. The disclosure shows the expected loss in the net 
    fair value of Freddie Mac's assets and liabilities from an 
    immediate nationwide decline in property values of 5 percent.
 Public disclosure of an annual independent rating from a 
    nationally recognized statistical rating organization.

    In July 2002, the GSE's made an additional commitment to 
voluntarily register their common stock with the Securities and 
Exchange Commission under the Securities Exchange Act of 1934 so that 
both companies will become reporting companies under that law. Freddie 
Mac is fully committed to completing this process as soon as our 
financial statements are brought up to date.
    Freddie Mac would support giving the regulator authority to ensure 
we carry out these important public commitments. Taken together, they 
significantly enhance the degree of market discipline under which the 
GSE's operate. Robust and frequent credit and interest-rate risk 
disclosures, combined with the release of annual independent ratings 
and the issuance of subordinated debt, constitute an important ``early 
warning system'' for investors.
Affordable Housing Goals
    I would now like to say a few words about mission oversight. 
Freddie Mac's mission is to ensure a stable supply of low cost 
mortgages for America's families--whenever and wherever they need them. 
This mission defines Freddie Mac and what we are trying to accomplish. 
Our business model flows directly from our Congressional charter, which 
requires us to focus exclusively on financing residential mortgages.
    Meeting the annual affordable housing goals is a key aspect of our 
meeting our mission. Established in 1993 and increased in 1995 and 
2000, the three affordable housing goals specify that significant 
shares of Freddie Mac's business finance homes for low- and moderate-
income families and families living in underserved areas. In 2000, HUD 
specified that 50 percent of Freddie Mac's mortgage purchases must 
qualify for the low- and moderate-income goal,\7\ 31 percent must be of 
mortgages to borrowers in underserved areas,\8\ and 20 percent must be 
of mortgages to low- or very-low income borrowers or those living in 
low-income areas.\9\ Freddie Mac has successfully met all the permanent 
housing goals, which are the highest and toughest of any financial 
institution.
---------------------------------------------------------------------------
    \7\ Low- and moderate-income families have incomes at or below 100 
percent of the area median income.
    \8\ Underserved areas are defined as (1) for OMB-defined 
metropolitan areas, census tracts having a median income at or below 
120 percent of the median income of the metropolitan areas and a 
minority population of 30 percent or greater; or a median income at or 
below 90 percent of median income of the metropolitan area; and (2) for 
nonmetropolitan areas, counties having a median income at or below 120 
percent of the State nonmetropolitan median income and minority 
population of 30 percent or greater; or a median income at or below 95 
percent of the greater of the State nonmetropolitan median income or 
the nationwide nonmetropolitan median income.
    \9\ Low-income areas refer to census tracts in which the median 
income is at or below 80 percent of the area median income. Low-income 
families have incomes at or below 80 percent of area median income, 
while very low-income families have incomes at or below 60 percent of 
the area median income.
---------------------------------------------------------------------------
    The existing statutory and regulatory structure provides great 
discretion to our mission regulator to determine the goals--and creates 
strong incentives for us to achieve them. The HUD Secretary currently 
has the regulatory authority to establish and adjust the housing goals. 
In the event a GSE fails to meet one or more of the goals--or there is 
a substantial probability that a GSE will fail one or more of the 
goals--the Secretary is authorized to require the submission of a 
housing plan. Further, the Secretary may initiate a cease-and-desist 
proceeding and impose civil money penalties for failing to fulfill the 
housing plan. By contrast, bank regulators do not have authority to 
bring enforcement proceedings against an institution that is not 
meeting its CRA obligations. These are strong incentives for the GSE's 
to strive to meet the goals year after year--to say nothing of the 
reputational ``penalty'' for failing to meet a goal.
    Considering that we have consistently met the permanent affordable 
housing goals, and that existing powers already are the industry's 
toughest, additional enforcement authority seems completely 
unnecessary. Additional enforcement authority would add little to the 
legislative and regulatory incentives that Congress and HUD have put in 
place. Therefore, we respectfully suggest that no additional authority 
is needed.
Conclusion
    Freddie Mac has long supported strong regulatory oversight. It is 
critical to the achievement of our mission. As we have stated on 
previous occasions before the Congress, our core principles for the 
creation of a new regulatory structure are credibility, commitment to 
the GSE housing mission and a high degree of bi-partisan support.
    As I have outlined today, Freddie Mac is prepared to embrace 
significant enhancements that will make our regulatory structure 
stronger, in many cases, than the bank regulatory model. Building these 
new enhancements into existing law would give the new GSE regulator 
comparable supervisory and enforcement powers as bank regulators. In 
addition, it would impose tougher regulatory requirements in many 
areas, including program approval standards and a risk-based capital 
stress test. Our mission regulator would continue to oversee the most 
challenging, quantitative affordable housing goals in the industry--
with tremendous powers to enforce them. Taken together, this enhanced 
GSE regulatory structure is strong, solid, and credible. It is key to 
maintaining the confidence of the Congress and the public that we can 
meet our vital mission while remaining at the forefront of capital and 
risk management.
    Thank you for the opportunity to appear today. I look forward to 
working with Chairman Shelby, Ranking Member Sarbanes, and the Members 
of this Committee to secure the future of our housing finance system 
and, with it, the dreams of millions of families.
                               ----------
                  PREPARED STATEMENT OF NORMAN B. RICE
   President and Chief Executive Officer, Federal Home Loan Bank of 
                                Seattle
                            October 16, 2003
    Good morning Chairman Shelby, Ranking Member Sarbanes, and Members 
of the Committee. I am Norman B. Rice, President and Chief Executive 
Officer of the Federal Home Loan Bank of Seattle.
    I would like to thank Chairman Shelby and the Committee for the 
opportunity to speak today on behalf of the Council of Federal Home 
Loan Banks, and the more than 8,000 member financial institutions that 
partner with us in building healthy communities and economies across 
our country.
    I think it is appropriate for me to start this morning by 
commending Congress for two things regarding the Federal Home Loan Bank 
System.
    The first is for creating the 12 banks under the authority of the 
Federal Home Loan Bank Act of 1932. Congress created the banks to both 
stabilize and improve the availability of funds to support 
homeownership in this country. And the banks have delivered an 
unmatched legacy of innovation and service to the U.S. housing market 
for the last 70 years.
    The second is for the current work underway regarding regulatory 
restructuring of the housing GSE's. Clearly, Congress has the right and 
responsibility to scrutinize the regulatory oversight of the housing 
GSE's, and to ensure that they provide the Nation's network of 
community-based financial institutions with the safest, soundest source 
of residential mortgage and community development credit possible.
    Like the Members of this Committee, the 12 Federal Home Loan Banks 
seek world-class regulatory oversight of our system. After all, our 
members have almost $40 billion in private capital invested in our 
banks. Due to our joint and several liability, we seek the same quality 
oversight and transparency that are of paramount concern to you, the 
U.S. Treasury, bondholders, and the public.
    Along with the regulatory reform process now underway, the Bank 
System is also working toward voluntary SEC registration, pending 
resolution of critical accounting and reporting accommodations.
    On September 17, 2003, the Federal Housing Finance Board issued a 
proposed regulation that would require the 12 banks to register their 
stock with the SEC under Section 12(g) of the 1934 Securities and 
Exchange Commission Act. Under this regulation, the Federal Home Loan 
Banks would also be required to submit periodic and current reports 
such as 10-K's, 10-Q's and 8-K's.
    Each bank has until January 15, 2004 to provide comments on the 
proposed regulation to the Finance Board.
    The Seattle Bank Board of Directors, at our September 2003 meeting, 
adopted a resolution calling for voluntary SEC registration, and we are 
now moving to make that happen.
    In addition, over the last year, the system's SEC Task Force has 
met several times with SEC officials to discuss the resolution of 
outstanding accounting and reporting issues we believe are necessary to 
accommodate the unique cooperative structure of the Bank System.
    The bottom line: The goal of the Federal Home Loan Banks is to 
provide complete and transparent financial disclosures that are 
considered no less than ``best in class.''
    So, I am pleased to sit before you today representing the 
collective intent of the Federal Home Loan Banks to work diligently 
toward that goal as the process and debate around regulatory reform 
moves forward.
    Among the 12 Federal Home Loan Banks you will find at least three 
banks--Boston, Cincinnati, and Indianapolis--that do not support direct 
regulatory oversight by the U.S. Treasury. These banks strongly believe 
that because the Bank System and Treasury are competitors in the 
capital markets--and Treasury provides an emergency line of credit to 
the banks--a systemic conflict of interest would be created. Therefore, 
they support maintaining the current regulatory structure provided by 
the Federal Housing Finance Board, which was approved by Congress in 
1989 when finalizing FIRREA legislation.
    While there remain clear differences of opinion within the Bank 
System on the matter of regulatory reform, we have reached consensus on 
four principles that we believe must serve as a framework for specific 
action and represent our bottom-line concerns as Congress moves forward 
on legislation.
    These principles are as follows:
Number 1--Preserve and reaffirm our mission.
    Mission is everything. Otherwise, why should any of the housing 
GSE's exist? We strongly believe that any legislation should accomplish 
the following regarding the mission of the Bank System:

 Provide cost-effective funding to members for use in housing 
    finance and community development.
 Preserve our regional affordable housing programs, which 
    create housing opportunities for low- and moderate-income families. 
    Since the inception of our Affordable Housing Programs in 1991, the 
    Bank System has contributed more than $1.7 billion in grants to 
    communities across America.
 Support housing finance through advances and mortgage 
    programs.
 Allow for innovative new business activities that advance our 
    mission without creating a cumbersome process that prevents us from 
    responding in a timely way to the needs of our member financial 
    institutions and the marketplace.
Number 2--A strong and independent regulator.
    Safety and soundness of the Bank System is our number one concern. 
This is neither a partisan nor an ideologically-driven endeavor. It is 
for this reason we ask that Congress protect the Bank System through 
the creation of a strong and independent regulator. This is absolutely 
consistent with the role of other bank regulatory agencies, in which 
the regulator responsible for safety and soundness has free and 
unfettered authority to determine policy, rulemaking, application, 
adjudicative, and budget matters.
    The primary responsibility of the regulator is to implement policy 
made by the Congress, and to do so in a safe and sound manner. We 
strongly believe that a regulator lacking true independence may 
eventually find itself pursuing other agendas, not the will of 
Congress, nor what is demanded to assure safety and soundness.
Number 3--Preserve Bank System funding.
    The reason a GSE can advance its housing mission more effectively 
than fully private companies is simple--we have a cost of funds 
advantage due to our GSE status. It is critical that we ensure that 
nothing is done to any of the housing GSE's that increases their cost 
of funds and, correspondingly, increases costs for financial 
institutions and consumers.
    In fact, we are convinced that strong, independent, and skilled 
regulatory oversight will give greater confidence to investors and 
continue to help us advance our housing finance mission.
    Therefore, any legislation must:

 Preserve the role and function of the Office of Finance.
 Ensure that neither the U.S. Treasury, nor the independent GSE 
    regulatory unit, has the ability to impede or limit our access to 
    the capital markets without cause.
 Not limit the financial management tools available to the 
    GSE's to prudently manage the financial risks inherent in our 
    funding and business activities.

    Although the shared service of the Office of Finance should be 
owned and operated by the Federal Home Loan Banks--and the banks should 
establish its governance principles and scope of operations--we believe 
the OF must be subject to the regulatory authority of any new 
regulator.
Number 4--Preserve the unique nature of the Bank System.
    While all three GSE's have much in common, we believe it is 
important to both recognize and preserve the unique nature of the 
FHLBanks.
    Therefore, any legislation must:

 Preserve the cooperative ownership of the Bank System and the 
    joint and several liability that is the underpinning of the Bank 
    System.
 Preserve the unique regional structure of the 12 banks that 
    assures we are locally controlled and responsive to the financial 
    and economic development needs of our local communities.

    Regardless of the regulatory structure established by Congress, we 
believe these principles must be considered as you move forward in your 
policymaking.
    In closing, I would like to put forward some thoughts that reflect 
my own thinking on these matters.
    I believe there are two threshold issues that can help you attain 
your benchmark purpose of protecting the public interest in the housing 
GSE's.
    First, there is much that separates the Federal Home Loan Banks 
from the two other housing GSE's, and these differences must be fully 
recognized and factored into any regulatory reform measures being 
considered.
    Let me list what I consider to be the key differences:

 Our mission is somewhat broader than the other housing GSE's, 
    incorporating economic and community development.
 There are different capital requirements, with the FHLBanks 
    required to hold 4 percent capital and the others required to hold 
    a lower percentage.

  When new capital rules were established by Congress through Gramm-
    Leach-Bliley, there was wide agreement among economists that the 
    Federal Home Loan Banks were required to hold too much capital 
    against advances.
  Given that the Bank System has NEVER suffered a credit loss on 
    advances, a 4 percent minimum requirement, we believe, is 
    excessive. It is important to keep in mind that requiring too much 
    capital can sometimes work against the goal of safety and 
    soundness. If an enterprise is underleveraged, it can create 
    pressure to take greater risk in order to generate better return on 
    equity.
  In the secondary mortgage business, the likelihood of credit losses 
    within the Bank System has increased. However, Fannie Mae and 
    Freddie Mac, who get paid a fee to put credit risk on their books, 
    are required to hold less capital, while the Federal Home Loan 
    Banks--who compensate lenders for keeping the credit risk on their 
    own books--are required to hold nearly twice as much capital. We 
    believe capital requirements should be standardized for all three 
    housing GSE's.

 The Bank System is cooperatively owned and capitalized by our 
    members, while the other housing GSE's must meet the earnings and 
    stock valuation expectations of Wall Street investors.
 Two housing GSE's pay Federal income taxes, but the Federal 
    Home Loan Banks pay special taxes equivalent to the Federal 
    corporate income tax rate of 26 percent. We are required to 
    contribute 10 percent of our net income for affordable housing 
    grants while the other GSE's have affordable housing goals.

  This is a highly efficient way of passing on our GSE subsidy, to 
    directly impact affordable housing and economic development in the 
    communities we serve. Though we appreciate the goals the other 
    housing GSE's maintain, we believe--as do most--the best way of 
    passing along our GSE subsidy is through our Affordable Housing 
    Program and the direct 10 percent contribution made by each of the 
    12 Federal Home Loan Banks annually.
  The Bank System, in 2002, generated $199 million to award as AHP 
    grants and subsidies, and over the last 13 years has awarded more 
    than $1.7 billion in grants and subsidies, making the banks one of 
    the largest sources of private funding for affordable housing in 
    the Nation.
  The Affordable Housing Program targets incomes lower than those 
    established by the housing goals administered by HUD. Affordable 
    Housing Program subsidies must be used to fund the purchase, 
    construction or rehabilitation of:

 Owner-occupied housing for very low-income, or low- or 
    moderate-income (no greater than 80 percent of area median income) 
    households; or
Rental housing in which at least 20 percent of the units will be 
    occupied by and affordable for very low-income (no greater than 50 
    percent of area median income) households.

    AHP subsidies may be in the form of a grant (direct subsidy) or a 
below-cost interest rate on an advance from a Federal Home Loan Bank 
member institution. In supporting home purchases, AHP funds may also be 
used for downpayment assistance for income-eligible, first-time 
homebuyers.
    These are not inconsequential differences.
    But, in fact, we increasingly have more in common. Most importantly 
for purposes of this discussion, we are all managing increasingly 
complex sets of financial, operating, and accounting risks. For 
example, all three housing GSE's pursue very sophisticated interest 
rate risk management strategies. And, all three would benefit from more 
rigorous oversight of these activities.
    In my view, as business activities and associated risks converge 
among the GSE's, so, too, must the regulatory oversight evolve and 
adapt to a more complex world, and to greater scrutiny by Congress, the 
marketplace, and the American people.
    Also, the choices you make on regulatory reform must be based on an 
underlying philosophy about the housing GSE's. In your judgment, is the 
public interest best advanced by encouraging competition among the 
housing GSE's or encouraging market domination by them?
    It should come as no surprise that I have some views on this topic.
    At the urging of the bank members of our system--the Nation's home 
lenders who own our cooperative--we have chosen to compete. That's why 
we jumped with both feet into the mortgage purchase business. In the 
end, the Nation's home lenders will better serve the Nation's 
homebuyers if there are choices and competition in the secondary 
mortgage market.
    We welcome that competition because we are convinced we have a 
better way to meet our Congressionally mandated housing mission--to 
create homeownership opportunities. Because we are a cooperative, we 
are not beholden to the kinds of expectations of Wall Street investors, 
and because of the way we purchase mortgages, more of the risk is 
dispersed to those best able to manage the risk.
    From a public policy point of view, full-fledged competition among 
GSE's is a way to more prudently manage GSE growth and to disperse risk 
among more investors.
    The decisions you are about to make on regulatory reform and 
oversight will directly influence how this country best serves our 
network of community banks and consumers, and how we best protect the 
public interest and investment in the housing GSE's.
    It is my job, as a President and CEO of one of the 12 Federal Home 
Loan Banks, to preserve and enhance the strength, integrity and value 
of our Bank System, and continue its legacy of service to our member 
financial institutions and the communities they serve.
    Every day, I remind myself that I work for a cooperative that has, 
at its core, a public mission of making our communities better places 
to live and work. I do not own any part of this bank; it is owned by 
our members, and we are, at all times, fully accountable to them.
    My role is to protect and enhance this cooperative, for the good of 
our financial institutions, our communities and the overall public 
interest invested in the Federal Home Loan Banks--the same purpose that 
each of you bring to this process.
    I look forward to continuing to work closely with Members of 
Congress and the U.S. Treasury as we look for new and better ways of 
strengthening the oversight and value of our housing GSE's.
    Thank you for your time this morning. I would be happy to answer 
any questions you may have regarding my testimony.
        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                       FROM JOHN W. SNOW

Prompt Corrective Action

Q.1. Clearly, OFHEO and the Finance Board do not have the 
complete arsenal of prompt corrective action tools that the OCC 
and other bank regulators have. In fact, the Finance Board has 
no statutory Prompt Corrective Action authority.
    Do you believe that a new regulator must have the same 
Prompt Corrective Action tools as the bank regulators? Has the 
Administration given any thought as to how to fashion Prompt 
Corrective Action triggers for the Federal Home Loan Bank 
System, given its unique capital structure? I would be 
interested in any input that you might want to offer.

A.1. Prompt Corrective Action requirements are important for 
ensuring that financial institution regulators take the 
necessary regulatory actions at appropriate times depending on 
the financial 
condition of their regulated entities. Such requirements 
provide greater assurance that financial problems will be 
corrected before it becomes too late. The Prompt Corrective 
Action provisions that are in place for bank regulators provide 
a good model for evaluating and developing such requirements 
for a new regulator for the housing Government Sponsored 
Enterprises (GSE's).

Receivership/Conservatorship Authority

Q.2. Your written testimony indicated that the new regulatory 
agency should have more than the powers associated with 
conservatorship.
    Which are the particular receivership authorities that you 
believe would be necessary? If the primary intent of a 
conservator is to maintain the ongoing business value of an 
enterprise, wouldn't broader receivership powers be 
unnecessary? What impact would receivership authority have on 
the ability of the GSE's to access the debt markets?

A.2. The Administration has proposed that the new regulatory 
agency for the housing GSE's should have broader powers than 
those associated with conservatorship. In particular, the new 
regulatory agency should have all receivership authority 
necessary to direct the orderly liquidation of assets and 
otherwise to direct an orderly wind down of an enterprise, in 
full recognition that Congress has retained to itself, in the 
case of Fannie Mae and Freddie Mac, the power to revoke a 
charter. The Finance Board has the authority to liquidate a 
FHLBank under certain circumstances.
    We would not expect that providing the new regulatory 
agency with receivership authority would have an undue negative 
impact on the ability of the housing GSE's to access debt 
markets. Providing the new regulatory agency with the ability 
to complete an orderly wind down of a troubled regulated entity 
should encourage greater market discipline as creditors would 
have to evaluate fully their investment decisions. As with the 
powers granted to bank regulators, we would expect that the new 
regulatory agency could use its authority to place an entity in 
conservatorship if that was the appropriate course of action. 
However, if financial circumstances were sufficiently 
troubling, placing an entity in conservatorship and maintaining 
the ongoing business value may not be the appropriate course of 
action. The broad goals of financial regulation in this regard 
should be to promote a resilient housing finance system. 
Maintaining the operations of an entity that is no longer 
viable is inconsistent with that goal. We look forward to 
working with the Committee in developing specific receivership 
authorities for the new regulatory agency.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 
                       FROM JOHN W. SNOW

Q.1. It is my understanding that if a new GSE regulating entity 
is created as an office within the Department of the Treasury, 
you would approve such a proposal only if Treasury had the 
power to approve its testimony, clear all of its proposed 
regulation, and maintain full control of its budget.
    If we are to establish a world-class regulator for the 
GSE's, isn't it important that such a regulator be an 
independent entity, like the Office of the Comptroller of the 
Currency (OCC), rather than an office within the Treasury 
Department, in order to ensure that its decisions are insulated 
from partisan politics and have greater credibility in the 
investor community? Furthermore, you stated that you believed 
that it was necessary for Treasury to have these powers over 
the new regulator in order to disabuse the investor community 
of any perceived Government backing. Wouldn't placing the 
regulator within Treasury with these powers increase that 
perception?

A.1. The degree of independence for a new GSE regulatory agency 
is vitally important with regard to specific matters of 
supervision, enforcement, and access to the Federal courts. The 
ability of the new regulatory agency to take actions regarding 
supervision and enforcement outside of the political process is 
important for ensuring that the new agency can properly oversee 
the operations of its regulated entities. Without such 
independence, a regulator may be prevented from taking the 
appropriate regulatory actions if such actions have unpopular 
political consequences. Likewise, providing the new regulatory 
agency with access to the Federal courts provides it with a 
necessary tool to perform its duties, and such access is 
consistent with the powers of our Nation's other financial 
regulators. Permanent budget authority is also an important 
component of independence for the new GSE regulatory agency.
    While political independence for the new regulatory agency 
is important, the structure and location of the new regulatory 
agency deserves special consideration. Drawing upon the 
statements of those who have recommended placing the new 
regulatory agency within Treasury, it seems that it is believed 
that the Treasury would lend stature, authority, depth of 
experience, and a broader perspective to the new agency. None 
of those things would be available if Treasury is walled off 
from the policymaking processes (approving testimony, clearing 
proposed regulations, and having review authority over the 
budget) of the new agency.
    Establishing a new regulatory agency for the housing GSE's 
within the Treasury Department does create the potential for 
reinforcing any market misperception of an implied guarantee of 
GSE obligations. That is why it is vitally important that the 
Treasury Department be able to monitor the new regulator's 
policies to ensure that such policies are not reinforcing any 
market misper-
ception of an implied guarantee and that such policies 
encourage greater market discipline of the GSE's. In that 
regard, Treasury approval of the new agency's policies will 
ensure that there is no confusion between Treasury debt, which 
is backed by the full faith and credit of the U.S. Government, 
and GSE debt, which does not have such backing.

Q.2. Do you believe that the current GSE minimum capital 
standard of 2.5 percent is too low or too high? Please explain 
in detail.
    Has Treasury performed an analysis of the impact a change 
in the GSE minimum capital standard might have both on the 
housing and the investor markets? If so, please submit this 
analysis for the record. On what basis do you believe the 
decision to increase or decrease the minimum capital 
requirement should be made? Please describe how you envision 
the process to work. Do you believe that the Director of the 
proposed financial regulating entity should have the sole 
discretion to set both the risk-based and minimum capital 
standards? Why would allowing the regulator to have discretion 
over risk-based capital be insufficient to maintain safety and 
soundness for the GSE's?

A.2. The current minimum capital standards for Fannie Mae and 
Freddie Mac are set in statute at 2.5 percent of on-balance-
sheet obligations and 0.45 percent for certain off-balance-
sheet obligations. We believe that the new regulatory agency 
should have broad authority with regard to setting the capital 
requirements of the Enterprises, both with respect to risk-
based capital and minimum capital. It is not a question of 
whether the current standard is too high or too low, but rather 
that the authority for setting capital standards needs to be 
flexible enough to employ the best regulatory thinking, 
conscious of the Enterprises' own measures of risk, so that the 
regulator can require that its regulated entities maintain 
capital and reserves sufficient to support the risks that arise 
or exist in its business.
    In regard to the impact a change in the GSE minimum capital 
standard might have both on the housing and the investor 
markets, we would not expect the new regulatory agency to 
initiate such a change unless the risks undertaken by the GSE's 
warranted such a change. In that regard, changes in capital 
standards should go toward strengthening the financial position 
of the GSE's and further promoting our goal of a strong and 
resilient housing finance system that serves the needs of our 
Nation's homeowners. In addition, we would expect that any such 
changes to capital standards would go through the standard 
notice and comment rulemaking process that all financial 
regulatory agencies employ.
    Similar to the authority of our Nation's other financial 
institution regulators, the new regulatory agency for the 
housing GSE's should also have the authority to adjust the 
GSEs' minimum capital standards. Minimum capital standards 
provide protection against the general, indefinable, perhaps 
unforeseen risks that are present with any financial 
enterprise. Financial institution regulators rely on both 
minimum and risk-based capital standards in evaluating the 
financial health of their regulated entities. While risk-based 
capital standards are more finely tuned to the particular risks 
of a financial institution, the methodology for determining 
such standards is subject to its own unique set of risks. One 
such risk is model risk--the risk that the financial models 
underlying the risk-based capital standard turn out to be 
incorrect. Model risk is a key indefinable or unforeseen risk 
that risk-based capital standards will not adequately capture. 
Thus, not providing the new regulatory agency with the ability 
to adjust minimum capital standards would limit new agency's 
effectiveness as a financial regulator.

Q.3. Current law provides that if one or both of the GSE's were 
in serious financial trouble, they would be placed in 
conservatorship, meaning that the Office of Federal Housing 
Enterprise Oversight (OFHEO) would attempt to financially 
restructure the GSE's to maintain their assets. In your 
testimony, you recommended changing this authority to 
``enhanced receivership,'' directing the new regulator to 
liquidate the assets of the GSE's with ``appropriate wind down 
authority.'' Why do you believe that the current 
conservatorship authority should not be kept? Why is it not in 
the public interest to maintain the assets of the GSE's, 
instead of liquidating them to private entities?

A.3. The Administration's proposal regarding receivership does 
not envision eliminating the new regulatory agency's authority 
to place an entity into conservatorship, but rather it provides 
the new regulatory agency with the receivership authority 
necessary to direct the orderly liquidation of assets and 
otherwise to direct an orderly wind down of an enterprise, in 
full recognition that Congress has retained to itself, in the 
case of Fannie Mae and Freddie Mac, the power to revoke a 
charter. Such receivership authority is necessary because if 
financial circumstances were sufficiently troubling, placing an 
entity in conservatorship and maintaining the ongoing business 
value may not be the appropriate course of action. The broad 
goals of financial regulation in this regard should be to 
promote a resilient housing finance system. Maintaining the 
operations of an entity that is no longer viable is 
inconsistent with that goal.

Q.4. How does Treasury plan to regulate the process for new 
program and activity approval of the GSE's? In your testimony, 
you asserted that you believed Treasury did not recommend prior 
approval of new products and activity, but you did recommend 
giving Treasury the ability to withhold prior approval of new 
programs. Please elaborate on this. What criteria would 
Treasury propose for approval of new programs and activity? 
Please describe them in detail. How would this process differ 
from the current process administered by HUD? How would 
Treasury propose defining the 
difference between new programs and new activity? Many policy 
experts believe there is an unavoidable tension between 
maintaining safety and soundness and aggressively pursuing 
affordable housing goals. In reviewing new GSE programs and 
activity, how would Treasury balance safety and soundness of 
the GSE's with their housing mission objectives? What expertise 
in housing finance does Treasury have, that HUD does not, to 
justify Treasury becoming the new program and activity 
regulator?

A.4. The Administration has proposed that the authority for 
approving new activities of the housing enterprises be 
transferred from the Department of Housing and Urban 
Development (HUD) to the new regulatory agency. This proposal 
is consistent with availability of one of the central tools 
that every effective financial regulator has--the ability to 
say ``no'' to new activities that are inconsistent with the 
charter of the regulated institutions, inconsistent with their 
prudential operation, or inconsistent with the public interest. 
The current financial regulator for Fannie Mae and Freddie Mac 
lacks that authority, one of its most serious weaknesses, and 
if we are serious about creating an effective, credible 
financial regulator, it must have the authority to approve new 
activities.
    As long as we are going to maintain a bifurcated regulatory 
structure for Fannie Mae and Freddie Mac, there may be some 
tension between mission regulation and safety and soundness 
regulation. As it relates to new activities approval, the 
Administration's proposal addresses this tension by providing 
the Secretary of HUD with a consultative role in reviewing new 
activities. Through this consultative process, HUD would 
continue to have an important role to play in providing its 
expertise on new activities that have a direct impact on the 
housing and mortgage markets.
    The Administration's proposal for regulatory reform of the 
housing GSE's also strengthens the authority of HUD to promote 
the housing goals of Fannie Mae and Freddie Mac. In particular, 
HUD would continue to have responsibilities for setting the 
affordable goals for Fannie Mae and Freddie Mac and enforcing 
the Fair Housing Act. Under our proposal, HUD would also be 
provided explicit enforcement authority over the housing goals 
to ensure that Fannie Mae and Freddie Mac are meeting their 
housing promotion requirements.
    In terms of the process for new activities, it is important 
to understand that Treasury's formal role in approval of new 
activities would only arise in those few cases when a new 
activity was such a departure from existing norms as to require 
formal promulgation of a new regulation. That is to say that 
variations within the GSEs' current secondary market activities 
that clearly are authorized by statute may not require any 
Treasury review of proposed regulatory changes by the new 
agency. In fact, we would not expect approval of new activities 
to require new regulations in most cases.

Q.5. In your testimony, you argued that including the Federal 
Home Loan Bank (FHLB) System in GSE regulatory reform would be 
better than keeping them out. However, you mentioned that there 
were significant differences between the FHLBanks and the other 
housing GSE's. What differences between the FHLBanks and the 
other housing GSE's do you believe are significant with respect 
to their regulation and would you specifically address such 
differences in legislation reforming their oversight? Please 
explain in detail.

A.5. The importance of our housing finance markets requires 
that all of the housing GSE's be included in a single program 
of world-class supervision. We see the need for this for the 
Federal Home Loan Bank System just as we see it for Fannie Mae 
and Freddie Mac. There are some differences between the 
FHLBanks and the other housing GSE's that require special 
consideration as changes to their regulation are considered. 
Some of these include: Debt issuance of FHLBanks by the Office 
of Finance; how the differing capital structures of the housing 
GSE's are addressed; and how the cooperative ownership 
structure of the FHLBanks would be addressed. While some of 
these issues may need to be addressed specifically with 
legislation, another useful way to account for the unique 
characteristics of housing GSE's is to create two divisions 
within the new regulatory agency--one division specializing in 
Fannie Mae and Freddie Mac and one in the FHLBanks. We look 
forward to working with the Committee on these issues.

       RESPONSE TO A WRITTEN QUESTION OF SENATOR SUNUNU 
                       FROM JOHN W. SNOW

Q.1. Secretary Snow, if you are calling for the GSE's to comply 
with bank-like capital standards, are you suggesting the 
elimination of the .45 percent capital charge that Fannie Mae 
and Freddie Mac currently hold for off-balance-sheet assets, 
such as mortgage-backed securities that they guarantee? Are you 
calling for a new capital requirement to be imposed on the off-
balance-sheet assets of banks?

A.1. We are not suggesting the elimination of any particular 
capital requirement nor are we suggesting new capital 
requirements for banks. The key aspect of our housing GSE 
regulatory reform proposal with respect to capital requirements 
is that we believe that the regulator should have broad 
authority with regard to setting the capital requirements of 
the Enterprises, both with respect to risk-based capital and 
minimum capital. Given the unique nature of mortgage guarantee 
business of Fannie Mae and Freddie Mac such authority could be 
used to set minimum capital standards for those obligations 
even though they are off-balance-sheet obligations. The new 
regulatory agency's authority for setting capital standards 
needs to be flexible enough to employ the best regulatory 
thinking, conscious of the Enterprises' own measures of risk, 
so that the regulator can direct its regulated entities each to 
maintain capital and reserves sufficient to support the risks 
that arise or exist in its business. One such risk is clearly 
the credit risk associated with the GSEs' guarantees of 
mortgage-backed securities, and the new agency should have 
authority to require capital for that risk.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                       FROM JOHN W. SNOW

Q.1. As I said in my opening statement, I am very concerned 
about the unintended consequences this legislation may have on 
small banks. I am especially concerned that they may find 
themselves limited in products they can use to make loans to 
underserved populations and for CRA compliance. Do I have your 
commitment today to do what we can to ensure small banks are 
not adversely affect by this legislation?

A.1. In developing our approach to regulatory reform for the 
housing GSE's we have been focused on two core objectives: 
Promoting a sound and resilient financial system, and increased 
homeownership opportunities for less advantaged Americans. 
Small banks form an important component of our housing finance 
system, and we do not see any reason why improving the 
regulation of the housing GSE's would have a negative impact on 
their operations. In contrast, we would expect that 
improvements in the regulatory oversight of the housing GSE's 
would help to ensure that we have a system in place that serves 
the needs of small banks and their customers both today and in 
the future, and I am committed to that result.

Q.2. As you know, the OCC and the Fed require banks to notify 
their respective regulator after they have engaged in a new 
activity. Why do you think the OCC/Fed model would not work for 
the GSE's?

A.2. The Administration has proposed that the authority for 
approving new activities of the housing enterprises be 
transferred from HUD to the new regulatory agency, and we do 
think that the OCC model for new activity approval is an 
appropriate model for the new regulatory agency. The key 
element is flexibility: Flexibility in bringing new products on 
line and flexibility to provide fully adequate supervision.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER 
                       FROM JOHN W. SNOW

Q.1. Secretary Snow, the initial thinking after Freddie's 
problems erupted was to put Fannie and Freddie's regulator into 
Treasury to bring confidence to the market. Is this still a 
timely rationale for moving the regulator into Treasury or have 
the markets calmed themselves regarding Fannie and Freddie and 
this issue has died?

A.1. While the recent problems experienced by Freddie Mac 
highlighted problems with the housing GSEs' current regulatory 
oversight regime, the rationale for regulatory reform goes 
beyond these recent events. Because housing finance is so 
important to our national economy, we need to have a world-
class regulatory agency to oversee the GSE's in a manner that 
is consistent with maintaining healthy national markets for 
housing finance. There is a general recognition that the 
supervisory system for the housing GSE's has neither the tools, 
stature, authority, nor resources to deal effectively with the 
current size, complexity, and importance of these enterprises. 
As with all forms of Government regulation, policymakers should 
continually evaluate where improvements can be made. It is in 
that regard that the Administration is recommending 
improvements to the oversight of our housing finance system.

Q.2. Secretary Snow, Treasury is now interested in including 
the Federal Home Loan Banks in a bill. I was confused after 
your testimony today because in it you say ``that all housing 
enterprises be included in a single program of world-class 
supervision.'' But in your response to Senator Hagel you said 
there should be two divisions, one for the Banks and one for 
Fannie and Freddie. Do you mean one bureau with two divisions 
or two bureaus? Please clarify what you mean. What is your 
thinking for the structure you propose?

A.2. The key point is that whatever the structure of the new 
housing GSE regulatory agency, the new agency should have the 
same set of enforcement tools and the same overall financial 
supervisory regime in place for all of its regulated entities. 
At the same time, the underlying statutory authority and 
business operations of Fannie Mae and Freddie Mac in comparison 
to the FHLBanks is different, so some specialization in 
regulation may be necessary. One way to address these issues 
would be to create one regulatory agency with two divisions. 
One division would be responsible for Fannie Mae and Freddie 
Mac, and the other division would be responsible for the 
FHLBanks. Under such a structure, benefits in financial 
oversight could be achieved through the sharing of best 
practices in examination procedures and overall measurement of 
risk, while at the same time the unique characteristics of each 
of these entities could also be considered.

Q.3. Secretary Snow and Secretary Martinez, if Fannie and 
Freddie are put into Treasury, you discuss wanting new program 
and/or new activity review. The GSE's are concerned that this 
might impede their ability to be creative and innovative with 
new mortgage products. Do you agree?

A.3. We see no reason why the GSEs' innovation should be 
stifled under a process whereby the new regulatory agency has 
authority to approve new activities. Our Nation's bank and 
thrift regulators have fostered and encouraged innovation using 
the same type of approval authority, and we see no reason why 
providing similar authority to the new regulatory agency would 
stifle innovation by housing GSE's.

Q.4. Secretary Snow, the GSE's are concerned that giving the 
regulator greater discretion to change risk-based capital 
standards might result in higher costs for homeowners and 
renters. Has Treasury considered this concern and what is your 
response?

A.4. In developing our approach to regulatory reform for the 
housing GSE's we have been focused on two core objectives: 
Promoting a sound and resilient financial system, and increased 
homeownership opportunities for less advantaged Americans. To 
serve both of these objectives we need to devote careful 
attention to the resilience of our system of housing finance. 
Housing finance is so important to our national economy that we 
need a strong, world-class regulatory agency to oversee the 
prudential operations of the GSE's and the safety and soundness 
of their financial activities consistent with maintaining 
healthy national markets for housing finance.
    In providing the new regulatory agency with the discretion 
to change risk-based capital standards, we would not expect the 
new regulatory agency to initiate such a change unless the 
risks undertaken by the GSE's warranted such a change. In that 
regard, changes in capital standards should go toward 
strengthening the financial position of the GSE's and further 
promoting our goal of a strong and resilient housing finance 
system that serves the needs of our Nation's homeowners today 
and in the future, ultimately increasing home affordability.

Q.5. Secretary Snow, do you know if anyone in the Government 
has studied or is studying what the cost or impact to the 
Federal Home Loan Banks will be of registering their stock with 
the SEC? (If he says no. You might suggest that some staff 
attention be given to this issue.)

A.5. The FHLBanks have raised the concern of potential costs or 
unintended effects of registering with their stock with the 
SEC. It is my understanding the FHLBanks and the SEC continue 
to discuss details (for example, how the joint and several 
liabilities of the FHLBanks will be described) regarding 
concerns the FHLBanks have raised with registration. I am 
confident that these types of concerns can be worked out, which 
would then remove any remaining impediment to the FHLBanks' 
registering with the SEC.
    As it relates to studying the issue of cost or impact on 
the FHLBanks, it is difficult to see how providing greater 
financial disclosure to the market could have a negative impact 
on the FHLBanks unless such disclosure reveals new information 
to financial market participants that raises questions 
regarding the FHLBanks' credit quality.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                       FROM MEL MARTINEZ

    The mission of Fannie Mae and Freddie Mac is expanding 
homeownership, and their housing goals are a barometer of that 
mission.
Q.1.a. Do you believe the current housing goals are sufficient 
to fulfill the GSEs' mission? If yes, then why change the 
current system?

A.1.a. No, HUD believes the current goals are not sufficient to 
ensure that the GSEs' focus on expanding homeownership. Goals 
must be dynamic to ensure that areas where there is a need can 
be adequately targeted. Under the Administration's proposal, 
HUD would receive enhanced authority to establish and enforce 
housing goals for the GSE's. This enhanced authority would 
include the ability to establish an annual home purchase goal 
for the GSE's which could be specifically targeted to first-
time homebuyers, low-and moderate-income homebuyers, homebuyers 
in underserved areas, and homebuyers of special affordable 
housing. Other proposed enhancements include the ability to 
add, modify, or rescind existing goals as needed to better 
serve housing needs. In addition, to ensure that this function 
is given significant attention, the Administration also 
proposes establishing a new office within HUD, with the costs 
of regulation to be funded, as with other financial regulators, 
through assessments on the regulated entities, the GSE's.

Q.1.b. What do you see as the dividing line between encouraging 
affordable mortgage lending and credit allocation? How do we 
make sure these goals are insulated from the political process?

A.1.b. Congress chartered both Fannie Mae and Freddie Mac to 
fulfill certain public purposes, including providing ongoing 
assistance to the secondary market for residential mortgages, 
which 
includes activities relating to mortgages on housing for low- 
and moderate-income families involving a reasonable economic 
return that may be less than the return earned on other 
activities. The Department's housing goals for the GSE's are in 
furtherance of these purposes and reflect Congress's 
objectives. In return for confining their businesses to meeting 
these objectives, the GSE's receive substantial benefits, 
estimated by the Congressional Budget Office in May 2001 at 
$10.6 billion per year.
    With enactment of the Federal Housing Enterprises Financial 
Safety And Soundness Act, FHEFSSA, in 1992, Congress clarified 
the GSEs' public purposes further by establishing specific 
affordable housing objectives and mandating that HUD establish 
quantitative targets under each goal. As a result of these 
actions, the requirement for improved performance and 
accountability in affordable mortgage lending and the 
requirement to allocate credit for these purposes are the same 
thing. In setting annual targets for each GSE under the FHEFSSA 
and to ensure that the Enterprises are able to provide 
liquidity to residential mortgage markets as intended by their 
charter acts, HUD evaluates the level of each goal against six 
factors as set forth in the FHEFSSA. These factors include the 
size of the market for each goal, the GSEs' past performance 
under the goals, and the GSEs' ability to lead the market. The 
purpose of these considerations is to assure that the goal 
levels are appropriate. The process and methodology that HUD 
relies upon in making its determinations weigh these 
considerations based on objective market data and are published 
for evaluation, review, and comment in each proposed rule for 
new goals. This transparent process ensures that goal levels 
are established in an environment that is objective and 
insulated from undue political influence.

Q.1.c. How would the home purchase goal proposed by the 
Administration differ, operationally, from the current housing 
goals?

A.1.c. The Administration's proposal would allow HUD to 
establish, through regulation, four components of an annual 
home purchase goal for single-family dwelling units. These 
components would include first-time homebuyers; low- and 
moderate-income homebuyers; homebuyers in central cities, rural 
areas, and other underserved areas; and homebuyers of special 
affordable housing. The components, expressed as percentages of 
each GSE's home purchase mortgage business, would be 
established at levels that would increase the GSEs' secondary 
market financing of home purchase mortgages serving the charter 
missions of the GSE's and the goals established by the FHEFSSA. 
The components would be enforceable as goals.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 
                       FROM MEL MARTINEZ

Q.1. In your September 10 House Financial Services testimony, 
you said that you felt that it was important to place new 
program and activity approval authority with the proposed new 
regulator entity at Treasury. You said it should be moved to 
Treasury because you felt that such authority impacted the 
safety and soundness of the GSE's.
    You have proposed the creation of a new oversight office 
within HUD to oversee affordable housing goals. With an 
appropriate level of funding and a staff skilled in evaluating 
the financial implications of new programs and activities, why 
do you believe that such a HUD office would be unable to 
effectively regulate new program and activity approval?

A.1. The Administration's proposal provides for establishing a 
new regulatory office within the Treasury Department. The new 
office, consistent with Treasury's experience as a financial 
regulator, would be responsible for overseeing the GSEs' safety 
and soundness. The new office also would have authority to 
review GSE 
activities that frequently present safety and soundness issues 
as primary concerns. Because new activities may also have 
mission implications, the new office will be required to 
consult with HUD in its reviews. This approach allows HUD to 
retain a key role as the GSEs' mission regulator while also 
ensuring that the new safety and soundness office has all the 
tools necessary to function as a world-class regulator.

    In your testimony, you have argued that the GSE's lag the 
private market in lending to minority and first-time 
homebuyers. It is my understanding that the studies you cite 
include data from the Home Mortgage Disclosure Act (HMDA), 
which doesn't reflect purchases of seasoned loans, and includes 
data from the private market that includes a higher percentage 
of the subprime market than the GSE's.
Q.2.a. Can you cite for the record a study that compares 
minority and first-time conventional loan borrowers using data 
that includes seasoned loans that definitively demonstrates 
that the GSE's lag the private market among borrowers with 
similar income, credit, wealth, and racial profiles?

A.2.a. HUD and private researchers have published numerous 
studies on the GSEs' performance in funding affordable home 
purchase mortgages. These studies concluded that both Fannie 
Mae and Freddie Mac have lagged the primary market in 
purchasing loans for groups covered by the housing goals: Low- 
and moderate-income and special affordable borrowers and 
borrowers living in underserved areas. HUD's most recent study 
analyzed GSE and market data through the year 2000.
    This response presents updated data for 2001 and 2002 and 
includes analysis of first-time homebuyers. The analyses 
reported in the tables below compare characteristics of loans 
originated in the conventional conforming market, as shown in 
HMDA data, with characteristics of loans purchased by the 
GSE's, as shown in the data they have provided annually to HUD.
    Loan characteristics (such as underserved area loans) are 
presented in the form of percentage shares of loans originated 
in the conventional conforming market, as compared with 
corresponding percentage shares of loans purchased by Fannie 
Mae or Freddie Mac. The percentage shares (or ratios) for the 
market are limited to loans originated during the current year, 
adjusted to exclude loans originated by ``B and C'' subprime 
lenders. As explained below, the GSEs' purchases include both 
(a) current-year, newly originated mortgages and (b) prior-
year, seasoned mortgages, for which percentage shares can be 
presented in alternative ways.
    Question 2(a) raised the issue of the GSEs' purchases of 
seasoned loans. It is not possible to provide consistent 
comparisons including seasoned loans as well as newly 
originated loans, because the market data, provided under the 
Home Mortgage Disclosure Act (HMDA), do not include the 
seasoned loans that are available for purchase by the GSE's. 
There are different ways to treat seasoned loans when comparing 
the GSEs' purchases to market originations. The most 
appropriate and most consistent is to exclude seasoned loans 
from the GSE data for the year in which they are purchased by 
the GSE's, and count them instead in the year in which they are 
originated. This approach is taken in the accompanying Tables 1 
and 2. Table 1 reports the GSE data on an ``origination-year'' 
basis. This is the closest in concept to the market data, which 
are also presented on an ``origination-year'' basis. The GSE 
data in Table 1 for the year 2001 include all the GSEs' 
purchases through 2002 of loans originated during 2001; in 
other words, it includes the GSEs' purchases of 2001 
originations during both 2001 and 2002. Thus, in Table 1, 
seasoned loans (that is, 2001 mortgage originations purchased 
by the GSE's in 2002) are reallocated back to their year of 
origination. This places them on a comparable basis with the 
HMDA market origination data. As shown in Table 1, low- and 
moderate-income families accounted for 41.7 percent of the 
GSEs' purchases (through 2002) of 2001 mortgages. Table 1 also 
shows that low- and moderate-income families accounted for 42.9 
percent of the mortgages originated in the conventional 
conforming market during 2001. Thus, for low- and moderate-
income loans, the GSEs' purchases of 2001 originations lagged 
the 2001 origination market.
    The percentages reported in Table 1, taken together, show 
that the ratios for each of the GSE housing goals (indicated as 
``Both GSE's'') were behind the market ratios in both 2001 and 
2002. Freddie Mac lagged behind both the market and Fannie Mae, 
except in 2002 when Freddie Mac equaled Fannie Mae in the 
special affordable category. Fannie Mae's mortgage purchase 
ratios lagged behind the market ratios, except in 2002 when 
Fannie Mae surpassed the market in the low- and moderate-income 
category.
    Table 2 compares the GSEs' ratios with market loan 
origination ratios for three race/ethnicity categories. Again, 
the ratios for ``Both GSE's'' were behind the market ratios for 
African American borrowers, Hispanic borrowers, and all 
minority borrowers in both 2001 and 2002. During 2001 and 2002, 
Fannie Mae's ratios lagged behind the market in the African 
American category but exceeded or equaled the market in the 
other two categories (Hispanic and All Minorities). Freddie 
Mac's ratios fell below the market in all three race/ethnicity 
categories in both 2001 and 2002.
    Tables 3 and 4 repeat the analyses in Tables 1 and 2, 
except that the GSE data are expressed on a ``purchase year'' 
basis. This means that all the GSEs' purchases in a particular 
year are compared to mortgages originated in the market in that 
same year. Thus, in this analysis, the GSEs' data for 2001 
include not only their purchases during 2001 of mortgages 
originated during 2001, but also their purchases of prior-year, 
or so-called ``seasoned mortgages,'' such as mortgages 
originated during 1999 or 2000. These ratios for the GSE's are 
not as directly comparable to the market ratios as are the 
ratios in Tables 1 and 2. They measure the overall purchase 
activity of the GSE's during 2001, rather than the purchases of 
the GSE's of loans originated in 2001.
    Using this ``purchase year'' approach, Table 3 compares the 
percentage shares of goal-qualifying mortgages in the GSEs' 
purchases and market originations. It shows that all of the GSE 
housing goal category ratios (indicated as ``Both GSE's'') were 
behind the market ratios in both 2001 and 2002. Freddie Mac 
lagged behind Fannie Mae, while Fannie Mae's mortgage purchase 
ratios equaled or exceeded the market ratios in 2002. Table 4 
compares the GSEs' 
ratios with market loan origination ratios for three race/ 
ethnicity categories. Again, the ratios for ``Both GSE's'' were 
behind the market ratios for African American borrowers, 
Hispanic borrowers, and all minority borrowers in both 2001 and 
2002. However, Fannie Mae's ratios exceeded the market in two 
of three racial/ethnicity categories in 2001 and all three 
racial/ethnicity categories in 2002, while Freddie Mac's ratios 
fell below the market in both years.
    As explained above, the GSEs' ratios in Tables 3 and 4 
include their purchases of loans originated both in the current 
year and in prior years. The GSEs' purchases of loans 
originated in prior years typically tend to include a greater 
share of goals-qualifying mortgages than do their purchases of 
loans originated in the year of purchase by the GSE. Thus, the 
GSE percentages tend to overstate the GSEs' performance in a 
particular category, relative to a consistent concept of loans 
originated in a given year (as presented in Tables 1 and 2).
    Tables 3 and 4 present the comparisons in the way that HUD 
traditionally has reported the GSEs' performance, even though 
the data are not as comparable as the origination-year basis. 
Throughout the 1990's the GSE's lagged the market by such a 
substantial margin that the differences in coverage between the 
GSE and market data did not affect the result materially and 
did not change the basic conclusion. The GSEs' improvement in 
very recent years, and the renewed public interest in their 
performance, has led HUD to refine the analysis and make the 
comparisons as precise as possible. These comparisons, as 
mentioned, appear in Tables 1 and 2.
    Table 5 compares the GSEs' funding of mortgages for first-
time homebuyers with market loan originations for first-time 
home buyers. This table shows that first-time homebuyers 
represented 37.6 percent of market loan originations, compared 
with 26.5 percent of the GSEs' purchases; thus, the GSE's fell 
substantially short of the market originations ratio for first-
time homebuyers over the period 1999-2001. For minority first-
time homebuyers, the GSE ratio was 6.2 percent, compared to a 
market originations ratio of 10.6 percent. For African American 
and Hispanic first-time homebuyers, the GSE ratio was 3.8 
percent, compared to a market originations ratio of 6.9 
percent. For first-time homebuyers, particularly first-time 
minority homebuyers, both GSE's substantially lagged the 
private conventional conforming market. HUD has not previously 
published this comparison.





Q.2.b. If you are able to definitively demonstrate such a 
difference between the GSE's and the private market exists, 
please describe why such a difference exists, considering that 
it is in GSE's financial interests to buy as many conventional 
loans as possible.

A.2.b. In the past, the GSE's generally focused on borrowers 
with traditional backgrounds and living in suburban settings, 
as Congress observed in the early 1990's: ``Inadequate access 
to mortgage credit is a particular problem which results, in 
large part, from the vestiges of redlining and the unintended 
consequences of the Enterprises' orientation toward suburban 
and ``plain vanilla'' mortgages.'' \1\
---------------------------------------------------------------------------
    \1\ Senate Report 102-282, May 1992, p.38.

    The GSE's have made significant changes in their 
underwriting guidelines in recent years and, in conjunction 
with primary lenders, have introduced a variety of new products 
and programs for nontraditional buyers. Thus, major gains have 
been made by the GSE's in serving traditionally underserved 
borrowers and neighborhoods. However, HUD and others believe 
that additional steps could be taken by the GSE's, without 
damaging their safety and soundness, to reach out further to 
this market.
    For example, research on the GSEs' mortgage purchases has 
found that many of their goal-qualifying loans have rather low 
loan-to-value ratios. This has raised concerns that some 
nontraditional borrowers who are unable to make high 
downpayments are not able to obtain conventional loans that 
could be purchased by the GSE's, thereby forcing these 
borrowers to more expensive loans, such as FHA-insured loans. 
In this regard, there are indications that both GSE's 
understand the importance of improving access for borrowers 
with low downpayments. For example, Fannie Mae recently 
announced a plan for a joint venture with a mortgage insurer to 
increase such purchases.

Q.2.c. Why hasn't HUD updated the affordable housing goals yet 
using its current authority? When do you plan on updating them?

A.2.c. HUD is currently working on establishing new affordable 
housing goals. However, determinations regarding the market 
share, upon which each goal is based are highly dependent upon 
current census data. Complete data from the 2000 census has 
only recently become available. HUD's regulations state that 
housing goals will remain in effect until such time as a new 
regulation is promulgated. The Department anticipates that new 
goals will be in place for 2005. With respect to rulemaking for 
affordable housing goals and other HUD regulatory 
responsibilities, it is important to remember that the 
Department has limited staff that it can devote to these 
regulatory activities, because it lacks the ability to fund its 
regulatory activities through assessments on the GSE's. Other 
financial regulators do have assessment authority. The 
Administration's proposal, which will establish a dedicated 
office and staff to carry out HUD's regulatory responsibilities 
and which will provide for funding based upon fee assessments 
on the GSE's, will markedly improve HUD's ability to carry out 
its functions.

Q.3.a. How does HUD currently define the difference between new 
programs and new activity and/or products?

A.3.a. HUD relies on the current statutory definition in the 
Federal Housing Enterprises Financial Safety and Soundness Act 
of 1992 (FHEFSSA), as well as its legislative history, in 
making determinations about what is subject to review as 
required under the FHEFSSA. Section 1303 of the FHEFSSA defines 
a ``new program'' as--

    any program for the purchasing, servicing, selling, lending 
on the security of, or otherwise dealing in, conventional 
mortgages that (A) is significantly different from programs 
that have been approved under this Act or that were approved or 
engaged in by an enterprise before the date of the enactment of 
this Act [10/28/92]; or (B) represents an expansion, in terms 
of dollar volume or number of mortgages or securities involved, 
of programs above limits expressly contained in any prior 
approval.

    The legislative history states that ``[n]ew products or 
programs that differ from existing programs because of 
insignificant variations in mortgage characteristics, technical 
improvements, or those, generally, that represent 
recombinations of features used in existing programs need not 
be submitted for approval.'' \2\ There is no statutory 
definition or legislative history that differentiates 
``activities'' from either ``products'' or ``programs.''
---------------------------------------------------------------------------
    \2\ Senate Report 102-282, May 15, 1992, p.15.

---------------------------------------------------------------------------
Q.3.b. Is there a problem with this definition? Why or why not?

A.3.b. The current definition is imprecise. It is often 
difficult to make the distinction between products and programs 
for regulatory purposes. Both GSE's have relied upon the 
imprecise language to determine for themselves that nearly all 
initiatives are either products, mortgage features, or other 
activities that do not fall within the meaning of ``new 
programs'' as defined in FHEFSSA. As a result, even though the 
current statute requires the GSE's to receive prior approval 
from HUD before instituting a new program, they rarely seek 
this approval.

Q.3.c. If there is a problem with this definition, how would 
you propose changing it?

A.3.c. The Administration is proposing the creation of a world-
class regulatory office within the Treasury Department with 
authority over both safety and soundness and the review of new 
and ongoing activities of the Enterprises. The Administration's 
proposal for new activity review better delineates the scope of 
oversight authority by removing the definitional distinctions 
that have contributed to confusion and misunderstanding in the 
past.

Q.4.a. You sent the Congress legislative language that would 
give the HUD Secretary the authority to rescind housing goals 
that Congress has established for these companies by only 
giving 30 days notice. By my reading of this language, you 
could rewrite the goals set by Congress simply by determining 
in your opinion that there are other housing needs. Why does 
HUD need the power to rescind housing goals with 30 days 
notice?

A.4.a. The Administration's proposal would not authorize HUD to 
rescind housing goals upon a 30-day notice. Under the 
Administration's proposal, HUD may only establish, modify, or 
rescind a goal by regulation, with formal notice and comment. 
Therefore, if HUD rescinds a goal or establishes a new goal, it 
can only be done by notice and comment rulemaking.
    A new goal would not become effective until at least a year 
after it was promulgated by a final rule, that is, following at 
least a 1-year transition period. For example, a new goal 
established by a final rule promulgated on October 1, 2004, 
would be made effective on January 1, 2006.
    Under the Administration's proposal, HUD could establish 
necessary implementation requirements for the transition, for 
example, procedures for reporting on the transitional goal or 
for applying the goal requirements. These transition 
requirements could be established by notice only after 
providing the GSE's at least 30 days to comment. The 
Administration's proposal is modeled on the transition language 
for establishing the goals under FHEFSSA. Accordingly, the 30-
day period is only relevant to the GSEs' opportunity to comment 
on the establishment of transition requirements for goals 
established through rulemaking.

Q.4.b. In your testimony, you argued that there should be a new 
first-time homebuyer goal. Wouldn't such a goal damage the 
housing refinancing or multifamily markets? Why not?

A.4.b. Under the Administration's proposal, the Enterprises 
could continue to purchase any volume of multifamily and 
refinanced single family mortgages that they desire with no 
adverse impact on their ability to achieve a first-time 
homebuyer goal. The reason for this lies in the way goals are 
established and performance under them is calculated.
    The Administration's proposal applies only to loans to buy 
homes that are purchased or securitized by the GSE's. There 
would not be a numerical target for the total number of home 
purchase loans, nor would there be a home purchase loan target 
in terms of the percentage of total GSE business that would be 
devoted to home purchase loans. Instead, the number of home 
purchase loans would be left to the business judgment of the 
GSE's. Whatever that number may be in a given year, some 
specified percentage of those loans would be for first-time 
homebuyers.
    The performance of the Enterprises under this component 
would be calculated by dividing the number of home purchase 
mortgages that are for first-time homebuyers by the total 
number of home purchase mortgages acquired, including both 
first-time and repeat homebuyers. The inclusion of other types 
of mortgages in the calculation, such as refinance mortgages, 
would indeed cause a corresponding drop in the reported 
percentage of first-time home purchase mortgages acquired and 
could possibly deter the Enterprises from purchasing these 
types of mortgages. This is not what the Administration 
proposes.
    Helping families become homeowners is an important public 
purpose of the GSE's, and home purchase loans are their ``bread 
and butter'' business. The housing goals do not now recognize 
the importance of homeownership. The Administration believes 
that they should.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                       FROM MEL MARTINEZ

Q.1. As I said in my opening statement, I am very concerned 
about the unintended consequences this legislation may have on 
small banks. I am especially concerned that they may find 
themselves limited in products they can use to make loans to 
underserved populations and for CRA compliance. Do I have your 
commitment today to do what we can to ensure small banks are 
not adversely affected by this legislation?

A.1. The Administration's GSE regulatory reform proposal 
provides that the new GSE regulatory office responsible for 
safety and soundness regulation will have the authority to make 
determinations with regard to the permissibility of new GSE 
activities. In carrying out this review authority, the new 
regulator must consult with HUD. The Administration believes 
that this new procedure will ensure that in any review of GSE 
activities, the GSEs' safety and soundness, as well as the 
GSEs' affordable housing mission, will be fully considered. 
Small banks, such as those in Kentucky that have expressed 
their concerns to you, serve important roles in funding 
affordable housing loans through their CRA programs. The 
Administration fully understands the extent to which CRA 
lenders, such as small banks, rely upon the GSE's to purchase 
seasoned portfolios of CRA-eligible loans and to offer products 
that meet those obligations. For these reasons, the 
Administration is confident that its regulatory proposal is the 
right approach. HUD's consultative role in new activity review 
along with enhanced goal-setting and enforcement authority will 
continue to provide strong oversight with respect to each GSE's 
affordable housing mission.

Q.2. As you know, the OCC and the Fed require banks to notify 
their respective regulator after they have engaged in a new 
activity. Why do you think the OCC/Fed model would not work for 
the GSE's?

A.2. With respect to the OCC/Fed model for regulation, the 
Department will defer to the Treasury Department because it is 
more familiar with the specifics of these models. However, I 
would like to point out that in developing its current 
proposals, the Administration followed the model previously 
established by Congress wherein prior approval was determined 
to be the appropriate method of regulation for Fannie Mae and 
Freddie Mac. (This approach was instituted under Fannie Mae's 
Charter in 1968 and Freddie Mac's Charter revision in 1989. The 
1992 Act reaffirmed the Department's authority for prior 
review.) The GSE's are limited-purpose corporations. At the 
time the 1992 regulatory legislation was enacted, it was 
apparent that the GSE's had also grown substantially since 
their creation, both absolutely and relative to the mortgage 
market. No single bank commands the market share that Fannie 
Mae and Freddie Mac do. Collectively, the Enterprises currently 
account for more than 70 percent of the conventional conforming 
mortgage market and between 40-50 percent of the entire 
mortgage market. In addition, the enterprises' mortgage-backed 
securities are widely held by other financial institutions in 
this country. These levels of concentration are so significant, 
and the implications of any unsafe enterprise activity so 
widespread, that the risk of significant financial impact 
extends well beyond the Enterprises themselves to the Nation's 
entire financial system. Given these implications and 
restrictions, the Administration believes that Congress was 
correct in mandating a prior approval review.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER 
                       FROM MEL MARTINEZ

Q.1. Secretary Snow and Secretary Martinez, if Fannie and 
Freddie are put into Treasury, you discuss wanting new program 
and/or new activity review. The GSE's are concerned that this 
might impede their ability to be creative and innovative with 
new mortgage products. Do you agree?

A.1. HUD understands that the ability of the GSE's to innovate 
new products is important to achieving their public purposes. 
The Administration's proposals are intended to strengthen 
regulation in a manner that ensures prudent oversight without 
impeding either GSE's business operations or their ability to 
innovate in carrying out their public purposes. As the 
Department responsible for ensuring that the GSE's carry out 
their affordable housing mission, HUD has an interest in 
supporting the GSEs' ability to develop the tools necessary for 
this purpose. The Administration's proposed procedure for 
reviewing new activities requires that HUD serve in a 
consultative capacity, thereby helping to ensure that new 
activities are consistent with the GSEs' public purposes and 
that reviews are conducted expeditiously. The Administration's 
new procedure will also ensure that in reviewing new 
activities, the GSEs' safety and soundness, as well as their 
affordable housing mission, will be fully considered.

Q.2. Secretary Martinez, you do not discuss the Federal Home 
Loan Banks in your statement. I wonder if you have any opinion 
about them regarding their housing mission and moving their 
regulator into Treasury?

A.2. Fannie Mae and Freddie Mac share many characteristics with 
the Federal Home Loan Banks (FHLBanks). Congress created all of 
these enterprises to serve specific public purposes, and they 
all have a housing mission. We welcome a discussion on this 
issue and look forward to working with Congress, the FHLBanks, 
and other interested parties regarding the appropriate 
regulatory structure for the FHLBanks.

       RESPONSE TO A WRITTEN QUESTION OF SENATOR SHELBY 
                    FROM FRANKLIN D. RAINES

Q.1. The Administration has proposed that the new regulator 
have all the receivership authority necessary to direct the 
orderly liquidation of assets. What difficulties would you see 
in moving to receivership powers akin to those held by the 
FDIC? What impact would receivership have on the ability of the 
GSE's to access the debt markets?

A.1. The receivership powers granted by Congress to the FDIC 
primarily protect the FDIC insurance deposit fund. The FDIC, as 
receiver, is charged with closing and/or selling a failing 
institution and giving priority to the claims of insured 
depositors. The charter of the troubled bank or thrift is 
extinguished. The receivership powers of the FDIC under Section 
11 of the Federal Deposit Insurance Act (FDI Act) are complex 
and have been subject to extensive interpretation by the FDIC.
    The FDIC is not required to put a bank or thrift into 
receivership; it may also elect to put an institution into 
conservatorship under Section 11 of the FDI Act in an effort to 
return the institution to financial health. The FDIC can also 
avoid putting an institution into receivership if the FDIC, the 
Fed, and the Treasury determine (in consultation with the 
President) that putting a bank or thrift into receivership 
``would have serious adverse effects on economic conditions or 
financial stability and any action or assistance . . . would 
avoid or mitigate such adverse effects . . . .'' 12 U.S.C. 
1823(c)(4)(G).
    Simply importing all of the FDIC's receivership powers 
under Section 11 of the FDI Act into the GSE legislation raises 
several issues.
    First, many of the provisions of Section 11 serve primarily 
to protect insured deposits, which the GSE's do not have. It is 
unclear exactly how those sections might be applied to the 
GSE's.
    Second, H.R. 2575's provision on ``enhanced 
conservatorship'' appears to import all of the FDIC's powers as 
a receiver without providing any of the protections that exist 
for insured banks or thrifts. The proposal does not provide for 
an exception similar to the one that would apply to large banks 
or thrifts that might prevent those institutions from being 
placed into receivership by the FDIC. Given the importance of 
the GSE's to the housing markets, the serious consideration 
that would be given, for example, to Citibank before putting 
the institution into receivership, would be appropriate for the 
GSE's.
    H.R. 2575 also does not appear to protect expressly certain 
types of contracts in the event of receivership. The 
``qualified financial contract'' exception to the FDIC's 
receivership powers (and the FDIC's interpretations thereof) 
was adopted to provide certainty to financial markets as to the 
treatment of these contracts by a receiver or conservator for 
an insured depository institution. Similar protections are 
included in the U.S. Bankruptcy Code for application in 
nondepository institution bankruptcies. In addition, the FDIC 
has provided by regulation (12 CFR 360.6), subject to the 
requirements therein, assurances to the markets and holders of 
mortgage-related securities issued by insured depository 
institutions that the FDIC will not reclaim, for the 
receivership or conservatorship estate, mortgage loans 
transferred by an insured depository institution into a 
securitization. Absent such express protections tailored to the 
GSEs' business, wholesale importation of the FDIC's 
receivership powers into GSE receiverships could, for example, 
impair the value and liquidity of the mortgage-backed 
securities issued in existing GSE securitization transactions, 
thus unnecessarily increasing costs and decreasing liquidity. 
Therefore, we believe that express protections for certain 
contracts and securi-
tizations are critical to providing certainty to the markets 
and insuring that the cost of raising funds for the secondary 
mortgage market is not unnecessarily increased.
    Creating uncertainty is not necessary to enhance the power 
of the conservatorship provisions of the 1992 Act if such 
enhancement is Congress' goal. For example, specific and 
additional grants of authority could be given to a GSE 
conservator within the framework of the 1992 Act and by 
including express limitations on repudiation or 
recharacterization of GSE contracts in the 1992 Act.
    We note that our answers above do not change the point made 
in our testimony before the Committee on October 16, 2003. We 
do not see any need for any change to the conservatorship 
provisions that exist in the 1992 Act. In 1992, Congress 
affirmatively rejected the receivership model for the GSE's in 
favor of the conservatorship model. The legislative history of 
the 1992 Act makes clear that Congress considered and rejected 
the receivership option for the Enterprises. The Senate 
Committee Report notes that the version of the 1992 Act first 
passed by the Senate (which contained conservatorship 
provisions substantively similar to those eventually enacted) 
``does not contain authority to appoint a receiver for the 
Enterprises.'' The Report explains:

    The Committee determined that providing for the appointment 
of a conservator was sufficient. This judgment takes account of 
the important role that the Enterprises play in our Nation's 
economy . . . . The Enterprises are clearly distinguishable 
from even the largest depository institutions, each of which 
may cease to be able to compete as a provider of financial 
services with varying degrees of economic impact. If the 
appointment of a conservator for an enterprise were ever to 
become imminent, the Congress would have the opportunity to 
consider the reasons for the Enterprise's condition and the 
options then available to address that condition. The 
legislation provides for continuing reports to the Congress on 
the capital condition of the Enterprises, so the Committee 
expects the Congress will have more than ample notice to 
proceed deliberately in considering any possible future action 
with respect to the enterprises.
    Senate Report, 102-282, at 16.

    The conservatorship powers Congress authorized in 1992 are 
very broad and would permit the conservator to run the 
institution on a day-to-day basis, including selling off 
assets, until the GSE returned to financial health or Congress 
took some other action. Pursuant to the 1992 Act, a conservator 
has ``all of the powers of the shareholders, officers, and 
directors'' of Fannie Mae or Freddie Mac. 12 U.S.C. 1369A(a). 
In addition, a conservator may (i) avoid any security interest 
taken by a creditor with the intent to hinder, delay, or 
defraud the company or its creditors, (ii) enforce any contract 
notwithstanding a provision of the contract providing for the 
termination of the contract upon the appointment of a 
conservator, and (iii) receive a stay in a judicial action or 
proceeding for up to 45 days. OFHEO also may require that a 
conservator set aside and make available for payment to 
creditors amounts that may be safely used for such purpose; all 
similarly situated creditors must be treated similarly. The 
appointment of a conservator does not affect OFHEO's authority 
under the 1992 Act to oversee the companies and to impose 
requirements and restrictions based on the capital-based 
classification system.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 
                    FROM FRANKLIN D. RAINES

Q.1. I realize that the GSE's have continued to meet their 
affordable housing goals. However, in light of the rising 
housing costs in many communities across the Nation, do you 
believe the current goals are sufficient to expand 
homeownership in high-cost communities across the country? Why 
or why not?

A.1. The current goals are only one measure of Fannie Mae's 
efforts to make homeownership more affordable in communities 
across the country. We believe the current goals are very 
demanding, particularly in the current business environment, 
and they are ensuring that we continue to expand homeownership. 
The low- and moderate-income goal applies across the Nation, 
including in high-cost communities, and to reach and exceed 
that goal we innovate to create products and partnerships that 
make homeownership more affordable to low- and moderate-income 
families everywhere.
    Many low- and moderate-income renters aspire to 
homeownership, but they often face daunting barriers such as 
the difficulties in accumulating a downpayment or qualifying 
for an affordable mortgage, especially with imperfect credit. 
Fannie Mae has worked with lenders and community partners to 
develop products and services to overcome these barriers. We 
have developed automated underwriting that has lowered the 
costs of mortgage originations, new low-downpayment products 
that help people get into homes with as little as $500 down, 
and products with flexible underwriting that serve credit 
blemished borrowers. We have worked to expand employer-assisted 
housing programs; many employers--especially in high-cost 
areas--have found it is in their interest to help employees 
afford a home as part of the employer's recruitment and 
retention strategies. These initiatives make homeownership more 
affordable in high-cost areas and help us meet our regulatory 
requirements. The results are clear, as shown below:




    The affordable housing goals set by HUD do not limit us to 
serving only targeted borrowers. They require us to devote a 
percentage of our business to these populations, but our 
mission is to serve a broader market. Our charter mandates that 
we provide liquidity to the market for residential mortgages, 
including, but not limited to, mortgages that qualify for the 
affordable housing goals. By attracting low-cost funding to the 
mortgage market and creating liquidity, we reduce the interest 
rate on all conforming mortgages by at least 0.25 percentage 
points. We serve this entire market in a way that expands 
liquidity and reduced mortgage rates for all conforming 
mortgages, while focusing special attention on low- and 
moderate-income borrowers.

Q.2. Are there any new affordable housing goals you would 
support adding to those currently authorized? If so, please 
describe them.

A.2. HUD sets housing goals as a regulatory requirement to 
ensure that Fannie Mae focuses particular attention on low- and 
moderate-income borrowers and underserved areas. We have 
consistently met or exceeded the current goals. The Agency is 
developing proposed goals for next year and beyond.
    Over the years, HUD has sought to establish goals that 
require the company to stretch beyond levels we might otherwise 
achieve, without threatening our safety and soundness or 
jeopardizing the liquidity of the mortgage finance system. HUD 
relies on predictions of market growth to establish these 
goals. This kind of forecasting is not easy and predictions are 
likely to be inexact. The refinance boom of the last 2 years, 
which exceeds anything foreseen by HUD when these goals were 
set, highlights that fact.
    It is critical that the housing goals structure allows 
Fannie Mae the ability to make business decisions based on 
actual market conditions. Under the structure created by the 
1992 Act, HUD has considerable flexibility in establishing the 
goals in its rulemaking process, and can use that authority to 
focus our efforts toward specific high-priority portions of the 
market.
    HUD's recasting of the goals in 2000 is an example of that 
flexibility. The Department increased all three housing goals. 
The goal for Fannie Mae's purchase of loans to low- and 
moderate-income borrowers was increased from 42 percent in 1999 
to 50 percent in 2000. In addition, the new goals that gave 
Fannie Mae an incentive to pay special attention to financing 
small multifamily properties and owner-occupied 2-4 unit 
properties.
    Going forward, it is critical that housing goals are not 
increased to the point that they threaten our safety and 
soundness or undermine our ability to serve a market that 
includes middle-class as well as low-income borrowers. Today, 
we work to expand the 
universe of Americans who can afford to purchase a home by 
increasing low-cost funding available for mortgages for middle 
class families, as well as for underserved communities. Goals 
that become too numerous or narrow can lead to fragmentation in 
the market and credit allocation. This would distort Fannie 
Mae's business and undermine the critical role we play in the 
market.

Q.3. If Congress were to establish an independent regulator and 
with a well-respected impartial Director to head it, why 
shouldn't that Director be able to raise minimum capital 
standards, if he or she believed it to be necessary to ensure 
the safety and soundness of the GSE's? Please explain.

A.3. Fannie Mae operates under two capital requirements--a 
minimum capital, or leverage, requirement and a risk-based 
capital requirement. Each quarter, Fannie Mae must meet both 
requirements.
    The leverage requirement, also known as minimum capital, 
does not change based on the risk of the assets a financial 
institution. Instead, the leverage limit serves as a capital 
``floor'' based on the general risk of an entity. Fannie Mae 
and Freddie Mac's leverage ratio, set by statute, is 2.5 
percent for on-balance-sheet assets and 0.45 percent for off-
balance-sheet assets. Unlike the bank leverage ratio, the GSE's 
leverage test requires capital support for off-balance-sheet, 
as well as on-balance-sheet, exposures. Fannie Mae's capital as 
a percentage of on-balance-sheet assets (as the bank ratio is 
calculated) was 3.4 percent on June 30, 2003. Including 
outstanding subordinated debt, that figure rises to 3.9 percent 
of on-balance-sheet assets. Bank regulators set minimum capital 
requirements, typically requiring a bank to hold 5 percent 
capital against on-balance-sheet assets, regardless of how 
risky those assets are, in order to be considered well-
capitalized. The leverage measure ignores all off-balance-sheet 
assets, although a bank may have significant off-balance-sheet 
exposures.
    Fannie Mae invests only in U.S. residential mortgages, 
which are far less risky than many bank investments like 
consumer debt, commercial real estate, or third-world debt. 
Thus, having a leverage limit for Fannie Mae and Freddie Mac 
that is somewhat lower than the leverage limit for banks makes 
sense if the average risk of Fannie Mae and Freddie Mac's 
assets is lower than the average risk of banks' assets. 
Experience shows that in fact the risks of holding a mortgage 
are a fraction of the risk of other loans. Furthermore, Fannie 
Mae's book of business is more geographically 
diverse than those of most banks, and the company is required 
to obtain mortgage insurance or other credit enhancements 
against higher risk loans.
    This lower risk is reflected in the comparable capital-to-
loss ratios of Fannie Mae and commercial banks. For the first 
half of 2003, Fannie Mae's ratio of capital to credit losses, 
on an annualized basis, was 357. By comparison, large 
commercial banks had a capital coverage ratio of only 17.7, and 
for the whole banking industry the ratio was 14.5.
    Increasing minimum capital when there is no increase in 
risk raises the cost of funds to housing and undercuts our 
ability to fulfill our mission.

Q.4. In [Director] Falcon's testimony from the October 23, 2003 
GSE hearing, he described adjusting the minimum capital 
requirement as a ``fail-safe'' mechanism, because the risk-
based capital standard cannot quantify all of the potential 
risks to the GSE's. Do you believe the current risk-based 
capital does not quantify all of the potential risks to the 
GSE's? Why or why not? What is your response to the notion of 
the need for a ``fail-safe'' mechanism?

A.4. No capital standard can quantify all the risks a financial 
institution faces. However, the risk-based standards applied to 
Fannie Mae and Freddie Mac are the most comprehensive in the 
industry and come much closer to covering all the risks the 
companies face than the capital standards that are applied to 
banks.\1\ These risks include credit risk, interest-rate risk 
(including prepayment risk), and operations risk.
---------------------------------------------------------------------------
    \1\ ``Primary emphasis is placed on a risk-based capital standard 
that reflects risks more accurately than bank and thrift standards by 
directly incorporating interest rate risk and by disaggregating credit 
risk to a much finer degree. The standard for GSE's also explicitly 
sets an acceptable limit for those risks: Survival for a 10-year period 
in an environment with credit losses equal on a national basis to the 
worst actual experience on a regional basis and sustained interest rate 
movements more threatening than any experienced in GSE history. At the 
same time, substantial allowance is made for other, less quantifiable 
risks. The result is a more forward looking standard, less tied to 
current, and sometimes misleading, balance sheet data.'' Federal 
Housing Enterprises Regulatory Reform Act of 1992, Report of the Senate 
Banking Committee, May 15, 1992 at 19 (emphasis added).
---------------------------------------------------------------------------

Credit Risk

    Fannie Mae and Freddie Mac are required to have enough 
capital to survive Depression-era credit conditions that last 
for 10 years. Such conditions over that period of time have 
never been seen in the country at large, at least in modern 
times.
    The coverage of credit risk in bank capital standards is, 
in contrast, less sophisticated--as is admitted by bank 
regulators worldwide. As a result, in a process commonly known 
as Basel II, the international bank capital standard setters 
are in the process of updating capital rules to make them more 
responsive to risk, although this effort will probably take 
several more years to implement.

Interest Rate Risk

    In the companies' RBC requirement, the draconian and 
prolonged credit shock is coupled with dramatic and sustained 
changes in interest rates. Indeed, an econometric study 
conducted for Fannie Mae by Nobel laureate Joseph Stiglitz and 
colleagues found that ``the probability of the stress test 
conditions occurring is less than one in 500,000.'' \2\
---------------------------------------------------------------------------
    \2\ Implications of the New Fannie Mae and Freddie Mac Risk-Based 
Capital Standard, Joseph E. Stiglitz, Jonathan M. Orszag and Peter R. 
Orszag, Fannie Mae Papers, Volume 1, Issue 2, March 2002 at 2. Paper 
available at http://www.fanniemae.com/global/pdf/commentary/ 
fmpv1i2.pdf.
---------------------------------------------------------------------------
    Banks do not have an interest-rate component in their risk-
based capital requirements. Interest-rate risk tends to be the 
largest risk in mortgage lending, particularly for a portfolio 
with geographic diversification. The standards applied to 
Fannie Mae cover this risk comprehensively; those for banks do 
not cover it at all.

Operations Risk

    To some extent, operational risk is the unquantifiable risk 
that is not covered by the credit and interest rate risk 
components of the stress test. In OFHEO's risk-based capital 
requirements, there is a 30 percent add-on to the stress test 
to provide an extra cushion to the capital already required by 
the stress test.
    Currently, banks do not have a requirement covering 
operational risk. Basel II contemplates adding one, but it will 
be lower than that applied to the GSE's. The add-on charge for 
banks is likely to be around 9 percent to 12 percent, roughly 
one-third of that applied to Fannie Mae.\3\
---------------------------------------------------------------------------
    \3\ Regulatory Treatment of Operational Risk, Basel Committee, 
September 2001.
---------------------------------------------------------------------------
    In addition to the distinctive structure of their risk-
based capital requirement, the minimum leverage ratio for 
Fannie Mae and Freddie Mac is unique in that it requires 
capital support for off-balance-sheet, as well as on-balance-
sheet, exposures.\4\ As the Senate Banking Committee reported 
with regard to the minimum capital requirements in the 1992 
Act:
---------------------------------------------------------------------------
    \4\ As of June 2003, Fannie Mae's core capital equaled 3.32 percent 
of total balance sheet assets.

    ``[T]he risk-based measure is supplemented by a more 
traditional minimum capital standard, which actually bears more 
in common with the risk-based measures for banks and thrifts, 
in that it explicitly covers the very sizable off-balance-sheet 
risks of the GSE's.'' \5\
---------------------------------------------------------------------------
    \5\ Senate Banking Committee, id. (Emphasis added)

    The leverage requirement for banks does not have a similar 
provision. Banks often have large off-balance-sheet exposures, 
and those exposures have been increasing in recent years, 
partly in an effort to avoid the leverage requirement that 
would apply if they were held on balance sheet.
    Additionally, it is appropriate that the leverage ratio for 
banks provides an additional cushion against interest rate and 
prepayment risks since, as outlined above and unlike the Fannie 
Mae stress test, bank risk-based capital requirements do not 
include a component for these risks.
    Thus, to the extent that the minimum capital requirement is 
regarded as a ``fail-safe'' mechanism, Fannie Mae has one that 
is tailored to our operations and consistent with the level of 
risk we manage.
    In order to judge the appropriateness of the mandated 
requirements for the GSE's, they have to be viewed within the 
context of the companies' restrictive charters. Fannie Mae is a 
private company with a single purpose--to promote homeownership 
through secondary market operations in residential mortgages. 
Confined as we are to residential mortgages, Fannie Mae is 
exposed to less credit risk than a typical large complex bank, 
operating in many countries around the world and investing in a 
range of asset classes that carry more risk and are more 
difficult to manage. Were the GSE charters as broad as a 
bank's, Congress would undoubtedly have required Fannie Mae to 
meet the same capital standards as banks.
    It should also be recognized that OFHEO has a panoply of 
supervisory powers to deal with problem situations, from cease-
and-desist orders, to civil money penalties, limitations on 
dividends, and a requirement to hold additional reserves 
against particular assets. These protections complement the 
capital requirements. And they reflect the practice in the 
banking industry where regulators have the power to set special 
individual capital requirements but rarely use that power, 
preferring to use their other supervisory powers instead.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGEL 
                    FROM FRANKLIN D. RAINES

Q.1. In a format similar to your annual report, please tell us 
what the fair value of Fannie Mae's shareholders' equity would 
have been on a quarterly basis for the last 12 quarters, using 
the definition of fair value that you have been applying in 
your most recent annual reports.

A.1. At the end of every year, GAAP requires us to provide the 
market value of our financial instruments. We go a step further 
by reporting the market value of all our assets and liabilities 
at the end of each calendar year. The estimated fair value of 
our net assets (net of tax effect) was $22.1 billion as of 
December 31, 2002, $22.7 billion as of December 31, 2001, and 
$20.7 billion as of December 31, 2000. Our fair value as of 
year-end 2003 will be included in our 2003 Form 10-K, which is 
due by March 15, 2004. Like many other large financial 
institutions, we believe this fair value balance sheet is an 
imperfect means to determine our profitability and value as an 
ongoing enterprise. We do not primarily use mark-to-market 
valuation measures to run our business or prepare a full fair 
value balance sheet on a quarterly basis.
    We run our business on the basis of core business results, 
which rely on historical cost accounting. Assets and 
liabilities are booked at their initial value and the cost is 
amortized and the income recognized over time. We believe this 
traditional approach to accounting provides the best 
representation of how our business operates.
    Mark-to-market valuation, on the other hand, takes a 
snapshot of the market value of an asset or liability at a 
specific moment in time. This would be useful for certain 
investors such as hedge funds that trade securities in the 
market every day, because that is how they would determine the 
net value of their business on a given day.
    But for portfolio investors like Fannie Mae, especially 
those that hold assets to maturity, marking to market is not a 
very meaningful way to measure our performance. Indeed, it 
might be misleading for management--and investors--to value our 
performance solely on a mark-to-market basis, for a very 
important reason.
    Mark-to-market accounting produces paper gains and losses 
that a held-to-maturity enterprise may never realize. That is 
why financial regulators generally do not consider these 
noncash, unrealized gains or losses in judging a company's 
financial strength, or in judging whether it meets regulatory 
capital requirements.

Q.2. With reference to the $16.09 billion of ``cashflow hedging 
results'' losses in your equity account, as reported in your 
quarterly statement, exactly what proportion of those losses 
are either realized, unrecoverable, or not recoupable because 
you have closed out the derivatives at a loss, and paid out the 
loss amount in cash? Are these losses likely to reverse 
themselves as the hedges come to maturity?

A.2. We provide on a quarterly basis our cashflow hedging 
results according to GAAP requirements. As you may be aware, 
these numbers have become very volatile since the 
implementation of Financial Accounting Standards Number 133 
(FAS 133), Accounting for Derivative Financial Instruments and 
Hedging Activities. The details behind these numbers are not 
publicly disclosed and are confidential and proprietary.
    FAS 133, Accounting for Derivative Financial Instruments 
and Hedging Activities, became effective for Fannie Mae in 
January 2001 and requires companies to record the current 
market value of derivative instruments on their balance sheets. 
Unfortunately, the standard can often result in an incomplete 
or distorted picture of a corporation's financial position. 
This is particularly true for investors who use derivative 
instruments extensively in their interest rate risk management.
    The reason is that FAS 133 requires all derivatives to be 
recorded at their current market value, while other assets and 
liabilities do not obtain the same treatment. Financial 
statements produced under FAS 133 include a mix of treatments--
some assets and liabilities are reported at their current 
value, while others are reported at historical cost. As a 
result, financial statements under GAAP can give an incomplete 
picture of a company's net worth and overall risk position.

Q.3. It has been alleged that permitting a regulator to review 
and approve Fannie and Freddie's new activities will stifle 
your innovation. Yet this country's banks are the most 
innovative in the world and they operate under a system in 
which their regulator has this authority. Please explain to us 
how reviewing Fannie and Freddie's new activities would stifle 
your ability to innovate.

A.3. Under current law, Fannie Mae must submit a new program 
approval request to HUD if an initiative is ``significantly 
different'' from a program that has been previously approved or 
is a program in which Fannie Mae had not engaged prior to 
passage of the 1992 Act. HUD may deny approval of any new 
program if our charter does not permit it or if the Secretary 
determines that the activity is not in the public interest. HUD 
generally has 45 days within which to approve a new program 
request. This short time frame for decisionmaking is crucial to 
timely market innovation.
    Some recent proposals have suggested that a regulator 
should review all of the ``new activities'' of Fannie Mae. In 
H.R. 2575, for 
example, the term ``activities'' is broadly defined to include 
``any program, activity, business process, or investment that 
directly or indirectly provides financing or other services 
related to conventional mortgages.'' This definition could 
require prior regulatory approval for every change in 
underwriting standards made by Fannie Mae or every transaction 
in which we engage to buy mortgages.
    Banks and other entities regulated by Federal financial 
regulators are not generally subject to prior approval 
requirements for their activities. In the banking context, 
``activity'' means line of business. The Gramm-Leach-Bliley Act 
contains a list of ``activities'' financial institutions may 
undertake without prior approval, such as insurance, securities 
underwriting, and merchant banking. Particular changes in the 
way in which an institution engages in one of these lines of 
business are also not subject to prior approval. In adopting 
this regulatory structure for banks, Congress has recognized 
that innovation within permitted lines of business benefits 
consumers and the economy as a whole. Financial institution 
regulation is biased against time consuming preapproval 
processes, and instead focuses on prudently imposed limitations 
and safety and soundness principles, compliance with which is 
evaluated by financial institution examiners.
    A comparable regulatory structure, if applied to Fannie 
Mae, would recognize that we have one main business line, 
mortgages, and would require no prior approval for new products 
or processes related to that line of business. The new 
regulator would, like bank regulators, rely on examiners, 
conducting on-site continuous examinations, to review all 
ongoing activities to determine that they are safe and sound 
and within our charter. Under the bank model, if Fannie Mae 
were to go into a broad new line of business, the company would 
be required to seek prior approval from its regulator.
    The mortgage market today provides consumers with a wider 
variety of products than ever before, and therefore is better 
poised to meet the individual financing needs of a broader 
range of homebuyers. This has been possible because the program 
approval 
requirements in the 1992 law respect the need for innovation. 
Lenders have been able to innovate and develop new products to 
reach underserved communities because we have been able to 
review the products and, whenever possible, assure them, in a 
timely manner, that we will purchase these loans in the 
secondary market.
    Imposing intrusive or cumbersome regulatory requirements or 
processes would put the Government--not the private sector--in 
the position of deciding or delaying which products are brought 
to market. This lack of predictability and potential for delay 
would 
inhibit our ability to work with our lender partners to support 
innovation to expand homeownership opportunities. Without that 
secondary market outlet, lenders would have to assume more risk 
and expense in developing innovative mortgage products that are 
vital for reaching new markets.

Q.4. Your company charges a ``guarantee fee'' for each mortgage 
sold to Fannie. It seems those guarantee fees continue to be 
high while your credit losses shrink. If losses are down, why 
the need for proportionately higher guarantee fees, and how 
much does this ultimately mean out-of-pocket to the individual 
mortgage customer?

A.4. Fannie Mae's guaranty fee has to cover the full costs of 
guaranteeing mortgages. These costs include:

 Insurance (credit) losses;
 The costs of credit enhancements where Fannie Mae pays 
    other parties to share possible losses, thereby dispersing 
    risk;
 The administrative costs of running the business; and
 The cost of capital needed to support the business.

    The proportion of the guaranty fee designed to cover 
expected losses is generally not the largest component of that 
fee. Best practice for financial institutions requires that 
they hold economic capital against the risks they face. 
Economic capital is an amount of capital sufficient to prevent 
company insolvency in bad economic times. In the case of Fannie 
Mae's guaranty business, best practice requires holding 
sufficient capital to withstand stressful economic conditions. 
That capital has to earn a competitive return--or it would not 
be attracted in the first place.
    As shown in Exhibit 1, insurance is somewhat unusual in 
that returns above the average occur more often than those 
below the average. (In more formal statistical terms, the 
median is greater than the mean.)
    Typically, in insurance, losses in very bad times tend to 
be greater than profits in good times. (Loss distributions are 
said to have ``fat tails.'') And, in guaranteeing loans as in 
other insurance, it takes many profitable outcomes to cover the 
losses from a single bad outcome (Exhibit 2). Thus, over a long 
period of time, there must be more occurrences of good outcomes 
to counterbalance the fewer, but weightier, bad outcomes. 





     And most crucially it means that one cannot look at the 
results from an individual year (or even from a particular 
cohort of business) to judge the adequacy of profits. 
Currently, Fannie Mae's portfolio is very strong from a credit 
perspective, and one should expect very good outcomes and low 
credit losses. Fannie Mae, like other insurers, looks beyond 
expected outcomes, to the unlikely possibility that a severe 
credit event could occur, leading to much higher levels of 
defaults. Holding sufficient capital to withstand such an event 
is a business and regulatory requirement. To do otherwise would 
rightly be regarded as an unsafe and unsound business practice. 
We compete for capital in the broader marketplace, and 
therefore this capital held against a potential credit event 
must earn the return it could have earned on a similarly risky 
investment elsewhere.
    Fannie Mae's 10-K clearly breaks out the different 
components of income and expense to the credit guaranty 
business. In 2002, total pretax guaranty fee income was $3.2 
billion, credit-related expenses were $92 million, and 
administrative expenses were $1.5 billion (including $638 
million in Federal income taxes). The credit-related expenses 
were indeed at record lows, as were delinquency and default 
rates for Fannie Mae.
    These surprisingly low credit expenses cannot be taken for 
granted. Credit expenses are expected to increase. Note that 
administrative expenses, excluding taxes, are almost 10 times 
as large as credit-related expenses. Although Fannie Mae is 
highly efficient (these administrative expenses were incurred 
on a book of business that averaged $1.8 trillion in 2002), the 
charged guarantee fee must be sufficient to cover these 
expenses as well.

Q.5. The Administration has proposed eliminating Presidential 
appointed members from your Boards and leaving the appointment 
responsibility in the hands of your shareholders. What are your 
thoughts on this?

A.5. We have seen many benefits from the presence of 
Presidential directors on the board of Fannie Mae. They have 
well represented the interests of the company's shareholders 
and helped advance our mission. Indeed, our board is seen as a 
leadership model of stakeholder representation on corporate 
boards. Our experience has been very good over the years with 
our Presidential directors and our preference would be to 
retain them. Ultimately, this will be an issue for the Congress 
and Administration to decide.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER 
                    FROM FRANKLIN D. RAINES

Q.1. Do you want to be under Treasury or do you want a beefed 
up independent regulator? If you were put into Treasury do you 
want [Fannie Mae/Freddie Mac and the FHLBank System] to be 
together under one bureau or do you prefer two separate bureaus 
and why?

A.1. Fannie Mae supports legislation to create a new safety and 
soundness regulator for Fannie Mae and Freddie Mac as a bureau 
of the Treasury Department, funded independently of the 
appropriations process.
    While recent events raise fresh questions about FHLBank 
regulation, it is also true that including the FHLBank System 
in regulatory reform legislation would complicate the 
legislative process. At a minimum, there are many questions 
Congress would have to answer before incorporating the Banks 
into any new regulatory structure. For instance, the Congress 
would have to decide whether to focus the Bank System on its 
traditional mission of providing advances or to endorse the 
Banks' recent ventures into acquiring mortgages. There are 
questions as to whether the current FHLB regulatory structure 
is consistent with the new lines of business the Banks are 
undertaking.
    However, if Congress decides to include the FHLBanks in a 
reform proposal, we believe that Fannie Mae, Freddie Mac, and 
the Bank System should be placed under the umbrella of a single 
regulator, and that the FHLBanks mortgage acquisition 
activities should be subject to the same set of safety and 
soundness regulations that apply to Fannie Mae and Freddie Mac. 
Such a regime would best be served by a single bureau that 
could institute comparable regulatory requirements for 
comparable activities.

Q.2. In your view, what is the difference between new program 
and new activity standards?

A.2. Under the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992, the standard for HUD prior approval of 
``new programs'' is simple: The current law says the Secretary 
must disapprove a ``new program'' if it does not comply with 
our charter or is not in the public interest. The 1992 Act also 
established time limits for consideration of new program 
requests by the Secretary. A ``new program'' is generally 
defined by the 1992 Act as a broad and general plan or course 
of action for purchasing or dealing in mortgages that is 
significantly different from programs previously approved by 
HUD or engaged in prior to enactment of the 1992 Act.
    Secretary Snow described the concept of a ``new program'' 
very well in his recent testimony before the Senate: New 
programs are akin to ``new lines of business.''
    Some proposals have suggested that a regulator should 
review all of the ``new activities'' of Fannie Mae. In H.R. 
2575, for example, the term ``activities'' is broadly defined 
to include ``any program, activity, business process, or 
investment that directly or indirectly provides financing or 
other services related to conventional mortgages.'' This 
definition is so broad that it could encompass every change in 
underwriting standards made by Fannie Mae or every transaction 
in which we buy mortgages.
    Bank regulators do not mandate prior approval for 
``activities'' in the manner some have suggested would be 
appropriate for Fannie Mae's ``activities.'' In the banking 
context, the term ``activities'' is used to mean ``lines of 
business.'' The Gramm-Leach-Bliley Act contains a list of 
preapproved ``activities'' financial institutions may 
undertake. The ``activities'' listed in the statute are broad 
lines of business, including insurance business, securities 
underwriting business, and merchant banking business.
    Any proposal requiring prior notice for Fannie Mae's 
``activities,'' as defined in H.R. 2575, clearly has no 
parallel in current banking law.







                        PROPOSALS FOR IMPROVING
                    THE REGULATION OF THE HOUSING
                    GOVERNMENT SPONSORED ENTERPRISES

                              ----------                              


                       THURSDAY, OCTOBER 23, 2003

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:06 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order.
    This morning the Committee meets to hold our second hearing 
on proposals to improve the regulation of Government Sponsored 
Enterprises. During our hearing last week, we heard from the 
Administration and the Government Sponsored Enterprises. Today, 
we will hear from a variety of viewpoints, including the 
current regulators.
    These hearings will provide the Committee with a thorough 
debate of the critical issues that must be resolved in order to 
establish a strong and credible regulator for the Government 
Sponsored Enterprises. It is my view that any new regulator 
must oversee the Federal Home Loan Bank System as well as 
Fannie Mae and Freddie Mac. Comprehensive regulatory reform of 
this nature deserves careful consideration, and this Committee 
will work diligently to craft an appropriate reform package. 
Whether we can do so this fall is not clear, but I will 
certainly make this a continued priority as the Chairman.
    For our first panel today, we welcome three witnesses: Mr. 
John Korsmo, Chairman of the Federal Housing Finance Board; Mr. 
Armando Falcon, Director of the Office of Federal Housing 
Enterprise Oversight; and Mr. Douglas Holtz-Eakin, Director of 
the Congressional Budget Office.
    Our second panel will include five witnesses: Mr. John D. 
Koch, Executive Vice President and Chief Lending Officer, 
Charter One Bank of Cleveland, Ohio, testifying on behalf of 
America's Community Bankers; Mr. Dale Torpey, President and CEO 
of Federation Bank of Washington, Iowa, testifying on behalf of 
the Independent Community Bankers of America; Mr. Allen 
Fishbein, Director of Housing and Credit Policy for the 
Consumer Federation of America; and Mr. Robert Couch, Chairman 
of the Mortgage Bankers Association; and Ms. Iona Harrison, 
Chairman of the Public Policy Committee of the National 
Association of REALTORS'.
    I want to thank all of the witnesses for appearing before 
the Committee today.
    Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman, for 
convening this important hearing. As you said, this is the 
second opportunity for the Committee to consider the question 
of how to effectively regulate the GSE's--Fannie Mae, Freddie 
Mac, and the Federal Home Loan Banks.
    Understanding and improving the supervision of the GSE's 
involves many complex and challenging issues. I think our 
hearing last week made that clear. Testimony from two Cabinet 
Secretaries and representatives of the regulated entities I 
think made valuable contributions to our deliberations. But I 
believe it is fair to say that there are a number of questions 
still to be examined. I look forward to further consideration 
of those issues today.
    Of course, the GSE's do not make the mortgage market 
function by themselves. They work in partnership with a network 
of lenders and realtors who are integral to the smooth running 
of our housing finance system. We will hear today from several 
representatives of these industries who interact daily with the 
GSE's. I look forward to hearing their perspectives, indeed the 
perspectives of all of our witnesses today, as we examine this 
question of effective supervision of these entities.
    Mr. Chairman, I want to commend you for putting together 
hearings with a variety of interested parties on this important 
issue so that we really get the benefit of a wide range of 
points of view.
    Finally, as I did last week, I want to underscore the 
importance of acceding to the Administration's request for an 
additional $7.5 million for OFHEO to conduct reviews of 
accounting practices at the enterprises it regulates. I very 
much hope that will be included in the funding for fiscal year 
2004. It is an Administration request, and I very much hope 
that Congress will deliver on it.
    While we deliberate on creating a new, more effective 
regulatory structure, we obviously need to be sure that the 
current regulator is adequately funded.
    Thank you very much.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman, for holding this 
very important meeting and hearing. I would like to thank all 
of our witnesses that are going to testify for their testimony.
    Last week, we heard from two Cabinet Secretaries as well as 
representatives from Fannie Mae, Freddie Mac, and the Federal 
Home Loan Banks. Now we will hear from the Federal Housing 
Finance Board, the CEO of OFHEO, and the representatives from 
the banking industry, the realtors, and the consumer groups. I 
applaud the Chairman for bringing so many who could be affected 
by the GSE legislation before the Committee.
    We all agree that Fannie and Freddie need a new regulator. 
Even Fannie and Freddie agree to that. But that was the easy 
part. Now we have to figure out how to do it. If we do not do 
it right, we are simply rearranging the deck chairs on the 
Titanic. It will sink. We all agree that we must not do 
anything in this bill that could harm our housing markets, and 
I warn those that are in positions of authority in the Treasury 
to watch what they say. As of yesterday, one of them popped his 
mouth off, and the market went completely haywire in the 
interest rates.
    We all agree we must worry about unintended consequences. I 
do want to reiterate a concern I voiced last week at the 
hearing we had. I had a number of small community banks in 
Kentucky, contact me about their concerns about this effort. We 
only have small banks in Kentucky, and they are scared to 
death. My small banks are worried that they will not be able to 
use the same GSE products they use today. They are worried 
about the products they use to stay in compliance with their 
CRA obligations, and they will not have them available if we do 
something to change the regulator.
    I would like to make sure my little banks are not harmed. I 
would like to hear from all of our witnesses on if they feel 
this concern is a valid concern.
    I would also like to hear from our witnesses on whether or 
not they feel the Federal Home Loan Bank should stay with their 
existing regulator or should be moved to a new regulator and 
why, because I do not agree with the Chairman on this, and I 
would like to hear from our witnesses. I will look forward to 
broaching this with our witnesses and in the question and 
answer period.
    Once again, I thank all of our witnesses for testifying, 
and we thank the Chairman for holding the hearing.
    Chairman Shelby. Senator Johnson.

                STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Thank you, Mr. Chairman, for calling 
today's hearing to discuss the regulatory framework for housing 
GSE's, and I welcome the members of our panels today.
    It is critical that we move forward with regulatory 
restructuring, and today will give us an opportunity to get the 
current GSE regulators' take on what tools will be useful in 
strengthening oversight. But even more important, we will hear 
from those who work together with the GSE's to make affordable 
housing a reality for millions of Americans.
    Mr. Chairman, I have to admit that my patience has worn 
thin with Treasury at the moment. A statement yesterday from 
our Assistant Secretary of Financial Institutions, Mr. 
Abernathy, making veiled threats about what might happen to the 
GSE $2.5 billion line of credit with the Treasury if they do 
not get their way relative to a proposed safety and soundness 
regulator under the Treasury having the authority to approve 
new products and very low firewalls between the Agency and the 
Treasury Secretary and the politics of the Treasury Department 
are very distressing to me and should be distressing to anyone 
concerned about affordable housing for American families.
    I am disappointed at what appears to be a decreasing 
momentum for regulatory reform. Clearly, there is a significant 
agreement about the need for strengthened regulatory oversight, 
and yet at last week's hearing, Secretary Snow put forward a 
proposal that I think raised as many questions as it answered.
    It is essential, I believe, that any new GSE regulator, if 
housed in Treasury, be independent in the same way or in 
similar ways as the OCC and the OTS. I have signed a letter 
with some of my Committee colleagues supporting the idea that 
the GSE regulator may well be moved to Treasury, and yet I am 
disappointed that the Administration seems to want to retreat 
from the conventional wisdom that it is good policy to remove 
the financial regulators from political forces.
    The whole point of this exercise is to create a credible 
regulator. Why would we want to do it in a way that increases 
its vulnerability to political whims, regardless of which party 
is in the White House?
    We need to look at safety and soundness implications for 
allowing a regulator to set minimum capital requirements as 
well as the effects such a change in capital would have on the 
affordable housing mission of the GSE's. In addition, 
thoughtful deliberations must take place on how new products 
and activities should be addressed in any legislation to alter 
the regulation of GSE's. I share the concern that my colleague 
from Kentucky has expressed about the regulatory oversight 
structure of the Federal Home Loan Banks, and I think we need 
to approach that with great care as we progress on this issue.
    And yet, at the same time that we look at changes in the 
regulatory structure, we have to take great care not to upset a 
system of housing finance that has allowed successfully 
millions of middle-income Americans to realize the dream of 
homeownership. There is a ``First, do no harm'' criteria here, 
I believe, that we need to address. In so many ways, the 
housing GSE's have helped to create a system that has 
strengthened our communities and broadened the reach of 
homeownership. That should continue to be our top priority, and 
I look forward to working with my colleagues in a bipartisan 
fashion on this Committee to that end.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Hagel.

                STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you. I want to add my 
welcome to our guests this morning, and I appreciate very much 
their testimony and an opportunity to exchange thoughts about a 
rather vital issue for the future of our housing market. 
Really, it is attached to and part of a significant dynamic of 
our economy, which you all understand, and we appreciate that.
    Mr. Chairman, I also appreciate your continued focus on 
this issue, with this a hearing coming back to back with last 
week's hearing. And I would hope that this Committee will be in 
a position to actually finalize something soon, and I know the 
Chairman's commitment to that. There is little question, as my 
colleague from Kentucky noted, as to a requirement to reform 
what you are doing every day so that there is a new sense of 
confidence in the market as we move forward into this new 
century.
    Thank you.
    I might, as a matter of personal privilege, Mr. Chairman, 
acknowledge that our distinguished colleague from Kentucky's 
birthday is today.
    [Laughter.]
    It is worthy of note because there is a new serenity about 
him, a new peacefulness.
    [Laughter.]
    He is more docile than I have ever seen him, and I 
attribute it all to a wiser, more mature U.S. Senator on his 
birthday. Happy birthday, Senator Bunning.
    Mr. Chairman, thank you.
    Chairman Shelby. Thank you, Senator Hagel. You noticed 
something we have not noticed about the Senator.
    [Laughter.]
    Chairman Shelby. Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman. And Happy 
Birthday. I cannot say anything else to begin.
    Let me also say, Mr. Chairman, how much I appreciate these 
hearings. You have assembled an array of witnesses that will 
provide valuable insights to the Committee as we go forward, 
and thank you for that. I think it is good that we have the 
regulators here who can offer very specific recommendations 
based upon real experience over several years, and I think that 
is very valuable.
    There are several issues, obviously, that I think we should 
touch upon: Whether the Housing Finance Board and OFHEO should 
be merged together in some new constellation of regulators; 
whether the GSE's' regulator should have the ability to set 
minimum capital standards--that is an issue that repeatedly 
comes up before us and amongst us; how we can best ensure that 
Fannie Mae and Freddie Mac and the 12 Federal Home Loan Banks 
are expanding affordable housing opportunities for low-income 
families. We talk a lot about the housing sector here. It is a 
very vital part of our economy, but, frankly, we are not doing 
enough to produce low-income homes in this country, and that is 
something that these Government enterprises should be at the 
forefront of trying to do. I know they have a mission and they 
are doing it, but I think we can do more.
    Then, of course, the overarching question, the impact of 
any changes we make on the housing finance industry, as alluded 
to by Senator Bunning and others, that has to be foremost in 
our considerations.
    Again, thank you, Mr. Chairman, for scheduling these 
hearings, and I appreciate your interest in this very important 
topic.
    Thank you.
    Chairman Shelby. Thank you, Senator Reed.
    Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman. I simply join in 
thanking you for holding these hearings. They are very useful 
and informative. We are learning a great deal, and I am willing 
to get on with it.
    Thank you.
    Chairman Shelby. Gentlemen, your written testimony will be 
made part of the record in its entirety. We will start with Mr. 
Korsmo, and you proceed as you wish.

                  STATEMENT OF JOHN T. KORSMO

            CHAIRMAN, FEDERAL HOUSING FINANCE BOARD

    Mr. Korsmo. Good morning, and thank you, Mr. Chairman, 
Ranking Member Sarbanes, and distinguished Members of the 
Committee.
    In December 2001, this Committee and the Senate honored me 
with confirmation to membership on the Federal Housing Finance 
Board, and President Bush entrusted me with the Board's 
chairmanship. During my confirmation hearing, both Senator 
Sarbanes and former Senator Gramm impressed on me--indelibly--
their concern over the Finance Board's inadequate performance.
    In response, I committed myself to leading the Agency to 
fulfill the intent of Congress in FIRREA in 1989 and the Gramm-
Leach-Bliley a decade later, that is, to create a credible 
arm's-length regulator for the Federal Home Loan Banks. I 
testify today not as an apologist for the Federal Home Loan 
Banks and certainly not as a partisan for the Finance Board 
but, rather, as a safety and soundness regulator who takes his 
oath of office and his promise to this Committee very 
seriously.
    In that spirit, I offer my experience at the Finance Board 
as you seek to establish policy for the supervision of the 
Nation's 14 housing-related Government Sponsored Enterprises.
    The Federal Home Loan Bank Act grants the Finance Board the 
authority, the independence, and the executive branch voice 
that I believe are needed for robust supervision of Government 
sponsored public trusts.
    Of course, not only are regulatory tools necessary, but 
also the willingness to use those tools. At this Committee's 
oversight hearing on September 9, I discussed the aggressive 
and disciplined agenda of improvement my colleagues and I have 
undertaken at the Finance Board. Today, in the interest of 
time, let me cite my earlier testimony and give you just a 
brief update on activities since that oversight hearing.
    Our Office of Supervision is continuing its enhancement of 
bank supervision and oversight and its expansion of critical 
staff. The Finance Board now has more than double the number of 
examiners on staff when I took the oath of office in December 
2001. This core of 18 staff examiners will expand to 30 by this 
time next year, and it is supplemented by additional financial 
analysts, accountants, and risk management and mortgage 
specialists. My prepared testimony includes a chart that 
summarizes the examiners' accreditations and experience, and I 
think you will find them impressive.
    Effective oversight of GSE's also requires full 
transparency of the regulated entities. The day following this 
Committee's oversight hearing, the Finance Board unanimously 
adopted a proposed rule to require each of the Federal Home 
Loan Banks to comply with the periodic financial reporting 
provisions of the Securities Exchange Act of 1934. I regard SEC 
registration as critical to improving corporate and financial 
transparency, a factor of significant value to both Federal 
Home Loan Bank members and investors in Federal Home Loan Bank 
debt.
    I believe the Finance Board has dramatically improved the 
job it does of ensuring the safety and soundness and housing 
mission compliance of the Federal Home Loan Banks. As I come 
before you today, I know of no immediate or imminent safety and 
soundness or liquidity imperative forcing us to do the job of 
recasting supervision of the housing GSE's any way but the 
right way--with a strong, independent regulator. We are all 
aware the stakes are high if gains made are diluted or lost in 
the course of attaining the worthy goals of GSE reform. These 
high stakes suggest to me the value of undertaking a complete 
review of all housing GSE's, their charters and missions, and 
their role in the capital and mortgage markets, not just for 
today but also for the future. Development by policymakers of a 
coherent national agenda clearly outlining Government and 
private housing finance roles and informed policy to ensure 
another seven decades of stability, growth, and innovation in 
housing finance will guarantee all parties to the debate are 
fully equipped to design a world-class supervisor able to 
evolve along with the housing GSE's and the markets of 
tomorrow.
    A review of housing GSE charters and principles would not 
preclude, of course, immediate action with respect to OFHEO. 
OFHEO's mission could well benefit from budget independence and 
the granting of the full powers in use by other banking 
supervisors, including the Finance Board, under the Federal 
Home Loan Bank Act. I understand as well that Congress may 
decide to establish an enhanced regulatory structure for Fannie 
Mae and Freddie Mac that includes the Federal Home Loan Banks. 
If so, I would urge this Committee, of course, to equip the new 
regulator with the principles of strength and independence 
proven by the Federal Reserve, FDIC, OCC, and OTS, augmented by 
the proven housing GSE supervision features already in practice 
at the Finance Board.
    But your effort must also focus on the very real 
differences--differences of charter, differences of ownership, 
differences of capital structure--that exist between the 
Federal Home Loan Banks on the one hand and Fannie Mae and 
Freddie Mac on the other and anticipate adoption of reasonable 
methods to accommodate those differences. This is no small 
task, and I respectfully ask you to proceed carefully.
    As a matter of housing GSE policy, Congress and the 
Administration may also wish to safeguard in a consolidated 
regulator the potential for Federal Home Loan Banks to offer to 
their members products and services in competition with other 
housing GSE's to lower costs and increase choices for 
homebuyers.
    Thank you, Mr. Chairman and Members of the Committee, for 
the opportunity to appear before you this morning. I am pleased 
to respond to any questions.
    Chairman Shelby. Mr. Falcon.

                STATEMENT OF ARMANDO FALCON, JR.

                      DIRECTOR, OFFICE OF

              FEDERAL HOUSING ENTERPRISE OVERSIGHT

    Mr. Falcon. Chairman Shelby, Ranking Member Sarbanes, and 
Members of the Committee, thank you for inviting me to appear 
before you today. I am pleased to provide my views on 
improvements that can and should be made to the regulatory 
oversight of Fannie Mae and Freddie Mac. My views are my own 
and are not necessarily those of the President or the Secretary 
of Housing and Urban Development.
    When I took office as Director of OFHEO in October 1999, I 
quickly realized that the Agency's long-term success was 
jeopardized by inadequate resources, a constraining funding 
mechanism, and a lack of powers equal to those of other 
regulators. And so over the past 4 years, I have been a 
consistent advocate of legislation designed to address those 
shortcomings, and so I was encouraged by the Administration's 
comprehensive proposal. I am in general agreement with it, but 
I do have a few concerns that I hope can be properly addressed.
    I would like to outline my views in the context of five 
guiding principles. They are: First, the regulator should 
remain independent; second, the regulator should be permanently 
funded, outside the appropriations process; three, the 
regulator should have powers equal to those of other safety and 
soundness regulators; four, the regulator should have full 
discretion in setting capital standards; and, five, legislation 
should build on progress made.
    Adherence to each of these principles will strengthen 
supervision and the safe and sound operation of the 
Enterprises. Our ultimate goal and benchmark should be to 
establish a new regulator that is on an equal plane with the 
OCC and the OTS, both of which operate as independent safety 
and soundness regulators within the Treasury Department. I 
would like to elaborate on the five principles.
    First, the regulator should remain independent. The concept 
of an independent Federal agency to oversee Fannie Mae and 
Freddie Mac was established in the legislative history of the 
1992 Act that created OFHEO. The need for regulatory 
independence was born out of Congress' experience with the 
savings and loan crisis. I had the privilege of serving as 
counsel to the House Banking Committee for 8 years during that 
difficult period. One of the clear lessons learned was that all 
safety and soundness regulators should be objective, 
nonpartisan, and protected from political interference. This is 
especially critical at times when regulators must make 
difficult and sometimes politically unpopular decisions. In 
addition, independent regulation protects Congress' ability to 
receive the regulator's best judgment on regulatory matters 
unfiltered and without delay. With billions of dollars of 
potential taxpayer liability at stake, it is in everyone's 
interest that this important safeguard not be weakened.
    Second, the regulator should be permanently funded, outside 
the appropriations process. Currently, OFHEO is funded annually 
through the Federal budget and appropriations process, even 
though the Agency does not utilize any taxpayer funds. OFHEO is 
funded through assessments on the Enterprises, but those 
assessments cannot occur until approved by an appropriations 
bill and at a level set by the appropriations act. OFHEO is the 
only safety and soundness regulator funded in this limited 
manner. At a minimum, this serious anomaly should be fixed.
    Third, the regulator should have powers equal to those of 
other regulators. While OFHEO's regulatory powers are fairly 
comparable to those of other financial safety and soundness 
regulators, certain authorities need to be provided and others 
clarified. For example, a safety and soundness regulator should 
have independent litigation authority, enhanced hiring 
authority, and a full range of enforcement powers provided to 
financial regulators. Also, the laws should be revised to 
provide clearly that the regulator is empowered to address 
misconduct by institution-affiliated parties and to exercise 
general supervisory authorities.
    Fourth, the regulator should have full discretion in 
setting capital standards. Capital is one of the fundamental 
bulwarks of effective safety and soundness regulation. The 
regulator should have broad discretion to exercise his or her 
best judgment, using all the information available through the 
examination process and otherwise, to determine if capital 
adjustments are necessary. All other safety and soundness 
regulators have this discretion.
    Going forward, the Agency needs to have the authority to 
modify both minimum and risk-based capital standards. This 
authority would help meet the changing mix of enterprise 
business, the market environment in which they operate, and the 
changing nature of risk measurements themselves.
    Fifth, legislation should build on progress we have made 
over the last 10 years. Regulating Fannie Mae and Freddie Mac 
requires a specialized skill set. The capacity to model the 
cashflows of all the mortgages, debt, and other financial 
instrument of the Enterprises needed for the stress test is 
unique among financial institution regulators.
    Over the past 10 years, OFHEO has developed the specialized 
expertise, from our examiners and financial analysts, to our 
researchers and capital analysts, and that is necessary to 
supervise those two unique companies. The cost in terms of lost 
regulatory capacity spent while trying to rebuild that 
infrastructure would be substantial. That is why I recommend 
that, if a new regulator is established, OFHEO's personnel, 
regulations, and administrative infrastructure should be 
transferred intact to the new agency. I believe it would be 
highly counterproductive to do otherwise.
    There are a couple of other matters I would like to briefly 
discuss. First, I agree with Secretary Snow that the 
Presidentially 
appointed board members should be discontinued. This is not a 
reflection of current or former Presidentially appointed 
directors. Rather, I think corporate governance would be 
enhanced if the shareholders were allowed to select all members 
of the board.
    Also, I support the granting of authority to the safety and 
soundness regulator to determine whether the activities of the 
Enterprises are consistent with their charters. This would mean 
that a single regulator would have the ability to review all of 
the Enterprises' activities--new and existing. This change will 
consolidate the supervision of the enterprises in a manner 
consistent with the authorities of other regulators.
    In conclusion, let me raise two other points. I would be 
remiss in not noting my appreciation for the interest and 
support of the Members of the Committee, as expressed by 
Senator Sarbanes, with respect to the Administration's request 
for an additional $7.5 million for the Agency to conduct its 
business. I would urge the Committee to help us get those 
additional funds, and they would be much needed.
    Second, with regard to our ongoing investigation of Freddie 
Mac, I would like to inform the Committee of a recent 
development. Last night, OFHEO entered into a consent order 
with Mr. David Glenn, the former Vice Chairman, President, and 
Chief Operating Officer of Freddie Mac. Mr. Glenn now loses 
some $13 million in benefits, and under the order Mr. Glenn 
will cooperate fully with OFHEO, pay a civil money penalty of 
$125,000, and be barred from working for the Enterprises, even 
on a consultant basis. This is a significant development, and 
as you would expect, we will proceed deliberately and carefully 
in building a complete record of what has transpired. In 
addition, we will continue to take any appropriate regulatory 
action necessary to hold individuals accountable and bring this 
event to a proper resolution.
    I look forward to working with the Committee on the 
legislative developments, and I would be happy to answer any 
questions you may have.
    Senator Bennett. [Presiding.] Thank you.
    Dr. Holtz-Eakins.

                STATEMENT OF DOUGLAS HOLTZ-EAKIN

             DIRECTOR, CONGRESSIONAL BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you very much, Senator Bennett, 
Senator Sarbanes, Members of the Committee. Thank you for the 
chance to be here today.
    Over nearly two decades and in what amounts to nearly 15 
studies and testimonies, under the direction of Congress the 
Congressional Budget Office has looked closely at the housing 
GSE's and GSE's more generally. And as Congress contemplates a 
restructuring of the oversight and regulation of those GSE's, I 
thought it would be useful to frame the discussion in the 
context of the broad findings of that body of research. What 
emerges from those studies are really three major points.
    First, the sponsored status of the GSE's provides an 
implied guarantee which bestows upon them substantial benefits; 
second, these substantial benefits at the same time expose 
taxpayers to a risk that they will be forced to pick up the 
losses from the failure of a GSE in excess of those that can be 
accommated by private capital and, finally, an effective 
regulator can help to manage these risks, but not entirely 
eliminate them. These findings may be helpful to the Congress 
in thinking about the design of a new regulator.
    Let me talk about each of these points in turn.
    The benefit bestowed upon GSE's is that, compared to a 
fully private sector enterprise that has equivalent capital and 
takes equivalent risks, a GSE can both borrow more and borrow 
at a lower rate than this comparison firm. How can it do this? 
Well, the implied guarantee stems from the existence of several 
features of its setup: the line of credit at the Treasury, the 
exemption from SEC registration and disclosure requirements, 
the exemption from State and local taxes, the fact that some 
members of the board of directors are appointed by the 
President, and that Federally insured banks can hold larger 
amounts of GSE's' securities than private securities. These are 
sufficient in the eyes of market participants to overwhelm the 
explicit denial of such a guarantee by the GSE's.
    In 2001, the Congressional Budget Office estimated that the 
implied subsidy to the housing GSE's during the period 1998 to 
2000 was on the order of $10 to $15 billion per year, and if we 
were to update that today, we would guess that the current 
subsidy would be at the higher end of that range.
    This subsidy exists despite the fact that with the 
evolution of private capital markets and the maturation of 
mortgage finance in general, it no longer appears necessary for 
GSE's to be present in the market in order to generate a 
reliable flow of money to the housing sector.
    Nevertheless, the presence of this subsidy does place the 
taxpayer at risk. The implied guarantee means that taxpayers 
may be forced to assume risks for losses above the GSE's 
capital holdings. These risks emerge from various sources. The 
GSE's face credit risk from the default on mortgages, interest 
rate risks from changes in long-term rates, prepayment risks 
from the decisions of private borrowers, and operations risks 
in the conduct of any hedges against the previous risks, 
including the possibility of counterparty default in their 
derivative operations.
    The fact that a small credit risk may be present in GSE 
operations should not change the overall focus on the risk 
faced from the composite of these different sources, and indeed 
the ability to assess the overall risk facing a GSE is one of 
the paramount features of thinking about a new regulator.
    It is true that the presence of private capital in the 
GSE's provides some inherent incentives for monitoring and risk 
management, and the GSE's undertake great efforts, in fact, to 
manage their risks from prepayment and interest rate. However, 
this risk cannot be eliminated due to the private market 
incentives alone. As a result, it is useful to keep it within 
bounds so that the taxpayer does not face risks that are 
undesirable, and that there be a transparent statement of risks 
so that regulators, taxpayers, and Congress may be able to 
assess the risks that they face.
    Importantly, there is an extent to which shareholders will 
want to undertake more risk. If one looks at the record from 
1990 to 2000, the GSE's' average return on their equity of 
about 23 percent compared to 14 percent for similar private-
sector financial entities. The source of this increased rate of 
return is the fact that they held lower capital, less than half 
of the capital held by comparable private sector entities. This 
ability to get a higher return stems directly from the ability 
to exploit higher risk with that lower capital. The low 
capital, of course, places the taxpayer in the position of 
dealing with the consequences should there be some financial 
distress at a GSE, and in turn would place Congress in the very 
difficult position of deciding either to walk away from a GSE 
or to face the consequences of a financial shock of unknown 
magnitude.
    With that background, the design of any enhanced regulatory 
agency should have many objectives, and these should include 
the ability to limit taxpayer risk and the overall subsidy to 
GSE's. GSE's, Fannie and Freddie, in particular, have the 
ability to either hold directly mortgages which they purchase 
or to sell off mortgage-based securities. In holding mortgages, 
they undertake to incur the entire interest, prepayment, and 
operations risks. In selling off the mortgage-backed 
securities, they retain only the credit risk.
    In this way, their business model allows them to determine 
the degree to which the taxpayer is exposed to risk, and for 
that reason, the regulator should have the power to limit the 
risk that the GSE's undertake in order to protect the 
taxpayer's interest.
    Given the complex activities used to hedge against 
prepayment and interest rate risk, the regulator must have the 
ability to assess the quality of those hedges and the overall 
exposure to risk. The regulator must be able to prevent, in the 
worst case, a failed GSE from continuing to exploit such a 
subsidy by taking on more risk in an effort to return to 
solvency.
    In addition, it would be useful for the new regulator to be 
able to leverage the Public Company Accounting Oversight Board 
and the most obvious way to do that would be to give the 
regulator the ability to adjust the capital requirements of the 
GSE's in order to place the broad oversight of private capital 
markets on the side of the regulator. And to make that easier 
for the private sector, it would be useful to increase the 
public disclosure of oversight findings and the transparency of 
the GSE's in general.
    In closing, I would point out that Congress can support 
such a regulator in a variety of ways, not the least of which 
would be by setting boundaries for capital requirements that 
support the regulator's need to provide some insurance against 
the taxpayers facing unwanted risks and by forcing greater 
disclosure and registration requirements as a part of the 
ongoing oversight of the operations of the GSE's.
    I thank you for the opportunity to be here today and look 
forward to answering your questions.
    Senator Bennett. Thank you very much.
    Senator Bunning, you were the first Member of the majority 
here, let's start with you.
    Senator Bunning. A question for Chairman Korsmo. What issue 
would arise if all three GSE's were consolidated under one 
regulator? I know in your testimony you gave some examples, but 
do you foresee any others?
    Mr. Korsmo. I do not think it is possible, Senator, really 
to overstate the importance of recognizing the differences in 
the way that Fannie Mae and Freddie Mac and the Federal Home 
Loan Banks are structured and what constitutes their 
membership, their capital structure, and how they do business. 
The cooperative nature of the 12 Federal Home Loan Banks I 
think is significant. It was you, Senator Bunning, who cited 
the small banks in your State. I am from North Dakota. The 70 
members of the Federal Home Loan Bank of Des Moines from my 
State are extremely dependent on the liquidity options that 
membership in the Federal Home Loan Banks affords them.
    I think that important mission, as I say, has to be 
recognized and protected. I also think it is incumbent upon 
policymakers as they look at the possibility of combining 
regulation to recognize the importance of the competition that 
exists on a minimal level, but potentially at a larger level, 
between the Federal Home Loan Banks and Fannie and Freddie. I 
think the fact that the acquired member assets programs, which 
are really another methodology of providing housing finance 
liquidity to member banks, the growth of those programs is 
indicative of the need for another outlet, another service, if 
you will, to be provided, particularly to community lenders, 
but lenders of all sizes who are members of the system, another 
outlet for liquidity sources for mortgage financing that is 
afforded by their membership in the banks.
    I think also we want to take a very careful look at the 
affordable housing programs and measure the affordable housing 
programs at the Federal Home Loan Banks against the affordable 
housing goals that are now relevant for Fannie and Freddie. 
There are arguments in favor of both, but I think the success 
of the affordable housing programs, the importance that any 
number of Members of Congress have cited, the importance that 
those programs play in providing another source of affordable 
housing funding I think are significant. And so any review, I 
would hope, that would look at consolidation would take that 
into play.
    And, finally, of course, the whole question of the 
operation of the Office of Finance. The Office of Finance, of 
course, is the vehicle through which the Federal Home Loan 
Banks issue debt in the debt markets. It is an odd creature. It 
is not incorporated. It does not have a balance sheet. It has 
no management responsibilities. It is, if you will, a joint 
venture of the 12 Federal Home Loan Banks, and I think how that 
would function under a combined regulator needs to be looked at 
carefully.
    Senator Bunning. You almost took up my entire 5 minutes 
with one answer.
    Mr. Korsmo. Sorry, Senator.
    Senator Bunning. The last hearing that we had with 
Secretary Snow and Secretary Martinez, the need for financial 
experts to staff a new regulator for Freddie and Fannie, with 
the recent discoveries of losses at the banks in New York and 
Atlanta, there is a concern that the Finance Board may not have 
the resources to effectively regulate the Federal Home Loan 
Bank System.
    How do you respond to those concerns?
    Mr. Korsmo. I think certainly 18 months ago those concerns 
were legitimate, and I do not want to downplay what has 
occurred at both New York and Atlanta, although I will say that 
the Atlanta loss is an accounting loss, reflective of the 
vagaries of FAS 133. That is not to say that it is not 
significant.
    I will say that it has been an important process for us to 
set up a process to attract the kind of talent that is 
necessary, and I would suggest that we have made dramatic 
improvement in that regard over the last 18 months. And I think 
it goes beyond the question of adding examiners, for example.
    We have nine Ph.D.s in economics and finance on our staff 
who----
    Senator Bunning. And all of them have a different opinion.
    Mr. Korsmo. Who are involved in the process of establishing 
risk-monitoring procedures and risk-modeling procedures. They 
are the ones that--supervision, I should say, is more than just 
examination. Part of what we have accomplished is we have 
actually built a supervision function at the Federal Housing 
Finance Board that really did not exist until 2 years ago.
    And so I think we are making significant progress. Do we 
have a long way to go? I think the answer to that is yes, but I 
would hate to see any change in structure at this point lose 
the progress that we have made to this point.
    Senator Bunning. Thank you.
    Thank you, Mr. Chairman.
    Senator Bennett. Senator Sarbanes.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Let me follow up Senator Bunning's last question. The OCC 
has an average of 20 or so on-site examiners at each of the 
largest banks under its supervision. How many examiners does 
the Finance Board have on-site at each of the Federal Home Loan 
Banks?
    Mr. Korsmo. Today there are no examiners on-site, sir.
    Senator Sarbanes. How many examiners do you have all 
together?
    Mr. Korsmo. Today we have 18 staff examiners, three 
examiners who are also mortgage analyst specialists, and, of 
course, the supervisor of our supervision function.
    Senator Sarbanes. And I understand you have plans to go up 
to 30--is that right?--by the end of next year.
    Mr. Korsmo. That is correct.
    Senator Sarbanes. Now, that is 30 total to examine the 
whole system?
    Mr. Korsmo. That is correct.
    Senator Sarbanes. So we should compare that with the OCC 
having--well, I do not know the full number they have, but they 
have, on average, 20 resident examiners at each of the largest 
banks. Is that correct?
    Mr. Korsmo. I cannot speak to the situation at OCC. I do 
not know. Or OTS, I do not know.
    Senator Sarbanes. Well, what is your view of that 
situation?
    Mr. Korsmo. Needless to say, I am concerned about it, and 
that is why we have made, as I was mentioning to Senator 
Bunning in response to his question, fairly dramatic 
improvements from where we were when I arrived. And I have to 
thank my board colleagues for their support in this effort.
    When I got there, we had eight bank examiners on staff, 
eight very good examiners, but eight who had an impossible task 
of overseeing, as you so correctly point out, 12 very large 
financial institutions with, at the time, assets in excess of 
$700 billion, capital of $30 billion, debt in excess of $650 
billion.
    What we have put in place starting with the process of 
hiring a professional director of our Office of Supervision and 
a professional, experienced assistant director of our Office of 
Supervision is a very deliberate, a very disciplined, and a 
very orderly process to upgrade not only our examination 
function but also really to create an off-site supervisory 
function.
    Is the progress enough? Have we moved fast enough? That is 
a question, you know, I have to leave to others to decide. But 
I can tell you that the progress is dramatic. It is not where 
we want to be by any stretch of the imagination, but the 
movement is in the right direction.
    Senator Sarbanes. Where do you want to be? What is your 
goal?
    Mr. Korsmo. Our goal is--and part of the difficulty of 
moving any faster, sir, is the simple process of bringing 
qualified people on board and, frankly, attracting them. We are 
now at the point where we now have as many as 250 applicants 
for qualified exam positions. But we can only move so fast.
    Senator Sarbanes. How many examiners do you think you need? 
First of all, I take it it is your view that you do not know 
have enough examiners to do the job.
    Mr. Korsmo. Let me answer that question this way: I think 
we are doing a very effective job of oversight of the banks. Am 
I saying that we have enough? Clearly not. We have already 
budgeted, for 2004, to have more.
    Senator Sarbanes. All right. Well, how many do you think 
you need in order to do the job?
    Mr. Korsmo. Again, I think that is a question I cannot 
answer. Certainly our Director of Supervision----
    Senator Sarbanes. Well, you are the head of----
    Mr. Korsmo. --has suggested that 30 is what we can 
reasonably expect to have on board and coordinate a new 
supervisory function between now and the end of next year.
    Senator Sarbanes. Well, now, if you get the 30----
    Mr. Korsmo. Will we be done? No.
    Senator Sarbanes. --is that where you want to be? I mean, 
how many--you are the Chairman of this Board.
    Senator Bennett. If there were no budgetary constrictions 
and you could have whatever you want, what number would you 
give us?
    Senator Sarbanes. Yes, how many do you need to do the job?
    Mr. Korsmo. I appreciate the question, but understand, 
budgetary restrictions are not the only constraint. One of the 
constraints is doing this in a disciplined and orderly fashion. 
Moving from a supervisory program that was nonexistent to one 
that exists today has been serious progress. I do not know the 
answer to how many. I would suggest 50 or 60 is probably 
appropriate, and that is the goal that we have set long term.
    The problem is, of course, we cannot----
    Senator Sarbanes. So you have set a long-term goal?
    Mr. Korsmo. That is correct, sir, yes.
    Senator Sarbanes. Well, I wish we had gotten to that 
sooner.
    [Laughter.]
    What is that long-term goal?
    Mr. Korsmo. Fifty or 60.
    Senator Sarbanes. Well, my time is about up. I do want to 
ask a couple of questions to Mr. Falcon before the red light 
goes on.
    Senator Bennett. Proceed.
    Senator Sarbanes. In light of OFHEO's consent order with 
David Glenn, which you announced this morning, when do you 
expect a report on Freddie Mac to be completed?
    Mr. Falcon. We are going to take at least a couple of 
weeks, Senator, to assess the information that he will provide 
to us and determine how much additional investigation will be 
warranted by the information he gives us.
    At the end of the 2-week period, I would like to come back 
to you, if I may, and tell you based on what we have learned 
how much additional time we think it will take based on the 
additional investigative work.
    Senator Sarbanes. Do you have adequate resources to 
complete the report as you would like?
    Mr. Falcon. Not currently, however, once we get the 
supplemental funds, I hope that will suffice. But if it does 
not, I will certainly let you know as soon as we understand 
that.
    Senator Sarbanes. So your target date now for doing the 
report is when? Because, earlier, it was by now, as I recall.
    Mr. Falcon. Yes, and we were planning to release the report 
by the end of the month, but given the fact that we will have 
new information available to us from the second ranking 
individual in the company, I would not want to produce an 
incomplete report. I would rather, if you would allow us 
additional time, take that new information into consideration.
    Senator Sarbanes. All right. Thank you.
    Senator Bennett. Thank you.
    Senator Hagel.
    Senator Hagel. Thank you.
    Mr. Falcon, in your testimony, you said, ``I also support 
the granting of authority to the safety and soundness regulator 
to determine whether the activities of an enterprise are 
consistent with its charter authority.'' Would you develop that 
a little more fully? I note that you do talk further about it 
in your testimony, but why do you think that is so important?
    Mr. Falcon. I think it is important to establish as a 
benchmark that any new safety and soundness regulator should 
have, if one is established, the same authorities as every 
other safety and soundness regulator. And every other regulator 
does have the authority to opine on what activities are 
permissible under the terms of the charter. And certainly as 
the regulator with the enforcement powers over the two 
enterprises, I think consistent with that standard, we should 
have the authority to opine on what is and is not permissible 
under the terms of the charter.
    Senator Hagel. Obviously, to keep them within the mission, 
the charter of that mission.
    Mr. Falcon. Yes, Senator.
    Senator Hagel. Do you think the two GSE's that you regulate 
have drifted from that charter, that mission?
    Mr. Falcon. What I think has happened is increasingly there 
is a gray area. The terms of the charters are very ambiguous, 
and there is not a black and white line in the charters as to 
what they can and cannot do. But certainly as the marketplace 
evolves and changes and technology advances, certainly the gray 
area expands and the Enterprises will continue to test the gray 
area.
    Senator Hagel. So that is one of the reasons that you think 
this should be clearly defined, at least in the regulator's 
eyes, and within the empowerment of that regulator so it all 
connects?
    Mr. Falcon. I think it is to everyone's benefit that there 
not be uncertainty as to what is or is not permissible, 
including for the two companies. And if there was a regulator 
with the authority to clearly state that this is or is not 
permissible, you would not have any cloud hanging over the 
activities of the companies.
    Senator Hagel. There would be no question.
    Mr. Falcon. Right.
    Senator Hagel. Do you think, as we rewrite a new regulatory 
reform document, that we should be clear and more definitive?
    Mr. Falcon. I think that would be preferable.
    Senator Hagel. But still give the new regulator the 
enforcement powers over both--safety and soundness, and 
mission?
    Mr. Falcon. Yes.
    Senator Hagel. And more clearly define the mission.
    Mr. Falcon. Yes.
    Senator Hagel. Thank you.
    Mr. Holtz-Eakin, thank you for your contributions. I was 
interested in some comments you made about the housing market, 
and it leads me to this question: Do you think there is a 
continued need for GSE's?
    Mr. Holtz-Eakin. I think that if one looks at the various 
objectives of GSE's, one is to ensure a reliable flow of 
financial funds to the housing sector. There is a good reason 
to believe that in large integrated capital markets these flows 
would occur in the absence of GSE's, and indeed, there is some 
evidence in that private sector firms that have undertaken to 
provide capital market financing for those mortgages not 
covered by the GSE's and other firms that have securitized 
different kinds of loans, such as credit cards or commercial 
mortgages. So there is a considerable amount of 
evidence that these activities--the provision of funds and the 
disbursement of risk among capital market participants--can be 
undertaken by other entities as well.
    Senator Hagel. Do you think then that the markets have or 
are going to outgrow GSE's?
    Mr. Holtz-Eakin. I think there is every reason to believe 
the private capital markets can funnel these funds to the 
housing sector, and there is also some evidence in the research 
community that the private market is equal or in some cases 
ahead of the GSE's in providing funds to low-income borrowers. 
On those two fronts, there has been a maturation of private-
sector capital markets that has in many ways caught up to the 
GSE's.
    Senator Hagel. Thank you.
    My light is about ready to turn red, and I wanted to ask 
you a question, Mr. Korsmo. You, in your testimony, suggested 
to some extent that you look at Federal Home Loan Banks as 
maybe a competitor, some competition to the other two GSE's, 
more choice, lower rates, and so on. Could you define that a 
little bit more clearly, what you meant by that?
    Mr. Korsmo. As I alluded to, the acquired member asset 
programs, MPF and MPP, do provide albeit a small competitor at 
this point to Fannie and Freddie, they do provide competition, 
competition that I think has become recognized in some of the 
comments you probably heard Fannie and Freddie make about the 
desirability of banks being in that line of business, although 
I would argue it is the same line of business as advances.
    I think having another outlet, another vehicle for 
providing mortgage funding to lenders, particularly small 
lenders, particularly rural lenders, but also members of the 
Federal Home Loan Banks in general does provide a competitive 
edge that leads to lower costs, presumably over time, at the 
very least, for homebuyers.
    Senator Hagel. Thank you.
    Mr. Chairman, thank you.
    Senator Bennett. Thank you.
    Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    Mr. Falcon, the current minimum capital standard is 2.5 
percent for these GSE's. Is that too high or too low?
    Mr. Falcon. I believe it is adequate for the time being.
    Senator Reed. And the proposal is to allow the regulator 
set both the minimum capital and the risk-based capital. What 
are the advantages that you see for that, or disadvantages?
    Mr. Falcon. I think it would be an advantage to give the 
regulator the discretion to adjust both capital levels, if the 
regulator determined in its best judgment it was appropriate. 
There are two different types of standards. The risk-based 
capital standard is one that tries to quantify measurable risk 
through the use of models, through the use of historical 
analysis of performance of assets and liabilities. And that is 
all fed into a stress test which produces cashflows and 
determines what is the appropriate capital level.
    But nothing is ever fail-safe. That is why you also need a 
minimum capital standard to ensure that, at a minimum, they 
will always maintain a certain amount of capital. And so the 
two capital standards interact in that manner.
    If given the changes in the marketplace, the changes in the 
companies' risk profile, it is in the regulator's judgment that 
either standard needs to be adjusted upward, I believe it would 
be important for the regulator to have that discretion and to 
be able to exercise that discretion in a timely manner.
    Senator Reed. Why wouldn't it be sufficient simply to have 
the discretion to adjust risk-based capital since the most 
critical change is a result of business practices of the firm 
that drives the risk-based capital? That is something I think 
you alluded to in your response.
    Mr. Falcon. Right. Well, as I said, I think since risk-
based tries to capture quantifiable risk, I do not think it is 
ever possible to capture them perfectly, and so you always have 
to rely on at least a flat leverage type ratio as a fail-safe 
in the event that anything was not fully captured in a stress 
test.
    Senator Reed. Typically, risk-based capital is higher than 
minimum capital.
    Mr. Falcon. Not currently, sir.
    Senator Reed. Not currently?
    Mr. Falcon. Yes, Senator.
    Senator Reed. So, you are saying risk-based capital is 
lower than minimum capital?
    Mr. Falcon. Yes, sir.
    Senator Reed. And, again, I guess if you adjusted risk-
based capital up, you would effectively in this case compensate 
for the perceived lack of capital. You would just raise it 
above the minimum level, which you could do. Is that correct?
    Mr. Falcon. Yes.
    Senator Reed. While you have been Director of OFHEO, has 
HUD ever approved or declined to approve a new program or 
product that you believed would undermine the safety and 
soundness of one of your regulated entities?
    Mr. Falcon. Not that I am aware of, sir.
    Senator Reed. Do you see the difficulty there, where there 
could be a possibility of programmatic approval of something 
that would be unsafe or unsound? Wouldn't you object and 
wouldn't your objections--even though you technically do not 
have the authority, but your objections would be heard?
    Mr. Falcon. Well, I think they would be taken into account. 
Our role still would continue to be to make sure there was 
adequate capital held against the activity. So if we thought 
something was an extraordinary risk, even if it was consistent 
with the charters, we would make sure that there was adequate 
capital to set aside against the potential risk of loss of the 
activity.
    Senator Reed. Just a general question, and, Mr. Korsmo, you 
might respond to it also. There has been some discussion of 
having one regulator for both Fannie and Freddie and for the 
Federal Home Loan Banks. I know you have alluded to this and 
commented on it. Once again your thoughts, and then, Mr. 
Falcon, if you could comment.
    Mr. Korsmo. I certainly think there is the potential for 
advantages, and I will leave to the policymakers the decision 
as to whether or not those advantages outweigh the 
disadvantages. My only admonition along those lines is the one 
I made in my opening statement, and that is to remain cognizant 
of the very real differences that exist between the Federal 
Home Loan Banks and Fannie and Freddie in terms of charter and 
capital structure and membership structure. So long as those 
are recognized, the decision may be easier.
    Senator Reed. Mr. Falcon.
    Mr. Falcon. I think as the Federal Home Loan Banks develop 
into more of a competitor of the enterprises, I think it would 
be a benefit to the regulator of each entity to be able to 
fully understand the operations and activities of each. The 
real question is to what extent you have any uniformity of 
regulatory policies as expressed in the regulations or 
guidances, and whether or not you require--or have an 
uniformity as those policies apply to each entity. I think that 
is the more difficult question.
    Senator Reed. Thank you.
    Senator Bennett. Thank you.
    I would like to follow along on the comments that were made 
in response to Senator Hagel. Mr. Holtz-Eakin, you are 
suggesting the market would fill in for the GSE's if the GSE's 
were to disappear.
    Mr. Holtz-Eakin. I believe that there is a lot of evidence 
that the private markets can manage the finance of the U.S. 
housing sector, and at present the presence of an uneven 
playing field with taxpayers assuming a credit enhancement for 
the GSE's makes it impossible to observe them filling in, but 
in the absence of that there is good reason to believe they 
would.
    Senator Bennett. What would be the effect on cost? Would 
the price of mortgages go up if the GSE's were to disappear? 
You outline in your testimony or the GAO that the GSE's can 
borrow at lower rates of interest, and presumably that would go 
away. Would that not reflect in the higher cost in the housing 
market?
    Mr. Holtz-Eakin. The research we have done to date suggests 
that of the subsidy provided by taxpayers, about 25 basis 
points shows up in the form of lower rates to borrowers, the 
remainder is retained by the GSE's. Given our most recent 
estimates, there would be about a 25-basis-point impact on 
mortgage interest rates.
    Senator Bennett. Let me be sure I understand what you are 
saying. Would the mortgage rates go up by 25 basis points if 
the GSE's were to disappear?
    Mr. Holtz-Eakin. With no other changes in the market, the 
elimination of the implicit guarantee would raise mortgage 
interest rates by 25 basis points.
    Senator Bennett. Is that not a social good that the 
Congress decides is worth the implied guarantee, to have lower-
cost housing, particularly for the low-income Americans?
    Mr. Holtz-Eakin. It is clearly only one element of the 
overall benefit cost test: Whether the cost of having taxpayers 
assume more risk is outweighed by the benefits of this, 
particularly for low-income individuals. The research suggests 
that 25 basis points alone would not move substantial numbers 
of low-income borrowers into homes, that a larger movement in 
interest rates, of around 2 percentage points, is needed to 
really have a substantial impact on homeownership rates among 
lower-income individuals.
    Senator Bennett. So you are saying 25 basis points is 
basically trivial.
    Mr. Holtz-Eakin. Trivial is in the eye of the beholder, but 
those are the magnitudes that we estimate would happen and the 
magnitudes the research community suggests are important.
    Senator Bennett. Thank you.
    Now, following along the lines that Senator Reed raised, in 
our previous hearing and in post mortems of the previous 
hearing, it strikes me that one of the sticking points here is 
the question of the role of the regulator, assuming a new 
regulator is established within the Treasury, the role of the 
regulator and the role of HUD. I think that was the issue that 
Senator Reed's comments were getting toward.
    Mr. Falcon, you have said you as the existing regulator 
have never seen HUD do anything that would in fact affect 
safety and soundness. The GSE's prefer to deal with HUD because 
they prefer the devil they know to the devil they do not know. 
They worked out an accommodation with HUD whereby new products 
are approved relatively rapidly, and their fear, as I 
understand it, is that a new regulator would ultimately end up 
approving the same new products, but do so in a manner that 
would take enough time, create some bureaucratic arterial 
sclerosis, that it never moves, and ultimately therefore there 
would be a delay in getting new products to the market.
    Could you comment on that whole thing? I imagine you have 
given it some thought, and you are the only one who has had 
some practical experience with the dichotomy between HUD's role 
and a regulator's role.
    Mr. Falcon. The way things are set up now, Senator, is with 
HUD as the mission regulator, and us as the safety and 
soundness regulator, we are also tasked for enforcing, as the 
enforcement arm for the Enterprises, even in most matters 
related to mission regulation. If HUD thought there was an 
issue, an activity that the Enterprises could not engage in and 
an enforcement action was necessary, it would be up to OFHEO to 
take the enforcement action.
    As the safety and soundness regulator and responsibility 
for assuring that the Enterprises are in compliance with all of 
the laws and regulations that apply to them, we have to make 
sure that we understand what is going on in the area of their 
activities, and if we saw that there was a clear violation of a 
law, including their charters, we would step in and advise the 
company that it was not permissible. We have done that before.
    But where they operate in the vast gray area, we defer to 
HUD on what is permissible and what is not. What I am 
suggesting is that we just take it a step further and give the 
safety and soundness regulator the authority to also opine in 
this gray area. There are different ways to do this to make 
sure that HUD continues to have a role when the activity 
involves some affordable housing or low-income housing program. 
I think something could definitely be structured there. But I 
think it is just a matter of making sure that the regulator--we 
do not prefer that the agency is operating under a cloud and 
leave themselves open to a potential legal challenge, that it 
be clear what they can and cannot do.
    That is why I think it is the interest of the safety and 
soundness regulator to have this type of authority as all the 
others do.
    Senator Bennett. Senator Corzine.

               COMMENTS OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Chairman Bennett, and welcome 
to the panel. I apologize for not being here. I had another 
obligation.
    Just a quick question to Director Holtz-Eakin. This 25 
basis points has to be an average, cannot possibly be every 
single element. I think that is what Senator Bennett was 
talking about. It is a range of benefits to different mortgage 
takers. I would presume that since there are credit spreads in 
the mortgage market, in the mortgage lending market, that some 
people, while they may be spending a lot more than they would 
otherwise be, it is still going to be a lower spread than 
otherwise. I presume it is an average.
    Mr. Holtz-Eakin. There is certainly a spread, and this is 
an average result from our study.
    Senator Corzine. So that different elements of the market 
may benefit more than 25 basis points. Folks accessing with 
less quality credit or at least credit histories than other 
people, and therefore some of that might be more important for 
certain segments of the market than it would be others. It 
would not just be a standard 25 basis points.
    Mr. Holtz-Eakin. There will certainly be a spread, and what 
we will look at is those mortgages that qualify under Fannie's 
and Freddie's requirements.
    Senator Corzine. As you probably can recognize that 
sometimes the spread gets so much that supply and demand would 
actually allocate out some money at the long end of the 
widening of the spread, 200 basis points or 400 basis points 
for some element. It gets to a point where it is prohibitive or 
the market rate just gets to a marginal rate somebody cannot 
afford. I presume that at some level that occurs because of 
this.
    Mr. Holtz-Eakin. As an economist, I would never dispute the 
fact that some people get priced out of markets. I take that 
point. The degree to which that is an empirical phenomenon is 
not something we investigated.
    Senator Corzine. I think that when we are talking a about 
25 basis point, I think I do not know what the outstanding 
mortgage lending money is, but on an average basis, on an 
annual basis, time discounted value over a period of time, that 
is actually a pretty substantial benefit to consumers, and 
since it would be different for different segments I still 
think it is a quite substantial benefit for mortgage production 
and homeownership which I think is one of the core cases of 
what we would be arguing, why GSE's have a reason to exist.
    Mr. Holtz-Eakin. In terms of the magnitudes, our estimate 
at the time was $10 to $15 billion a year in subsidy, of which 
something on the order of half to two-thirds shows up in the 
form of lower mortgage interest rates. So that is a way to 
divide up the degree to which the subsidy benefits consumers.
    Senator Corzine. It goes to the core of whether 
policymakers think that is an appropriate way to generate these 
kinds of issues enough.
    Mr. Holtz-Eakin. Absolutely.
    Senator Corzine. I have a question, Mr. Korsmo. I know 
these things could take months. What is the capital standards 
that the Federal Home Loan Banks have? We talked about minimum 
standards and there are risk-based standards, but what do they 
look like at the Federal Home Loan Banks? Maybe you answered 
that in your testimony.
    Mr. Korsmo. Let me answer that question a couple of ways. 
Obviously, there is a statutory minimum of 4 percent that is 
included in the statute, a minimum leverage requirement that is 
based on the definition of capital that Congress has provided 
that goes to 5 percent. There is also a risk-based capital 
element that is established by regulation, as Mr. Falcon 
alluded to earlier with the case with Fannie and Freddie. The 
risk-based capital level that is provided by the regulatory 
definitions is below the statutory minimum, and so all the 
banks are operating under that 4 percent statutory minimum.
    There is a variety of course among the 12 institutions--I 
should say there is a variety of levels of capital among the 
variety of--among the 12 institutions I think they range from a 
low of about 4.2 percent maybe to a high in excess of 5.5. I 
know the Chicago Bank just announced their new level is 
approximately 5.15 percent. I can talk a little bit about what 
is included in the risk-based capital reg if that is----
    Senator Corzine. But it has not really bitten.
    Mr. Korsmo. No, it has not really bitten, that is correct.
    Senator Corzine. Have you looked at the nature of your 
risk-based capital standards relative to what OFHEO has 
developed with regard to the GSE's?
    Mr. Korsmo. I have not. There is a comparison of course. 
The standards are different and the factors that go into the 
standard are different. For example, our scenarios are 
substantially different than the scenarios under which OFHEO 
develops their risk-based capital standard. It is much more----
    Senator Corzine. I see the red light is on. Are those 
differences a function of a different mission, different 
purpose, or are they a function of different intellectual 
framework?
    Mr. Korsmo. I think they are different intellectual 
framework, different methodology.
    Senator Corzine. If there was a consolidation, then we 
would want to think about how----
    Mr. Korsmo. They would have to be reconciled, yes, sir.
    Senator Bennett. Thank you, Senator.
    Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I would like to inquire about 
the Federal Housing Finance Board in its role as a 
nonappropriated agency, as you enact your own budget and assess 
the Banks on the cost of the operation. How important is this 
authority in your ability to carry out your mission?
    Mr. Korsmo. I think it is significant, and I would 
certainly urge the policymakers to take a look at any new 
regulatory body or any change in the current regulatory 
structure to reflect the ability to generate a budget.
    Senator Allard. So you think OFHEO or any new agency that 
we set up should have that capability?
    Mr. Korsmo. Yes, sir, I do indeed. Obviously, there have to 
be some constraints. I think that the process at the Finance 
Board, whereby the budget is adopted by a majority vote at an 
open meeting provides the balance that is necessary to make 
sure that we are not penalizing the entities we regulate by the 
budget process.
    Senator Allard. Dr. Holtz-Eakin, how do we apply 
accountability to a regulatory agency like this? I think back, 
for example, of the FDA. Before they approve drugs they go back 
to the industry and say, well, we are not going to approve any 
more applications for new drugs and we are going to slow down 
the process unless you work with us to increase fees on 
services. Is there a way that we can bring accountability into 
the budget process on that type of a proposal or do we already 
have it?
    Mr. Holtz-Eakin. I think accountability follows 
transparency on the part of both those being regulated and the 
regulator. So the degree to which the regulatory oversight 
process is transparent and made as clear as possible to all 
parties--the regulators, those regulated, and the Congress--
will help accountability more probably than any other single 
factor, the observability of the actions of both parties. If I 
had to pick one thing, I would point to that.
    Comparability across regulatory agencies is useful as well, 
so that in the same way that competition in private markets 
allows comparison shopping, having the same accounting 
standards and disclosure standards and being able to observe 
differences across----
    Senator Allard. I would like to have both of you respond to 
this question. How do we know you, the regulator or regulators, 
have established a reasonable budget? If it does not go through 
the appropriation process? Any of you who would like to respond 
to that.
    Mr. Falcon. I think what would weigh heavily on my mind is 
the fact that what powers you give us can also be taken away. 
If we abuse the authority that you would give us at OFHEO to 
set our own budget outside the appropriations process, and we 
abuse that authority by not being responsible with how we set 
our budgets, then you would have every opportunity to put us 
back in the appropriations process. But our budget process 
would be very transparent, and our assessments would be based 
on a regulation that would be set in formula, would be 
predictable to the companies that we regulate, and they would 
not be set without their input through the regulatory process.
    Senator Allard. You imply in your comments that somehow it 
is always easy to get legislation through the Senate. It is 
not.
    [Laughter.]
    How is it that we have, again, I come back to 
accountability, and Mr. Korsmo, maybe you want to speak on 
that.
    Mr. Korsmo. I think Dr. Holtz-Eakin is right. It is the 
transparency of the process that is significant, and that is 
why one of the things we have done in the last 2 years at the 
Finance Board is to adopt the budget in an open meeting. 
Previously, it was done by notational vote. One year it was 
adopted by fiat of the chairman. I think the assurance of 
accountability that lies at least in the structure of the 
current Federal Housing Finance Board, besides the obvious 
element of transparency is the fact that the 8,008 financial 
institutions who are members of one or another of the 12 
Federal Home Loan Banks and who pay those assessments 
ultimately, I suspect you would hear from them if they thought 
our level of assessment was inappropriate.
    Senator Allard. I am going to move on--my time is about 
ready to expire. Mr. Chairman, if I may just briefly----
    Senator Bennett. Does anyone else have an additional 
question they would like to ask?
    Senator Sarbanes. Yes, but why do you not----
    Senator Bennett. Why don't you go a little bit over time. 
And I have one additional question.
    Senator Allard. Then I do not have any questions. That will 
take care of it for me.
    So we have divided responsibility. How do we get 
communication channels open so regulators can communicate back 
and forth, and maybe if you all, Mr. Falcon and Mr. Korsmo, 
would talk about that a little bit.
    Mr. Falcon. It does occur through regulatory agencies. Our 
examiners are part of an interagency examination council, where 
they meet regularly to discuss evolving benchmarks, evolving 
regulatory practices, and best practices at the different 
entities that we all regulate. That occurs I think at different 
type of program levels within the agencies. It certainly, as 
issues come up that are of mutual interest to myself and the 
chairman, we certainly discuss those with each other.
    Mr. Korsmo. I think that is one limitation under which we 
operate that could be corrected. Our examiners do not belong to 
FFIEC, Federal Financial Institutions Examination Council. I 
think that is a shortcoming. The ability for us to participate 
in that process would be very important, particularly the 
opportunity to interact with other examiners of large financial 
institutions.
    Senator Allard. So this would be to your advantage then in 
that respect, to be brought in with Fannie Mae and Freddie Mac 
with a Treasury regulator. That would give you an----
    Mr. Korsmo. I think that is a larger issue, Senator. A 
simpler approach to it would just be to make the Federal 
Housing Finance Board a member of FFIEC, which it is not today.
    Senator Allard. I see.
    Thank you, Mr. Chairman.
    Senator Bennett. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Mr. Korsmo, you have been increasing the 
budget, but you could set the budget at the figure that you 
thought was necessary in order to adequately regulate, could 
you not?
    Mr. Korsmo. We could. Again, I will mention that in the 20 
months I have been there, what we have tried to do is proceed 
in a deliberate, disciplined, and orderly fashion. One of the 
things----
    Senator Sarbanes. I understand that. I was prompted to ask 
you that question by your response to Senator Allard, saying 
that your member banks, you would presume, would protest if you 
were taking the budget up. But there is a conflict there, is 
there not? You are the regulator. If you do not think the 
budget is adequate you need to make it adequate whether they 
protest or not, do you not?
    Mr. Korsmo. That is absolutely correct, sir, which I think 
you will see reflected in the budget for fiscal year 2004 where 
we have made a fairly dramatic increase.
    Senator Sarbanes. All right. I wanted to ask both you and 
Mr. Falcon this question. If an independent regulator were to 
be set up, perhaps not in the Treasury, or even in the 
Treasury, I mean wherever, should it be a single person 
regulator or a multiperson regulator, and why, or does it make 
any difference?
    Mr. Falcon. My preference would be for a single head of the 
agency as opposed to a board or commission structure. I have 
not had experience being the chairman of the board, regulatory 
agency run by a board, but I can tell you from my experiences 
as a single head of an agency that it provides me the ability 
to take quick and decisive action as necessary without the need 
to consult with a board. It provides me to clearly set the 
mission of the agency. It allows me to make sure that all the 
policies are consistent with those as in my best judgment I 
think are appropriate.
    Now, granted, you can have some of that with a board 
structure as well, but I think just as far as the ease in 
running the agency, the administrative functions, as well as 
setting policy, I much prefer a single head of an agency.
    Mr. Korsmo. As Director Falcon has only had the experience 
of the single member or single director institution, I have 
only functioned with a board. There are certainly limitations 
inherent, and he has outlined them, in functioning with a 
board. The flip side of that of course is there are certain 
advantages I think that are inherent in having five individuals 
who come from different backgrounds, different perspectives, 
the opportunity to participate in the decisionmaking process.
    If I were to construct an administrative process for the 
Finance Board, would I structure it precisely the way it is 
now? I am not sure that I would. But again, it is the only 
paradigm I have experienced. So, I would say it certainly 
works.
    Senator Sarbanes. Thank you.
    Chairman Shelby. [Presiding.] Thank you.
    Dr. Holtz-Eakin, your testimony indicates that when the 
GSE's hold more mortgages in portfolio the risk faced by the 
GSE's may be increased. You also indicate in your written 
testimony that this activity has increased over time. What are 
some of the possible explanations for the shift in activity by 
the GSE's, and what can you tell us about how the GSE's have 
managed the risk.
    Mr. Holtz-Eakin. I can only speculate on the ultimate 
motivation for shifts in portfolios. The result is that by 
holding more risk there is a greater rate of return to these 
activities, and one would expect that to be reflected in return 
on equity, for example.
    The degree to which that risk is managed is very hard to 
quantify. Net positions on hedges and derivatives are very 
difficult for even the best examiners to keep up with on a day-
to-day basis. It is one of the challenges that would face any 
regulator, and for that reason, quantifying the management of 
that risk is hard. The bottom line is, however, they have 
earned higher rates of return on equity than have comparable 
private-sector financial institutions, and that typically is 
associated with greater risk.
    Chairman Shelby. To what extent is it necessary to achieve 
liquidity in the housing finance markets, to have the GSE's 
hold mortgage or MBS's in portfolio?
    Mr. Holtz-Eakin. I do not think that is a central part of 
achieving liquidity. Financial markets will price the 
attributes of securities, not the names on them, and the risk 
characteristics--the 
interest rate risk, the prepayment risk--have little to do with 
who has actually got its name on the securities.
    For the Nation as a whole, there will be an outstanding 
stock of mortgages at any point in time, and the bearing of 
that risk is typically a voluntary action in private markets. 
The GSE's shift some to the taxpayer in a slightly different 
fashion.
    Chairman Shelby. Mr. Falcon, you have indicated that you 
believe the new safety and soundness regulator should have 
program approval authority. Do you believe this would inhibit 
the GSEs' ability to meet their mission of expanding 
homeownership?
    Mr. Falcon. I do not think it would. The authority would 
not be used in a manner to inhibit their ability to fulfill 
this affordable housing mission. In fact, as we have performed 
our regulatory duties, because we have some role in charter 
compliance presently, where we see a clear violation we will 
step in and tell the Enterprise that is not permissible. And as 
we put our risk-based capital standard in place, we did that in 
a way that did not provide any disruption to the company, it 
was a smooth implementation. And they are meeting the standard 
now. I think it is more a necessity for the risk for the safety 
and soundness regulator to be able to ensure that the companies 
are in compliance with the charters and that none of their 
activities are under a cloud.
    Chairman Shelby. You also suggest a mechanism to ensure 
that the new regulator solicit and consider all views. How 
would such a process work in practice, just briefly?
    Mr. Falcon. I think what would be beneficial is that when 
the agency decided that there was an activity that needed to be 
reviewed for purposes of charter compliance, that it should put 
out a notice to all interested parties that the agency is 
considering that activity, and ask for comment from anyone who 
is interested about whether or not in their view the activity 
is or is not permissible, and the benefits and the downsides of 
the activity.
    Chairman Shelby. Doctor, as you know, the minimum capital 
threshold of 2.5 percent that Fannie and Freddie are subject to 
is often compared to the 4 percent minimum capital standard 
that banks and thrifts must meet. Fannie and Freddie--and they 
have done it here--that they do not need to hold as much 
capital as banks and thrifts because they pursue lower-risk 
activities, which there is some truth to. How would you respond 
to this assertion? If a 2.5 percent threshold was appropriate 
in 1992 how should the Congress evaluate whether it remains the 
appropriate threshold today?
    Mr. Holtz-Eakin. I think there are two types of responses 
to that. The first is that I think the record is quite clear 
that the overall credit risk pursued by the GSE's is, in fact, 
relatively modest. However, that is only a narrow component of 
the overall types of risks that I outlined in my testimony. 
Judging the adequacy of capital standards against those other 
risks, which are, in fact, shared by the private sector, is 
probably a more fruitful way to go.
    In revisiting the minimum capital requirements, it is 
useful to keep in mind that one part of the purpose of those 
capital requirements would be to ensure not just the 
institutions but the overall impact of those institutions on 
financial markets against large disruption. That is a role that 
regulators should have a keen eye toward and may affect the 
decision on capital requirements.
    Chairman Shelby. Mr. Korsmo, the Finance Board supports 
requiring each Federal Home Loan Bank to register with the 
Securities and Exchange Commission. I agree with enhancing 
disclosure, but I am not sure that all the appropriate issues 
have been addressed here. My question to you is: How does the 
Finance Board propose to address certain unique structural 
factors in the Federal Home Loan Bank System, such as joint and 
several liability of the system?
    Mr. Korsmo. That is an excellent question, Mr. Chairman. 
And our view on that has been that the best way to address 
those questions is to have the questions resolved between the 
12 potential registrants and the SEC themselves. At least 5 of 
the Banks have been actively engaged in those discussions. 
There were certainly any number of threshold issues that we 
recognized that the Finance Board is having to have some 
successful resolution in terms of their accounting practice 
prior to moving ahead. I think we have made sufficient 
progress, that the final progress needs to be made between the 
staff of the SEC and the staffs of the 12 potential 
registrants.
    Chairman Shelby. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Let me just follow on on this joint and several concept. Do 
you have joint oversight of the consolidated balance sheet? Do 
you look at balance sheet and the risk-based capital standards? 
Are they applied on a consolidated basis?
    Mr. Korsmo. I understand that joint and several liability 
only applies to consolidated obligations. I guess the short 
answer to your question is yes.
    Senator Corzine. So you look at the minimum capital 
standards and the risk-based capital standards for the overall 
balance sheet even though the joint and several only relates to 
the----
    Mr. Korsmo. No, no. I am sorry.
    Senator Corzine. You look at the individual unit banks.
    Mr. Korsmo. That is correct.
    Senator Corzine. I just have a question then. The main 
financing technique for the Banks is through the consolidated 
borrowing debentures. One last question that I had. Mr. Falcon, 
I think I used the term ``mind boggling'' last time when I 
talked about a $1.5 to $3 billion estimate, under reported 
earnings, and that seemingly has grown from that $1.5 to $3 to 
$4.5. Are there any obvious explanations on the size of what 
moved us out of that range, and when do we feel that a full 
accounting for the difference in Freddie Mac can actually be 
explained?
    Mr. Falcon. The process is on track to be concluded 
sometime in mid-November, and so they will then be issuing 
statements, assuming everything goes as planned. That is just 
the magnitude of which earnings were moved into future time 
periods, rather than being recognized in the earlier time 
periods if the proper accounting rules were utilized. It is 
just a reflection of the cumulative impact of all the different 
transactions that we are engaged in to try to smooth out these 
earnings over time.
    Senator Corzine. Was there a standard procedure that was 
used that was used to move forward earnings?
    Mr. Falcon. There was a wide variety of different types of 
transactions.
    Senator Corzine. Pardon?
    Mr. Falcon. There was a wide variety of different types of 
transactions.
    Senator Corzine. It was not just one kind.
    Mr. Falcon. Right, right.
    Senator Corzine. It was not a generic methodology.
    Mr. Falcon. No.
    Senator Corzine. Thank you.
    Chairman Shelby. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    Two quick questions. Simply the terminology that has been 
used around here. There has been reference to the taxpayer 
subsidy. Subsidy usually means that if it is not done, money 
ends up in the Treasury. Is there a suggestion that if the 
GSE's were eliminated there would be an extra $10 billion in 
the Treasury?
    Mr. Holtz-Eakin. The nature of the subsidy is the lower 
borrowing costs to the GSE's and the budgetary reflection of 
that is the low probability, over long periods of time, that 
there would be an event which would place the taxpayer at the 
risk of actually providing funds directly was done with the 
Federal Farm Credit System in the 1980's.
    Senator Bennett. But there is not a subsidy like a farm 
subsidy that we can quantify every year. If we were to 
eliminate the GSE's, presumably there would be an elimination 
of risk, but there would not be an immediate amount of money 
showing up in the Treasury if we eliminated the GSE's.
    Mr. Holtz-Eakin. There would not be a cashflow to the 
Treasury, but the situation is similar to credit reform, where 
we could reflect on the budget the implicit cost of that risk 
and take account of it in budgetary deliberations.
    Senator Bennett. Is there a budget figure for implied risk?
    Mr. Holtz-Eakin. Not in this area, but in other areas where 
guarantees are provided by the Federal Government credit reform 
does allow for an explicit entry in the budget for the value of 
that guarantee.
    Senator Sarbanes. Yes, but the more you talk that way, the 
more explicit the guarantee becomes and everyone runs around 
saying this is not an explicit guarantee and they are required 
to state it absolutely. Then everyone comes along here, it is--
I mean you are sitting there at the table taking an implicit 
guarantee and making it explicit, are you not?
    Mr. Holtz-Eakin. I am not. I am not in any way advocating a 
particular budgetary treatment. I am trying to explain that to 
the extent that it is perceived to be a guarantee, it has 
consequences for the real provision of resources and perhaps 
for the Government.
    Senator Bennett. There is no cashflow subsidy.
    Mr. Holtz-Eakin. Not at present.
    Senator Bennett. The only other question. We talk about 
taxpayer risk, and I admit there is an implication of some 
taxpayer risk, but isn't the first line of risk the 
shareholders? They stand to lose everything if the GSE's fail, 
do they not?
    Mr. Holtz-Eakin. Absolutely. And the empirical question is 
the degree to which that line of defense is adequate. As was 
mentioned, I think in Mr. Falcon's opening remarks, capital is 
the bulwark against which you would place these risks, and the 
question is whether the capital is adequate.
    Senator Bennett. And if the capital is attracted to the GSE 
by the noncash subsidy and the risk is borne by the capital, 
maybe this is a good idea.
    Mr. Holtz-Eakin. The outcome is that the GSE's, as compared 
to simliarly rated private sector entities, have less capital. 
There is less there, and there is a higher rate of return 
because of this lower capital.
    Senator Bennett. Now we get into the Chairman's question 
about the reason there is less capital is that there is less 
risk because they do not issue credit cards, they stay with 
mortgages. And that is another philosophical argument. I simply 
wanted to be sure I understood the terms we are using here and 
when we are talking about subsidy we are not talking about a 
cash subsidy, we are talking about an implied subsidy, and when 
we are talking about risk, it is true that the risk is all held 
by the shareholders, and there is an implied risk for tax 
holders, but again, we cannot truly quantify it until we see 
how much of a disaster the shareholders have to absorb.
    Mr. Holtz-Eakin. The degree to which it can be quantified, 
we have taken one approach in our past studies which is to 
compare borrowing costs of comparable private sector entities 
with the GSE's. There is another approach basically called an 
options value approach--where by you could, in the same way, 
try to quantify the magnitudes involved, and if that was 
something of interest, we would be happy to work with you on 
that.
    Senator Bennett. Thank you, Mr. Chairman.
    Chairman Shelby. When we are talking about risk, the 2.5 
versus the 4, have there been any studies that any of you know 
done showing the real risk in the marketplace there? In other 
words, what is the percentage of losses of Freddie and Fannie 
compared to an ordinary bank that is into all kinds of other 
risk? See, they, by statute, are limited to what they can 
invest in. Is that not right, Mr. Falcon?
    Mr. Falcon. Yes, sir.
    Chairman Shelby. Go ahead. Do you know if there are any 
studies showing this, if there are risks, and then their risks?
    Mr. Holtz-Eakin. I think the spirit of the question is what 
are the outcomes that you can look at. You can look at the 
default rates and outcomes for comparable private-sector 
entities. In my testimony, I reference this. Over a 15-year 
period for comparably rated private sector entities, that rate 
is nearly 2 percent.
    Chairman Shelby. Gentlemen, we thank you for your testimony 
here today and participating. I apologize for having to leave 
and come back, but I am Chairman of a Subcommittee on 
Appropriations that has opened up on the floor, so I will be on 
the floor a lot today. Thank you.
    Chairman Shelby. We will now move to our second panel. All 
of your written testimony will be made part of the hearing 
record in its entirety, and if you would take 5 minutes 
apiece--I know that is compressing your time--to sum up your 
remarks, we would be very appreciative, and then we will get 
into the others.
    Mr. Koch, we will start with you. First, I want to yield to 
Senator Sarbanes for a statement.
    Senator Sarbanes. Mr. Chairman, I join with you in 
welcoming the witnesses, but I particularly want to welcome 
Iona Harrison, who is here on behalf of the National 
Association of REALTORS'. Ms. Harrison is from Upper 
Marlboro, Maryland in nearby Prince George's County. She has 
long been active in her community there. She has played an 
important leadership role with the realtors, both in the 
Maryland chapter and nationally, and we are very pleased she is 
here today, and I am looking forward to her testimony. Thank 
you.
    Chairman Shelby. Thank you.
    Mr. Koch.

                   STATEMENT OF JOHN D. KOCH

       EXECUTIVE VICE PRESIDENT AND CHIEF LENDING OFFICER

             CHARTER ONE BANK, NA, CLEVELAND, OHIO

                          ON BEHALF OF

                  AMERICA'S COMMUNITY BANKERS

    Mr. Koch. Chairman Shelby, Ranking Member Sarbanes, and 
Members of the Committee, I am John Koch, Executive Vice 
President and Chief Credit and Lending Officer for Charter One 
Bank in Cleveland, Ohio. I am also Chairman of America's 
Community Bankers GSE Policy Committee and a member of ACB's 
board.
    Many of our members are specialists in mortgage lending and 
actively involved in the secondary market. Therefore, we 
appreciate this opportunity to provide our comments to the 
Committee.
    ACB has intense interest in GSE regulatory reform for 
several reasons. We strongly support efforts to improve 
regulation of all the housing GSE's including the Federal Home 
Loan Banks to better ensure safety and soundness. We strongly 
support the secondary market role of Fannie Mae and Freddie Mac 
and their 
important housing mission. We particularly note their 
contribution to our underserved communities, which has been 
most substantial, but we further note that significant 
disparities still sadly exist in homeownership rates for low- 
and moderate-income households in this country.
    Our members are also substantial stockholders and borrowers 
in the Federal Home Loan Bank System. For example, my own 
institution has active relationships with all these entities. 
Charter One Bank services over $15 billion in home mortgages 
for Fannie Mae and Freddie Mac. Our Federal Home Loan Bank 
advances total nearly $10 billion. Our investment in the 
Federal Home Loan Bank System totals $700 million, which is our 
largest investment by far. So the safety and soundness of the 
Federal Home Loan Bank System is of paramount interest to us 
and to the members and to our bankers members across the United 
States.
    ACB recognizes that the legislative situation we face is 
very fluid. During the House Committee's consideration of this 
issue, we supported shifting regulation of Fannie Mae and 
Freddie Mac to a fully funded independent regulator within the 
Treasury. We also support an amendment to include the Federal 
Home Loan Banks in that agency. We continue to support both of 
these concepts and strongly urge you to consider including them 
in your legislation. It is essential that this new agency be 
independent. My written testimony details the key elements of 
independence that are currently provided to other financial 
regulators at this point in time. If the Treasury can not 
accept an independent agency within the Department, ACB would 
consider and support a stand-alone agency.
    Regardless of location, however, the new agency must also 
be able to fund itself without going through the annual 
appropriations process. It must have sufficient resources to 
get its job done. ACB strongly endorses the Administration's 
position that the new agency have the authority to review both 
current and future programs of Fannie Mae and Freddie Mac.
    For over a decade, HUD has not exercised its current 
program approval authority. As a result, Fannie Mae and Freddie 
Mac have engaged in or attempted to engage in activities 
inconsistent with their secondary market responsibilities. Most 
importantly, these activities further raise the risk profile of 
these institutions. New initiatives such as acquisition and 
development lending underscore this point, that the review 
process and the authority needs to be shifted into one 
regulator. This process after all is good enough for all the 
banks of this country throughout the entire banking system.
    ACB strongly agrees with the Administration's position that 
there should be no limit to the new agency's ability to adjust 
capital requirements for Fannie Mae and Freddie Mac. Let me be 
clear that we are not proposing that capital requirements be 
increased at this time, but capital is the foundation for the 
safety and soundness of our financial system, and must remain a 
flexible regulatory tool. Without capital authority the new 
regulator's power is gutted.
    While supporting the regulator for the housing GSE's, the 
new agency should administer the unique statutory arrangements 
that apply to each. The Federal Home Loan Banks are 
cooperatives, not public companies, and pose different 
regulatory issues. While acknowledging key differences, we note 
that the Federal Home Loan Banks, Fannie Mae, and Freddie Mac 
are all engaged in extensive interest rate management. A 
combined agency would be better able to supervise these risks. 
Concentrating all the expertise in one agency would provide 
good regulatory leverage for analysis of hedging risks, for 
example, investment concentrations, et cetera. This would be 
more efficient Government.
    I wish to again express ACB's appreciation for the 
invitation to testify to these important issues. We certainly 
support the Committee's efforts to strengthen the regulation of 
Fannie Mae, Freddie Mac, and Federal Home Loan Banks. We look 
forward to working with you as you craft legislation to 
accomplish this goal.
    Chairman Shelby. Thank you.
    Mr. Torpey.

                  STATEMENT OF DALE J. TORPEY

                       PRESIDENT AND CEO

               FEDERATION BANK, WASHINGTON, IOWA

                          ON BEHALF OF

            INDEPENDENT COMMUNITY BANKERS OF AMERICA

    Mr. Torpey. Chairman Shelby, Ranking Member Sarbanes and 
Senate Banking Committee Members, I appreciate this opportunity 
to present ICBA's views on proposals for improving housing GSE 
regulation. This is a matter of critical importance to 
community banking.
    I am Dale Torpey, President and CEO of Federation Bank in 
Washington, Iowa. I serve as Chairman of the ICBA's Lending 
Committee. I also chair the board of directors of the Federal 
Home Loan Bank of Des Moines. But my testimony today is 
delivered exclusively on ICBA's behalf.
    As a general principle, we do not believe the Treasury 
should direct the housing policy, just as it should not run the 
monetary policy of our Nation. In our view should Treasury be 
granted oversight of either Fannie Mae, Freddie Mac, or all 
three of the housing GSE's, its tax and fiscal policy 
responsibilities would likely present clear conflicts of 
interest with housing policy.
    We also share concerns expressed by others regarding the 
historical absence of housing policy expertise at Treasury. 
Since the Gramm-Leach-Bliley Act of 1999 widened membership in 
the Federal Home Loan Bank System and expanded the categories 
of eligible collateral for Federal Home Loan Banks' advances, 
thousands of community banks use advances as a competitive and 
flexible funding tool. Our ability to continue to use this 
increasingly important funding source is crucial to safe and 
sound asset liability 
management and to provide lendable funds for our communities. 
Similarly, the fact that Federal Deposit Insurance coverage 
levels have not increased since 1980 has given communities 
banks further incentive to turn to FHLB advances as a stable 
alternative funding source.
    ICBA continues to believe that Federal Home Loan Banks 
should be regulated by a separate and independent agency, a 
status the existing Federal Housing Finance Board already 
enjoys. Under FHFB's regulatory's guidance, the FHLB's have a 
near impeccable record of providing well collateralized 
advances to thousands of institutions. The FHFB has and 
continues to take important steps to upgrade its examination 
and supervision capacities. ICBA has long supported independent 
financial regulatory agencies such as the Federal Reserve, 
FDIC, and the SEC.
    Earlier this month the ICBA Board of Directors discussed 
FHLB regulation at length. Our board voted unanimously to 
oppose, including the FHLB's, in any new proposed new Fannie/ 
Freddie regulatory structure in Treasury. Our board did not 
discuss the concept of a new independent regulatory structure 
outside Treasury for Fannie/Freddie and the FHLB's, a concept 
voiced by some in recent days.
    While not our first preference, ICBA may not oppose the 
concept of a new independent regulator for all three housing 
GSE's outside Treasury depending on how the details flesh out. 
First, the specific regulatory powers of such an agency would 
have to be determined. We note that the FHFB and OFHEO do not 
currently have the same powers. Second, the unique ownership, 
operational, and capital structure and mission of the FHLB's 
would have to be recognized and preserved. Community banks are 
significant direct and indirect users of Fannie/Freddie 
conduits into the secondary mortgage market, and the sale of 
mortgages originated by community banks into the secondary 
market increases our liquidity and in turn allows us to make 
more loans in our communities.
    The current system has enabled us to reach record 
homeownership levels and to accommodate consumer refinancing 
needs in the recent low interest rate environment. We must be 
careful not to jeopardize this success.
    Regarding proposals to bring Fannie/Freddie regulation 
under Treasury, the ICBA reiterates its staunchly held view 
that any such entity must be politically independent in order 
to be a world class financial regulator.
    We strongly urge Congress to ensure that any potential 
legislation contain appropriate firewalls and independence 
between Fannie, Freddie, and Treasury's politically appointed 
policymakers.
    In closing, the ICBA urges the Committee to carefully and 
fully consider the issues associated with housing GSE 
regulation before rushing to action. There is no shortage of 
opinions and strongly held viewpoints on these issues. We 
concur with the sentiments expressed by a number of Committee 
Members that it is imperative that any regulatory structuring 
be done right, given its potential impact on our crucial 
housing sector and on community banks' continued ability to 
meet the lending needs of Main Street America.
    I thank you for the opportunity today to testify, and I 
would be pleased to answer any questions.
    Chairman Shelby. Thank you.
    Mr. Fishbein.

                 STATEMENT OF ALLEN J. FISHBEIN

             DIRECTOR FOR HOUSING AND CREDIT POLICY

                 CONSUMER FEDERATION OF AMERICA

                          ON BEHALF OF

            CONSUMER FEDERATION OF AMERICA, NATIONAL

          ASSOCIATION OF CONSUMER ADVOCATES, NATIONAL

           COMMUNITY REINVESTMENT COALITION, NATIONAL

          CONGRESS FOR COMMUNITY ECONOMIC DEVELOPMENT

               AND NATIONAL FAIR HOUSING ALLIANCE

    Mr. Fishbein. Thank you, Mr. Chairman, Senator Sarbanes, 
and Members of the Committee. My name is Allen Fishbein, and I 
am Director of Housing and Credit Policy for the Consumer 
Federation of America, and we appreciate the opportunity to 
testify on proposals for improving the regulation of housing 
Government Sponsored Enterprises.
    My opening statement today is also on behalf of the 
following organizations: The National Association of Consumer 
Advocates, the National Community Reinvestment Coalition, 
National Congress for Community Economic Development, and the 
National Fair Housing Alliance.
    As national consumer community and civil rights 
organizations committed to the promotion of fair and affordable 
housing for all of America's citizens, we watch with 
considerable interest the ongoing debate about possible changes 
to the regulatory structure for Fannie Mae and Freddie Mac, and 
wanted to share a few of our observations.
    We appreciate those in Congress who desire to assure the 
adequacy of safety and soundness and mission-related 
requirements for the GSE's. We also urge that Congress be very 
careful in tinkering with the GSE's' basic overall regulatory 
structure. At a minimum such changes to the regulatory 
structure should do no harm to the GSE's' housing mission. 
However, we also believe that the current debate provides an 
opportunity to clarify those areas of the GSE's' affordable 
housing mission that should be expanded. Fannie Mae and Freddie 
Mac have fulfilled an important part of their mission by 
providing affordable housing capital for low- and moderate-
income and minority households, yet much remains for the GSE's 
to accomplish in expanding fair and affordable housing 
opportunities for the residents of our Nation's underserved 
communities, such as providing greater assistance to first-time 
minority and low-income homeowners, securitizing multifamily 
rental mortgage products. Similarly, while the GSE's have been 
industry leaders in adopting policies to combat a number of 
predatory lending practices such as their repudiation of the 
purchase of single-premium credit life insurance products, they 
have yet to address certain other egregious lending practices.
    More specifically, we believe important improvements to 
present affordable housing goals requirement are desirable. 
Clearly, the establishment of these goals has served an 
important function, encouraging the GSE's to better serve the 
needs of underserved areas and low- and moderate-income 
households, and in fact, both Enterprises have consistently met 
or exceeded the goal level set for them. Nonetheless, the three 
statutory goals in place do not permit HUD to focus sufficient 
GSE attention to addressing some of the neediest segments of 
the mortgage market. Establishing an additional GSE home 
purchase goal and providing HUD with supplemental authority to 
set sub goals for GSE activity for particularly needs within 
the overall statutory goals, while not diminishing the ability 
of the GSE's to serve the needs of all consumers refinancing 
loans would enhance the overall effectiveness of this important 
mandate. Also, reform of the GSE's' housing goals should 
include provisions to expand opportunities for public input 
into this important area of regulation.
    Our strong interest in affordable housing extends to other 
aspects of regulatory restructuring as well. We are 
particularly concerned that proposals to shift general charter 
oversight and new program approval authority away from HUD to 
the Treasury Department will detract from the regulatory focus 
on the GSE's' performance of their housing mission. At the same 
time, funding the reasonable cost of this regulation through 
direct assessments of the GSE's and not through the 
appropriations process would go a long way in strengthening 
oversight capacity.
    We are also concerned with deliberations around two 
regulatory areas, capital requirements and the program approval 
process. First, the GSE's' capital requirement is one of the 
most critical and sensitive issues. We recognize that the 
establishment of appropriate capital requirements may at times 
involve tradeoffs, but we fear that unnecessary increases in 
capital requirements, particularly the minimum requirement, 
could result in a higher cost to homebuyers.
    Second, in evaluating any changes to the current program or 
approval process, a delicate balance is required between a 
careful 
examination of whether a new GSE product serves its important 
public mission and the need to not overburden these 
organizations' innovative efforts to provide new lending 
opportunities in the most difficult to serve communities. While 
there may be a need to improve the current approval process, we 
urge you to proceed cautiously and resist efforts to over 
encumber this process.
    While my testimony mainly focuses on regulatory oversight 
of Fannie Mae and Freddie Mac, we also offer the following 
comments on the regulation of the other GSE's, the Federal Home 
Loan Bank System. We believe the Federal Home Loan Bank system 
has evolved and must also have clear and specific housing goals 
that challenge lenders to better server underserved 
populations. Should Congress decide to abolish the Federal 
Housing Finance Board, the System's regulator, and transfer 
authority to another agency, we strongly prefer that mission 
oversight be transferred to HUD and that the Department also be 
provided with authority to establish new affordable housing 
requirements to ensure that activities undertaken by the 
Federal Home Loan Banks are targeted to low- and moderate-
income housing and other underserved community needs.
    In closing, we thank you, Mr. Chairman, and Senator 
Sarbanes for your work and attempting to strengthen the 
effectiveness of the GSE's, to serve the housing needs of 
America's underserved populations. We urge that you support 
provisions to strengthen the housing goals requirement, but 
also proceed with caution and resist the urge to make changes 
to their status or their charter that might result in fewer 
affordable housing opportunities.
    Thank you for this opportunity to testify and I would be 
glad to answer any questions you have.
    Chairman Shelby. Thank you.
    Mr. Couch.

                  STATEMENT OF ROBERT M. COUCH

             CHAIRMAN, MORTGAGE BANKERS ASSOCIATION

    Mr. Couch. Thank you. Chairman Shelby, Ranking Member 
Sarbanes, and distinguished Committee Members, thank you for 
inviting the Mortgage Bankers Association to speak at this 
important hearing.
    MBA members originate loans in the primary mortgage market 
and then sell those loans to Fannie Mae and Freddie Mac. MBA 
therefore has a keen interest in maintaining the safety and 
soundness of our country's real estate finance system.
    Fannie Mae and Freddie Mac play two important roles in the 
American home finance system. First, they provide market 
liquidity. Second, the buy affordable housing loans from 
lenders so that lower-income Americans and those living in 
underserved areas can get access to housing credit. Obviously, 
it is imperative to have effective oversight of the GSE's.
    The Mortgage Bankers Association endorses the principles 
for GSE regulation laid out by Secretary Snow and Secretary 
Martinez before the Committee earlier this month. Further, the 
Mortgage Bankers support certain core principles for effective 
regulation of Fannie Mae and Freddie Mac. First, effective 
safety and soundness oversight is vital. The Treasury 
Department successfully regulates both national banks and 
Federal thrifts and has successfully demonstrated its ability 
to fulfill the role of a financial safety and soundness 
regulator. The Mortgage Bankers support establishing Treasury 
as the safety and soundness regulator for Fannie Mae and 
Freddie Mac.
    Second, the GSE regulators, both within the Treasury and 
HUD, need to have adequate funding if they are going to live up 
to their important duties. The Mortgage Bankers Association 
urges this Committee to look at the Office of Thrift 
Supervision funding mechanism in drafting its legislation.
    Third, the safety and soundness regulator needs flexibility 
in setting capital standards. MBA does not mean to imply that 
today's capital requirements are inappropriate or inadequate in 
any way. Rather, MBA believes that the regulator needs the 
tools to respond to changing marketplace conditions. Capital 
standards are a fundamental tool in this regard. A statute 
should not unduly tie a regulator's hands.
    Fourth, a regulator needs adequate enforcement authority to 
correct any problems that may arise and more importantly, to 
deter problems in the first place. MBA believes that the 
banking enforcement tools have proven their effectiveness over 
the years and supports including such tools for the GSE 
regulator.
    Within these four core principles, one issue stands out to 
MBA as fundamentally important for the mortgage industry, the 
safety and soundness of GSE programs and activities. The 
activities of Fannie Mae and Freddie Mac have ramifications 
throughout the American mortgage market, and indeed throughout 
domestic and international economies.
    For these reasons all of their activities must be safe and 
sound, not just some. We believe that the approval of new 
programs and activities is fundamentally linked to financial 
safety and soundness. The safety and soundness regulator is in 
the best position to evaluate the appropriateness of new or 
proposed GSE programs. Congress should draw a clear line 
between the primary and secondary mortgage markets. In no event 
should the GSE's be permitted to encroach upon the mortgage 
origination process of use their Government-sponsored benefits 
to distort the competitive landscape of the primary mortgage 
market.
    MBA also believes that it is important that the regulator 
not micro-manage the GSE's, and that it not unduly constrain 
the GSE's' ability to innovate in a timely manner to meet 
marketplace needs. Fannie Mae and Freddie Mac have Government 
sponsorship so they can assist Americans with their housing 
needs. Effective safety and soundness oversight ensures that 
the GSE's are able to meet these needs. MBA strongly supports 
the affordable housing goals for Fannie Mae and Freddie Mac and 
endorses HUD's role in setting and enforcing those goals.
    MBA strongly urges Congress to reform the oversight of 
Fannie Mae and Freddie Mac in this manner so that they can 
continue their role in supporting housing, especially 
affordable housing.
    Thank you, and I am happy to answer any questions the 
Committee may have.
    Chairman Shelby. Thank you.
    Ms. Harrison.

                 STATEMENT OF IONA C. HARRISON

             REALTY EXECUTIVES-MAIN STREET, U.S.A.

                          ON BEHALF OF

        THE NATIONAL ASSOCIATION OF REALTORS'

    Ms. Harrison. Chairman Shelby, Ranking Member Sarbanes, and 
Members of the Committee, good afternoon. I am Iona Harrison 
with Realty Executives Main Street USA, a real estate brokerage 
firm in Upper Marlboro, Maryland. As incoming chair of the 
National Association of REALTORS' Public Policy 
Coordinating Committee, thank you for the opportunity to give 
NAR's views on proposals to enhance regulation of the housing 
GSE's.
    Before I begin my statement, let me first thank you, Mr. 
Chairman, and Senator Allard, if he were here, for efforts on 
the American Dream Downpayment Act. The Senate Banking 
Committee unanimously approved this bill with two important 
amendments that increased the FHA multifamily loan limits in 
high cost areas and improved the FHA hybrid ARM program.
    NAR leads a coalition of supporters who are hopeful that 
the bill will come to the Senate floor shortly. By adopting 
this legislation, Congress will send a strong message 
supporting the Administration on increasing homeownership 
opportunities. This bill is evidence of the importance this 
Congress and Administration place on homeownership 
opportunities. Your GSE reforms can ensure that this commitment 
remains a high priority in future years. To do so, NAR believes 
that a new safety and soundness GSE regulator must be truly 
independent and that program approval and housing mission must 
remain at HUD.
    The National Association of REALTORS' supports a 
credible and vigorous GSE regulator. REALTORS' agree 
that Fannie Mae and Freddie Mac should have an independent 
regulator for safety and soundness. We recommend that a new 
regulatory agency in the Treasury Department should have 
necessary and sufficient firewalls to ensure its political and 
operating independence similar to those that currently exist 
for the OCC and OTS.
    The Administration proposal to place GSE regulatory 
oversight and new program approval under the Treasury 
Department is a major change. REALTORS' expressed 
opposition to moving GSE housing mission and program approval 
from HUD when the Administration's plan was first released. Our 
concern is that housing policy has not been the purview or 
expertise of the Treasury Department. This has been the purview 
of HUD. Housing and real estate industries naturally look to 
HUD to address housing mission, programs and affordable housing 
goals. HUD should maintain its primacy in these areas.
    REALTORS' recognize that new programs could have 
an impact on safety and soundness. Therefore, the new regulator 
should have a consulting role to HUD on any safety and 
soundness implications. Program approval must continue at HUD 
under current standards. Congress deemed the Government 
Sponsored Enterprise model as an appropriate vehicle to advance 
homeownership and housing 
policy as recently as 1992 when it adopted the Federal Housing 
Enterprises Financial Safety and Soundness Act. Since that 
time, Congress, homeowners, the housing finance system, and the 
Nation's economy have all benefited tremendously. The 
unprecedented expansion of homeownership rates is undeniable 
testament to the efficiency and liquidity of the secondary 
mortgage market and the housing sector.
    Although realtors support a strong regulator, we insist 
that regulatory reform does not imply and should not result in 
any weakening of the current housing finance system. Targeted 
reform for GSE regulation should strengthen our housing finance 
system.
    Mr. Chairman, in conclusion, realtors support your 
deliberate, thoughtful consideration of what measures should be 
taken to improve GSE oversight. We look forward to working with 
you and I will be happy to answer any questions you may have.
    Chairman Shelby. Thank you. We have a vote on the floor but 
I thought I would start a few questions. Senator Sarbanes and I 
will have to go vote, recess the Committee, and come back, 
because you are too important to let loose yet.
    Mr. Koch and Mr. Torpey, the minimum capital threshold that 
we keep talking about at 2.5 percent that Fannie and Freddie 
are subject to is often compared, as we know, to the 4 percent 
minimum capital standard that banks and thrifts must meet. Do 
you believe that this is a fair comparison given the riskier 
set of assets held by banks and thrifts?
    Mr. Torpey. I can start with that. I think given the 
limited assets that the GSE's have that it is probably 
adequate. I always say within the banks that we always want to 
have at least 10 percent of any entity coming in, and many 
times 20 to 30 percent. But on the other hand we are dealing in 
our area with agriculture, with small businesses, with that 
thing. So the risks are completely different as far as I am 
concerned.
    Chairman Shelby. Mr. Koch.
    Mr. Koch. I think the real issue here is what activities 
are they getting involved in and the need to have the minimum 
capital reviewed by their primary regulator. For example, 
Fannie Mae and Freddie Mac have secured approval to get 
involved in A&D lending. A&D lending is land development 
activity, which is highly risky, involving expertise 
significantly different than simply investing in one to four 
family owner-occupied properties, or even owner-occupied 
apartments. There are zoning issues, there are guarantor 
issues. These are high-risk investment types.
    So the 2.5 percent minimum really needs to be weighed in 
terms of what kinds of new activities are they getting involved 
in. That is the real issue here. As new activities expand, and 
they have expanded dramatically without significant regulatory 
oversight, that is where the capital really becomes critical.
    Chairman Shelby. Senator Sarbanes is not going to be able 
to come back. He has other commitments and we have to vote, so 
I am going to yield to him now.
    Senator Sarbanes. Thank you very much, Mr. Chairman. First, 
I want to thank the panel. We certainly appreciate not only 
your oral testimony but also the careful work which has 
obviously gone into your written testimony. I just want to ask 
one question. I apologize I will not be able to return because 
we did not expect this vote to happen.
    The Assistant Secretary of the Treasury spoke at the 
Heritage Foundation yesterday, which was reported--which 
actually affected the bond markets as I think you are aware. 
One of the fellow panelists, in fact the resident fellow at the 
American Enterprise Institute said, the only realistic answer, 
talking about the GSE's, is to provide more competition in the 
secondary market. I think the only answer is privatization.
    I would just very quickly like to get a response of the 
members of this panel to that proposal, and the concern on the 
part of some that that objective is floating behind a lot of 
the discussion on this issue. If I could just quickly get a 
response.
    Mr. Koch. Very quickly, housing in the United States is the 
best in the world. We are the global envy on housing. 
Substantially changing the process in terms of privatization, 
we would not support at this time. We would support additional, 
however, efforts to assist low-income and moderate-income 
individuals in this country for enhanced housing opportunities.
    Senator Sarbanes. Mr. Torpey.
    Mr. Torpey. We would oppose that. I think Senator Bunning 
asked the question about the harm to small banks. If you 
privatize the system, you would have large banks that may have 
access to that, but I think the real harm here would be the 
harm to small community banks where we are not going to have 
access to the same funding that a large national bank would. 
And quite frankly, these small community banks are so important 
to these small communities that to privatize that I think would 
do great harm to the system.
    Senator Sarbanes. Mr. Fishbein.
    Mr. Fishbein. The GSE's were established to perform a very 
important public mission, not the least of which is to direct 
increased financing to improve opportunities for affordable 
housing for low- and moderate-income households and underserved 
communities, and we think that public mission and need 
continues and therefore, so should the GSE's.
    Senator Sarbanes. Mr. Couch.
    Mr. Couch. First to your issue of competition, the Mortgage 
Bankers Association has a long-standing policy that more 
competition is good and that is why we are in support of the 
Federal Home Loan Banks activities in the mortgage markets. 
With respect to privatization, we would be opposed to 
privatization because, as several of the panelists, said the 
system right now is working well and we would like to keep it 
doing what it is doing so well right now.
    Senator Sarbanes. Ms. Harrison.
    Ms. Harrison. Again, NAR's position is to promote 
homeownership at every level and to continue to provide 
mortgage vehicles to effect that goal. The GSE's have this 
unique homeownership mission that we would continue to support. 
Quite frankly, I personally feel that private sector would not 
necessarily have this goal in mind since I would think making a 
profit would be their primary goal and underserved people would 
continue to be underserved.
    Senator Sarbanes. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Shelby. We do have a vote, and because I have 
about four or five complicated questions, I would like, if I 
could, to submit those for the record, give you time, all of 
you, this panel, time to answer these for the Committee. Would 
that be agreeable to you?
    With that, we are going to go vote. We do not know what is 
going to happen behind that. We thank you for your testimony 
and we look forward to the answers to these other questions. 
You help us immensely. Thank you a lot.
    We are adjourned.
    [Whereupon, at 12:16 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
                  PREPARED STATEMENT OF JOHN T. KORSMO
                Chairman, Federal Housing Finance Board
                            October 23, 2003
    Good morning and thank you, Mr. Chairman, Ranking Member Sarbanes, 
and distinguished Members of the Committee.
    In December 2001, this Committee and the Senate honored me with 
confirmation to membership on the Federal Housing Finance Board 
(Finance Board) and President Bush entrusted me with the Finance 
Board's chairmanship. During my confirmation hearing, both Senator 
Sarbanes and former Senator Gramm impressed on me--indelibly--their 
concern over the Finance Board's inadequate performance.
    In response, I committed myself to leading the Agency to fulfill 
the intent of Congress in FIRREA and the Gramm-Leach-Bliley Act--that 
is, to create a credible arm's-length regulator for the Federal Home 
Loan Banks (FHLBanks). So, I testify today not as an apologist for the 
Banks and certainly not as a partisan for the Finance Board, but rather 
as a safety and soundness regulator who takes seriously his oath of 
office and his promise to this Committee.
    In that spirit, I offer today my experience as you seek to develop 
policy for the supervision of the Nation's housing Government Sponsored 
Enterprises (GSE's).
     Congress and the Administration are engaged in a worthy effort to 
ensure proper regulation of the GSE's, and this effort, I believe, 
would be well-served by seeking a broader context. That is, to craft an 
appropriate housing GSE regulator, policymakers should thoroughly 
consider what is to be regulated, both today and in the future. The 
first question to ask is what today's capital and mortgage markets look 
like, 70 years after the charters for housing GSE's were cast? What 
will these markets look like 10, 20, 30 years in the future? And what 
role or roles should Government Sponsored Enterprises play in those 
markets?
    Answering these questions I believe will require a thorough review, 
necessary to set the stage for a comprehensive reform debate in 
Congress, with participation by the executive branch, by the housing 
GSE's themselves and their competitors, and by the public.
    This review, of course, does not preclude immediate action with 
respect to the Office of Federal Housing Enterprise Oversight (OFHEO). 
OFHEO's mission could well benefit from budget independence and the 
granting of the same full powers in use by other banking supervisors, 
including the Finance Board under the Federal Home Loan Bank Act.
    The Federal Home Loan Bank Act grants the Finance Board the 
authority, the independence, and the executive branch voice needed for 
robust supervision of Government sponsored public trusts.
    Through FIRREA in 1989 and Gramm-Leach-Bliley a decade later, 
Congress drew on the lessons of the thrift crisis and the poorly 
conceived Federal Home Loan Bank Board to shape the Finance Board into 
a safety and soundness and mission watchdog for the Federal Home Loan 
Banks, granting the Finance Board all the authority and independence 
needed to be a world-class regulator.
    The Federal Home Loan Bank Act provides:

 Enforcement authority on a par with other Federal bank 
    regulators;
 Flexibility to tighten capital standards and risk monitoring, 
    if needed;
 Authority to review and approve new business activities in 
    advance;
 Authority to define and monitor affordable housing programs 
    conducted by Federal Home Loan Banks;
 Full authority to liquidate a Bank, to establish a 
    replacement, or to merge weakened Banks;
 The freedom to garner budget resources from the Banks and to 
    deploy them as most needed; and
 A direct voice on the Board for the executive branch in 
    overseeing the Federal Home Loan Banks' role in capital markets and 
    mortgage markets.

     None of these tools is found in OFHEO's statute. These tools 
should be considered for inclusion if Congress decides, after 
determining the appropriate future roles of housing GSE's, that a new 
regulator for some or all of the Enterprises is required.
Overview
    To properly consider the effective oversight of housing GSE's, as 
now constituted, Congress should proceed on the basis of proposals from 
the Administration and several Members that seek to increase the tools 
available to supervise Freddie Mac and Fannie Mae.
    As mentioned, the Federal Home Loan Bank Act, as amended by FIRREA 
and Gramm-Leach-Bliley, equips the Federal Housing Finance Board with 
the full set of supervisory tools required for world-class oversight. 
Increasingly, these powers are aggressively and ably employed by the 
Finance Board.
    Because markets are sophisticated and place a premium on actual 
performance and verifiable information, I do not believe simply 
changing the name or status of the agency responsible for the Federal 
Home Loan Bank Act will result in more favorable treatment of FHLBanks 
by investors. I know of no study concerning Federal thrifts and 
national banks, for example, substantiating the premise that distinct 
but effective regulators affect the price of borrowing by Federal 
thrifts and national banks.
    As this debate refocuses on substantive and difficult questions, it 
will be necessary to distinguish the risks inherent in the housing 
GSE's banking functions, the unique risks associated with housing GSE 
status, and the nature of possible future problems.
    It is also important to recognize that remedying the known 
shortcomings in the 1992 GSE Act regulating Freddie Mac and Fannie Mae 
and/or transferring Federal Home Loan Bank Act authority to a new body 
will not, in and of themselves, reduce or dilute the potential risks 
posed by the housing GSE's to the taxpayers and the economy. The 
housing GSE's are banking enterprises, and banking is an inherently 
risky business. In the housing GSE sector, these risks and market share 
are highly concentrated in the two largest enterprises.
    The housing GSE's have grown exponentially in size, sophistication, 
and inherent risk as capital and mortgage markets have revolutionized. 
All 14 housing GSE's now play critical roles in domestic and global 
capital markets and in U.S. housing markets. That growth, together with 
the reality of a perceived taxpayer guarantee, make it imperative that 
the Freddie Mac and Fannie Mae oversight statute be brought up to 
world-class and that Finance Board administration of the FHLBank Act 
complete its rapid evolution to world-class.
Unique Housing GSE Risks
    For holding companies, commercial banks, thrifts, and credit unions 
supervised by Federal banking agencies, the institutions' boards of 
directors determine the markets to be served, the products to be 
offered, and the pace of growth or retraction.
    For housing GSE's, the broad parameters of markets served, products 
offered, and growth are driven by Congressional charters.
    These charters were framed in the 1930's and charged the FHLBanks, 
Fannie Mae, and later Freddie Mac with providing liquidity for lenders 
making long-term amortizing home mortgages. The housing GSE's were part 
of a set of New Deal policy innovations, including Federal Housing 
Administration mortgage insurance and the activities now conducted 
under the aegis of Ginnie Mae, which have succeeded beyond all 
reasonable expectations in establishing the long-term amortizing 
mortgage as the industry standard, creating a secondary market in these 
loans, and creating a securitization market based on these products.
    The monopolies granted by both the FHLBank charter and the Freddie 
Mac and Fannie Mae charters also bear the seeds of systemic risk. 
Protection from broadly effective competition from other GSE's or fully 
private firms assists the housing GSE's in accomplishing their 
missions. But this benefit may also partially shield them from the 
harsher realities of the marketplace that tend to reward the best 
capitalized, best managed corporations in a given sector.
    Closely associated with monopoly privileges is the taxpayer 
guarantee that appears to flow from the bare fact of Government 
sponsorship and from the tax exemptions, securities law exemptions, 
Treasury ``line of credit,'' and other benefits of that sponsorship. 
Anecdotal but consistent and long-standing evidence indicates that the 
``implied guarantee'' and ``agency debt'' status are extremely valuable 
attributes. This distraction from assessing the credit-worthiness of 
housing GSE's on wholly tangible grounds is another systemic source of 
risk unique to these 14 Enterprises.
    Moreover, because the GSE's are expected to serve all markets 
through all parts of the business cycle, and more importantly, because 
the fundamental missions and roles have not been recalibrated as fully 
private firms have successfully followed the GSE's into most mortgage 
finance products and services, housing GSE's tend to grow without 
meaningful restrictions.
    As housing GSE's acquire greater exposure to inherent banking risks 
through growth, they also are exposed to increased risk as a result of 
their participation in derivatives, securities, and debt markets which 
have become more global, more sophisticated, more innovative, and more 
rapidly-evolving.
    These factors, weighed with the systemic risks of GSE status, argue 
that housing GSE risk in the future can only be significantly reduced 
by curtailing inefficient protections from competition and/or by 
recalibrating the charters so that housing GSE's actually shrink as 
fully private firms successfully take over some of the mortgage finance 
products and services now dominated by GSE's.
    The safety and soundness regulators of the housing GSE's are not 
the appropriate bodies for designing or effecting these charter 
reforms. The Government Sponsored Enterprises, by definition, are 
charged with accomplishing public objectives through private ownership. 
Only the public's representatives, the Congress and the Administration, 
can validly assess the need for future GSE participation in housing 
finance and capital markets and assign the benefits and obligations 
consistent with that need. The Congress and Administration are also the 
only valid bodies for determining the amount of risk to taxpayers and 
the national economy appropriate to the contributions of housing GSE's.
    Once the future roles of housing GSE's are assigned and the 
appropriate risk level is determined, it should be, as it is now, the 
duty of the Finance Board, OFHEO, and the Department of Housing and 
Urban Development (HUD), or whatever successor agencies Congress and 
the Administration may create, to police their governance and 
operations in managing inherent risks and their fidelity to housing GSE 
charters.
The Future of Housing GSE Supervision
    Mapping the future of housing GSE oversight, properly calibrated to 
match the future roles and risks of the Enterprises, begins with an 
honest assessment of the authorities governing the operation of OFHEO 
and the Finance Board.
    When Congress established a regulator for Freddie Mac and Fannie 
Mae in 1992, it did not provide OFHEO with all the tools and 
independence of the Office of the Comptroller of the Currency (OCC), 
Office of Thrift Supervision (OTS), the Federal Deposit Insurance 
Corporation (FDIC), or Federal Reserve.
    Even taking into account the new product and affordable housing 
portfolios assigned to HUD, these two housing GSE's are not supervised 
on fully comparable terms to Federal credit unions, national banks, 
Federal thrifts, bank holding companies, or, for that matter, the 
Federal Home Loan Banks.
    The 1992 GSE Act's deficiencies in funding and in supervision and 
enforcement tools and flexibility should be addressed.
    The Administration's proposals and some Congressional proposals 
largely bring to bear on Freddie Mac and Fannie Mae budget resources 
and supervisory tools fully comparable to those available to other 
Federal supervisors of financial institutions. The Administration also 
makes a common sense and plainly necessary proposal to give the public 
a role in shaping and overseeing Freddie Mac and Fannie Mae, which is 
similar to the executive branch participation on the Finance Board.
    As outlined above, the Finance Board already is endowed with the 
resources, strength, independence, and supervisory scope that mark 
world-class safety and soundness regulators.
    But until recently, the Finance Board was not fully discharging the 
mandates of the FHLBank Act or making full use of its independence and 
resources. Fortunately, these shortcomings are being rapidly and 
thoroughly rectified.
    Today, the Finance Board has more than double the number of 
examiners on staff when I took the oath of office in December 2001 and 
my Board colleagues and I began the process of rebuilding the 
examination and supervision functions at the Finance Board. This corps 
of 18 examiners will expand to 30 by this time next year and has been 
supplemented by additional financial analysts, accountants, and risk 
management specialists.
    The Finance Board is recruiting and hiring the best and brightest 
from other Federal banking agencies. The average Finance Board examiner 
has over 17 years of examination experience, and every examiner is a 
commissioned examiner, has a professional accreditation, or both.
    Finance Board oversight has improved in every way and the 
opportunity to work with the members of the Federal Home Loan Bank 
oversight team is now becoming a prestige career move.
     Attached to this prepared testimony is an appendix providing more 
detail on the new FHLBank supervision program being put in place and 
the progress made to date. The numbers provided in the appendix are 
impressive, but more important is the explanation of how the Finance 
Board has entirely revamped its approach to FHLBank supervision over 
the past 18 months.
    Certainly, the Federal Home Loan Bank Act already provides the 
Finance Board with power to meet any eventuality, and we are fast 
approaching world-class status in the size and skills, the capacity and 
sophistication, of our staff and their oversight of the 12 Banks.
    Mr. Chairman, you asked me to address other specific issues in my 
prepared testimony. Allow me to do so at this point.
Funding Process
    Independent boards have advantages and disadvantages compared to 
both the OCC/OTS model and to a less autonomous bureau within Treasury. 
One strength of an independent board is that budgets set by action of 
the Finance Board, for example, in public meetings provide a suitable 
degree of accountability in resource allocation without compromising 
independence through Congressional or OMB review.
Capital Regime
    The minimum leverage requirements and risk-based capital 
requirements now in force for FHLBanks appear to be appropriate. 
Importantly, the Federal Home Loan Bank Act permits the Finance Board 
to increase or tailor these standards if experience demonstrates a 
need.
SEC Registration
    Only through conservative management and superior transparency and 
governance will all 14 housing GSE's maintain the highest measure of 
market confidence. I believe superior transparency requires that each 
FHLBank commit to voluntarily meet the quarterly and annual financial 
reporting requirements of Section 12(g) of the Securities Exchange Act 
of 1934, as administered and enforced by the Securities and Exchange 
Commission (SEC). SEC registration and disclosure will enable markets 
to place greater reliance on and maintain greater confidence in the 
balance sheets, business prospects, and corporate governance of the 
FHLBanks. That is why, at its September 10, 2003, meeting, the Finance 
Board unanimously adopted and subsequently published for comment a 
proposed regulation requiring FHLBank 1934 Act registration.
Office of Finance
    Before closing this discussion of the possible or feared effects of 
housing GSE regulator reform on the funding of FHLBanks, I must alert 
the Committee to a question requiring considerable study before 
attempting any transfer of responsibility for administration of the 
FHLBank Act. The Act ratified the Federal Home Loan Bank Board's 
establishment of the Office of Finance (OF) to issue consolidated 
obligations (bonds and notes) on behalf of the FHLBanks. Several years 
ago, the Finance Board devolved authority over management of the OF to 
a board of directors appointed by the Finance Board. The OF has also 
been assigned the task of compiling and issuing combined financial 
reports for the 12 FHLBanks.
    But OF is an unusual corporate posture. It is not incorporated and 
has no balance sheet and no executive control of any FHLBank. OF 
instead acts as an agent for the FHLBanks and is the ``name and face'' 
shown to capital markets--which are not offered obligations in the name 
of any specific FHLBank, but rather ``System'' obligations issued 
through OF and backed by the joint and several liability of all 12 
FHLBanks.
    Understanding Treasury's apparent wish to avoid providing any 
reenforcement of the perception of an implied taxpayer guarantee behind 
housing GSE debt, Treasury's views should be included in determining 
whether and how to shift authority over OF to Treasury.
Conclusion
    Legislating the best set of tools and best structure for housing 
GSE supervision is an area of economic and housing policy that must be 
addressed.
    Before again locking into statute a system of supervision for some 
or all housing GSE's that is not world-class, policymakers from 
Congress, Treasury, HUD, and all 14 housing GSE's should begin the more 
comprehensive charter reform debate outlined above.
    That comprehensive reform debate should sort out--70 years after 
creation of GSE's and long-term amortizing mortgages--the most 
constructive role for housing GSE's in the mortgage finance marketplace 
of the 21st century. The questions policymakers should consider asking 
include:

 What is the right level of competition between housing GSE's 
    and other mortgage financiers?
 What is the right level of competition among the housing GSE's 
    themselves?
 What is the right level of risk to the taxpayers in proportion 
    to the benefits the housing GSE's confer on the Nation's housing 
    finance system?

    Once a coherent national policy clearly outlining Government and 
private roles in the future is in place, all parties to the debate will 
be fully equipped to design a world-class supervisor able to evolve 
along with housing GSE's appropriately sized and appropriately directed 
to best support but not interfere with the markets of tomorrow.
    I know of no immediate or imminent safety and soundness or 
liquidity imperative forcing us to do the job any way but the right 
way, and I think everyone is aware the stakes are high if the result is 
muddled.
    I suggest, therefore, that the housing GSE reform effort move in a 
logical, deliberate manner to define the roles Freddie Mac, Fannie Mae, 
and the Federal Home Loan Banks should play in a continually innovating 
mortgage finance market, to define the appropriate risks to assume in 
the institutions fulfilling those roles, and then to determine how best 
to regulate the roles and risks and innovations that result.
    Again, thank you for the asking me to speak to you today and for 
the attention this Committee gives to homeownership, housing 
affordability, and housing GSE issues.





               PREPARED STATEMENT OF ARMANDO FALCON, JR.
        Director, Office of Federal Housing Enterprise Oversight
                            October 23, 2003
    Chairman Shelby, Ranking Member Sarbanes, and Members of the 
Committee, thank you for inviting me to appear before you today. I am 
pleased to provide my views on improvements that can and should be made 
to the regulatory oversight of Fannie Mae and Freddie Mac. My views are 
my own and are not necessarily those of the President or the Secretary 
of Housing and Urban Development.
    When I took office as Director of the Office of Federal Housing 
Enterprise Oversight (OFHEO) in October 1999, I quickly realized that 
the Agency's long-term success was jeopardized by inadequate resources, 
a constraining funding mechanism, and a lack of powers equal to those 
of other regulators. Over the past 4 years, I have been a consistent 
advocate of legislation designed to address those shortcomings, and so 
I was encouraged by the Administration's comprehensive proposal.
    I am in general agreement with it, but I do have a few concerns 
that I hope can be properly addressed.
Guiding Principles
    I would like to outline my views in the context of five guiding 
principles. They are:

 The regulator should remain independent;
 The regulator should be permanently funded, outside the 
    appropriations process;
 The regulator should have powers equal to those of other 
    safety and soundness regulators;
 The regulator should have full discretion in setting capital 
    standards; and
 Legislation should build on progress made.

    Adherence to each of these principles will strengthen supervision 
and the safe and sound operation of the Enterprises. Our ultimate goal 
and benchmark should be to establish a new regulator that is on an 
equal plane with the Office of the Comptroller of the Currency (OCC), 
and the Office of Thrift Supervision (OTS), both of which operate as 
independent safety and soundness regulators within the Treasury 
Department. I would like to elaborate on the five principles.
Regulatory Independence
    First, the regulator should remain independent. The concept of an 
independent Federal agency to oversee Fannie Mae and Freddie Mac was 
established in the legislative history of the 1992 Act that created 
OFHEO. The need for regulatory independence was borne out of Congress' 
experience with the savings and loan crisis. I had the privilege of 
serving as Counsel to the House Banking Committee during that difficult 
period. One of the clear lessons learned was that all safety and 
soundness regulators should be objective, nonpartisan, and protected 
from political interference. This is especially critical at times when 
regulators must make difficult and sometimes politically unpopular 
decisions. In addition, independent regulation protects Congress' 
ability to receive the regulator's best judgment on regulatory matters 
unfiltered and without delay. With billions of dollars of potential 
taxpayer liability at stake, it is in everyone's interest that this 
important safeguard not be weakened.
    Like OFHEO, the Office of Thrift Supervision is another useful 
example of how a new independent regulator should be established as 
part of a Departmental organization. In 1989, Congress transferred 
responsibility for thrift regulation from the Federal Home Loan Bank 
Board to a newly created OTS within the Treasury Department. The OTS 
was established as a fully independent regulator. It has the same 
powers and unfettered ability to use those powers as the OCC.
    Congress should ensure that the new regulator has full statutory 
independence.
Permanent Funding
    Second, the regulator should be permanently funded, outside the 
appropriations process. Currently, OFHEO is funded annually through the 
Federal budget and appropriations process, even though the Agency does 
not utilize any taxpayer funds. OFHEO is funded through assessments on 
the Enterprises, but those assessments cannot occur until approved by 
an appropriations bill and at a level set by the bill. OFHEO is the 
only safety and soundness regulator funded in this limited manner. At a 
minimum, this serious anomaly should be fixed. Permanent funding will 
enable the regulator to fulfill its budgetary needs on a more 
reasonable basis without the timing constraint associated with the 
annual appropriations process. There should also be clear language that 
the Agency has the authority to levy special assessments or to 
establish a reserve fund as needed, to meet emergencies. Currently, any 
additional funds required to meet urgent, unexpected needs can be 
obtained only after a supplemental appropriation is enacted. This can 
delay action by the Agency to resolve problems early, before they 
threaten the safety and soundness of an Enterprise. Permanent funding 
will contribute to operational independence and will allow the Agency 
to respond quickly to any crisis at the Enterprises.
Enhanced Supervisory Authority
    Third, the regulator should have powers equal to those of other 
regulators. While OFHEO's regulatory powers are fairly comparable to 
those of other financial safety and soundness regulators, certain 
authorities need to be provided and others clarified. For example, a 
safety and soundness regulator should have independent litigation 
authority, enhanced hiring authority and a full range of enforcement 
powers provided to financial regulators. Also, the laws should be 
revised to provide clearly that the regulator is empowered to address 
misconduct by institution-affiliated parties and to exercise general 
supervisory authorities.
Flexible Capital Regulation
    Fourth, the regulator should have full discretion in setting 
capital standards. Capital is one of the fundamental bulwarks of 
effective safety and soundness regulation. The regulator should have 
broad discretion to exercise his or her best judgment, using all the 
information available through the examination process and otherwise, to 
determine if capital adjustments are necessary. All other safety and 
soundness regulators have this discretion.
    Going forward, the Agency needs to have the authority to modify 
both minimum and risk-based standards. This authority would help meet 
the changing mix of Enterprise business, the market environment in 
which they operate, and the changing nature of risk measurements 
themselves. As Secretary Snow has said in testimony before Congress, 
``Broad authority over capital standards and the ability to change them 
as appropriate are of vital importance to a credible, world-class 
regulator.'' I agree.
Build on Progress
    Fifth, legislation should build on the progress we have made over 
the last 10 years. Regulating Fannie Mae and Freddie Mac requires a 
specialized skill set. The capacity to model the cashflows of all the 
mortgages, debt, and other financial instruments owned, issued, or 
guaranteed by the Enterprises, needed for the stress test, is unique 
among financial institution regulators. Expertise in how these two 
secondary mortgage market companies manage mortgage risk, including the 
broad use of sophisticated derivatives and collectible debt is vital 
for effective regulation. In addition, an understanding of how the 
Enterprises are affected by the markets in which they operate is 
extremely important.
    Over the past 10 years, OFHEO has developed the specialized 
expertise, from our examiners and financial analysts, to our 
researchers and capital analysts, that is necessary to supervise these 
two unique companies. The cost in terms of lost regulatory capacity 
spent while trying to rebuild that infrastructure would be substantial. 
That is why I recommend that, if a new regulator is established in the 
Treasury Department, OFHEO's personnel, regulations, and administrative 
infrastructure should be transferred intact to the new agency. It would 
be highly counterproductive to do otherwise.
Additional Issues
    There are a couple of other matters I would like to briefly 
discuss. First, I agree with Secretary Snow that the Presidentially 
appointed board positions should be discontinued. This is not a 
reflection of current or former Presidentially appointed directors. 
Rather, I think corporate governance would be enhanced if the 
shareholders were allowed to select all members of the board. It is 
difficult for even the most conscientious director to fully contribute 
when their terms are limited to one year, unless reappointed, and last 
on average for only 15 months. Shareholder elected directors usually 
are reappointed for up to 10 years.
    I also support the granting of authority to the safety and 
soundness regulator to determine whether the activities of an 
Enterprise are consistent with its charter authority. This would mean 
that a single regulator would have the ability to review all of the 
Enterprises' activities--new and existing. This change will consolidate 
the supervision of the Enterprises in a manner consistent with 
authorities of other regulators. I appreciate the concern expressed 
about the primacy of the Enterprises' housing mission if and when the 
charter compliance responsibility is shifted. The goal, in fact, of 
enforcing charter compliance is to ensure that the Enterprises remain 
properly focused on their housing mission and not stray into extraneous 
ventures. Consistent with that goal, I think a mechanism can be 
instituted to ensure that a new regulator actively solicits and 
considers all views, including housing advocates, when exercising its 
authority. The importance of their housing mission is actually why the 
Enterprises exist. Strengthening their safety and soundness regulation 
supports that mission by ensuring that they are strong enough to 
provide the financial services that make that mission a reality.
Conclusion
    Mr. Chairman, before concluding my testimony, I would be remiss in 
not noting my appreciation for the interest and support of Members of 
this Committee during last week's hearing with respect to the 
Administration's request of $7.5 million in additional appropriations 
for OFHEO in fiscal year 2004. I look forward to working with the 
Committee on this request, as well as legislation to strengthen 
regulation of the Enterprises. I will be happy to answer questions that 
you and the Committee may have.
                               ----------
               PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
                 Director, Congressional Budget Office
                            October 23, 2003
     Mr. Chairman, Senator Sarbanes, and Members of the Committee, 
thank you for this opportunity to discuss the Congressional Budget 
Office's (CBO's) work on the economics, costs, and regulation of the 
Government Sponsored Enterprises (GSE's) for housing--namely, Fannie 
Mae, Freddie Mac, and the Federal Home Loan Banks. Broadly speaking, 
that work leads to three main points:

 The Federal Government confers substantial benefits on GSE's 
    through an implied guarantee of their debt and other financial 
    obligations;
 In doing so, the Government necessarily exposes taxpayers to 
    risks; and
 Effective regulation can reduce but not eliminate the risks to 
    taxpayers from the GSE's.
The Benefits of GSE Status
     The principal benefit of having the status of Government Sponsored 
Enterprise is the ability to borrow at lower rates of interest than any 
fully private firm holding the same amount of private equity capital 
and taking the same risks is able to do. Sponsored status also enables 
the GSE's to borrow far larger sums than would be available to private 
borrowers. Low-cost capital and easy access to the market is the direct 
result of an implied Federal guarantee of the GSEs' obligations.
     The implicit guarantee is communicated to investors in capital 
markets through a number of provisions of law that create a perception 
of enhanced credit quality for the Enterprises as a result of their 
affiliation with the Government. Those provisions include a line of 
credit at the U.S. Treasury; exemption from the Securities and Exchange 
Commission's (SEC's) registration and disclosure requirements; 
exemption from State and local income taxes; and the appointment of 
some directors by the President of the United States. In addition, 
although Federally chartered and Federally insured banks face a limit 
on the amounts that they can invest in other types of securities, that 
limit does not apply to the GSEs' securities. Taken together, those 
statutory privileges have been sufficient to overcome an explicit 
denial of Federal backing that the GSE's include in their prospectuses.
    GSE status and the benefits it conveys are no longer necessary to 
the functions that Fannie Mae, Freddie Mac, and the Federal Home Loan 
Banks perform. Those purposes include ensuring a reliable source of 
funds to housing and increasing access to mortgage credit by low- and 
moderate-income borrowers so that more families can own their homes. 
Private financial institutions that lack GSE status, such as Washington 
Mutual and Bank of America, currently maintain a reliable link 
between the wholesale capital markets and retail lenders who originate 
home mortgages not eligible for financing from the GSE's. Moreover, the 
Government has numerous more-direct policies to assist low-income 
homebuyers, including mortgage insurance offered by the Federal Housing 
Administration and other more-targeted programs administered by Federal 
agencies. 




    Private financial intermediaries, however, cannot match the low 
funding costs of the GSE's. To approach the GSEs' borrowing rates, they 
would have to raise more private equity capital and other private 
credit enhancements than do the housing GSE's. In short, they would 
need to convince lenders that they could replicate the Federal 
guarantee through private means. However, private providers of risk-
bearing or credit-enhancement services require compensation 
commensurate with the 
assumed risk. The requisite backing from private sources, therefore, is 
costly. By contrast, the Government, provides the benefits of low-cost 
funding without charge.
    Assisted by the implied Federal guarantee, the housing GSE's have 
grown into some of the largest financial institutions in the world. 
Their outstanding securities now exceed $4 trillion--or more than the 
entire U.S. public debt. In the process, Fannie Mae and Freddie Mac 
have come to dominate the U.S. residential mortgage market, accounting 
for almost 57 percent of residential mortgage debt (see Table 1).
    The value of the Federal subsidy to the GSE's can be approximated 
by comparing the Enterprises' actual funding costs with those they 
would face as private intermediaries. In May 2001, CBO estimated that 
difference--on the basis of a credit rating of AA-2 for the housing 
GSE's--to be $10 billion to $15 billion per year from 1998 to 2000. 
Adjusted for the growth of the Enterprises (but with any increases in 
risk ignored), the current annual subsidy is, at a minimum, above the 
upper end of that range.
The Exposure of Taxpayers to Risks from the GSE's
     By supporting the activities of the housing GSE's through an 
implied guarantee, the Government has assumed, on behalf of taxpayers, 
the risk of losses that might exceed the Enterprises' holdings of 
private equity capital. The housing GSE's offer public assurances that 
their assumed risks, especially for credit or default losses, are low 
in relation to their private capital. As a result, taxpayers may 
conclude that their own risk exposure is also low.
     The housing GSE's appear to be principally exposed to interest 
rate, prepayment, and operations risks. Interest rate risk refers to 
the different effect that changes in interest rates can have on the 
value of a firm's assets and liabilities and thus on its net worth. For 
example, an increase in interest rates will reduce the value of both 
fixed-rate assets and fixed-rate liabilities, but the value of assets 
will be hit harder if the assets have a longer maturity than the 
liabilities do. A rise in interest rates, therefore, can wipe out a 
financial intermediary's equity capital.
     Entities that hold portfolios of fixed-rate mortgages are also 
subject to prepayment risk. Specifically, the value of a portfolio of 
fixed-rate mortgages declines when borrowers exercise their option to 
refinance and prepay their existing mortgages in response to a decline 
in market rates. In combination, interest rate and prepayment risks 
mean that the housing GSE's are potentially vulnerable to losses from 
both increases and decreases in interest rates.
     Even those firms that appear to be well-managed are subject to 
operations risk, or the adverse effects of errors in judgment by 
management in protecting the value of a firm. That threat can manifest 
itself in lapses in the integrity and performance of existing controls, 
systems, and practices.
     Private equity holders and other stakeholders in the housing GSE's 
have some incentive to manage and control risk, but overall those 
incentives are weaker than those for investors in other entities. 
Market discipline is weakened by the Federal guarantee, which reduces 
the need for bondholders to monitor and restrict the Enterprises' 
risks. Further, equity holders have diminished incentives to resist 
risk taking to the extent that they believe that the Government would 
intervene to sustain the GSE's. Member institutions holding equity in 
the Federal Home Loan Banks may undervalue the Enterprises' risks 
because they can withdraw some of their equity from a financially 
troubled bank to reduce their potential losses. Following severe 
losses, equity holders who cannot withdraw their capital can have an 
incentive to accept increased risks by the Enterprises because that 
approach may be their only means of recovering those losses. In sum, 
the Federal Government cannot count exclusively on non-Federal 
stakeholders to limit the risks to taxpayers from the housing GSE's.
     Nonetheless, the housing GSE's are managing prepayment risk and 
interest rate risk through such means as issuing debt securities that 
can be redeemed at par before maturity and using derivatives, including 
interest rate swaps. Also, the GSEs' internal monitoring and safeguards 
reduce operations risk. Finally, the housing GSE's are limiting their 
exposure to credit risk by requiring private mortgage insurance on 
loans with less than a 20 percent downpayment and by leaving some of 
that risk with the loan originators.
     As a practical matter, however, the Enterprises' risks cannot be 
eliminated, nor would doing so be in the interests of equity investors. 
The risks of financing and holding a portfolio of mortgages are simply 
too varied and complex to permit management to identify them all and to 
find another party willing to accept them at a reasonable cost. The 
more feasible objective of holding interest rate and prepayment risks 
within acceptable bounds is among the most complex and difficult tasks 
facing the managers of mortgage portfolios. At the housing GSE's, risk 
management is assigned a high priority and is reported to be vigorously 
pursued with state of the art systems and analytical procedures. Even 
so, best practices intended to achieve vital objectives occasionally 
fail and produce unpleasant surprises.
     Matters are complicated further by shareholders' desire to retain 
some risks. The return on riskless financial activity is close to the 
return on U.S. Treasury securities. In competitive markets, investors 
can obtain high rates of return only by assuming risks. Fannie Mae and 
Freddie Mac have consistently earned high rates of return on equity. 
For example, the average annual return on their equity from 1990 to 
2002 was over 23 percent. A comparison group of large financial 
services firms averaged returns of less than 14 percent during that 
period. One essential operating difference between those two GSE's and 
private firms is that the GSE's hold less than half as much private 
equity capital per dollar of assets as the comparison firms do (3.70 
percent versus 9.14 percent). If Fannie Mae and Freddie Mac retained 
about the same risks as private financial services firms, then their 
higher rates of return on capital could be explained by their lower 
levels of capital.
     Future losses from risks retained by the housing enterprises would 
be borne by the Enterprises' equity investors up to the limit of the 
GSEs' equity and reserves. Creditors could then look to the Federal 
Government to cover losses above those amounts. Some observers claim 
that the Government's commitment is only conjectural and therefore 
potentially illusory. However, when another GSE, the Farm Credit 
System, suffered threatening losses in the 1980's, the Congress 
authorized up to $4 billion in Federal financial assistance to avoid a 
default on bonds that carried a similar guarantee. In that case, at 
least, the implied Federal guarantee 
became real. In the event of future losses by the housing GSE's in 
excess of their private capital, the Government would face a choice 
between ignoring a financial shock of unknown magnitude or confirming 
that its guarantee would be honored. The significant difference in the 
expected short-term costs of those alternatives suggests that the 
capital markets are likely to be correct in supposing that the 
Government will not walk away from its implied guarantee when the need 
for Federal support arises.
     A rough indication of the likelihood of such an event is provided 
by the cumulative average historical default rate for corporate debt 
with a credit rating comparable to that of Fannie Mae and Freddie Mac. 
Standard & Poor's reports that for debt rated AA-, the cumulative 
average default rate over 15 years is 1.92 percent. By that indication, 
a default by Fannie Mae or Freddie Mac is highly unlikely over the next 
15 years. But it is not an impossibility.
The Role of Regulation in Limiting Taxpayers' Risks
     By enhancing the housing GSEs' credit quality, the Federal 
Government gives the Enterprises substantial control over the risks 
faced by taxpayers and over the amount of the Federal subsidy. The 
Enterprises can increase that subsidy by expanding their volume of 
guaranteed debt, by engaging in riskier activities, by reducing their 
efforts to hedge existing risks, and by diverting income to activities 
outside their missions or distributing it to shareholders.
     Fannie Mae and Freddie Mac have two means of channeling funds from 
the 
capital markets to retail lenders: Investing in mortgages and 
guaranteeing mortgage-backed securities (MBS's). To invest in 
mortgages, the Enterprises issue debt obligations and purchase 
mortgages. Alternatively, they pool individual mortgages, insure the 
pools against credit risk, and sell undivided interests in the pools 
directly to 
investors in the form of mortgage-backed securities. Purchasing and 
holding mortgages as investments entails greater risks and returns for 
the GSE's than guaranteeing MBS's does. Fannie Mae and Freddie Mac have 
dramatically increased the size of their investment portfolios relative 
to their guarantees of MBS's since 1990 (see Table 2). In fact, Fannie 
Mae and Freddie Mac now hold in portfolio about one-third of their 
guaranteed MBS's. Similarly, the Federal Home Loan Banks have increased 
their portfolio holdings of mortgages from less than $1 billion in 1998 
to more than $60 billion in 2002 and to $90 billion by the middle of 
2003.
     When the Enterprises buy and hold mortgage assets in portfolio, 
they are retaining interest rate, prepayment, and credit risks on those 
loans. But when the GSE's sell mortgages to investors through 
guaranteed MBS's, they transfer interest rate and prepayment risks, 
retaining only the more transparent, manageable credit risk. As the 
GSE's move mortgages into their portfolios, they increase both the 
expected returns and risks to shareholders; for taxpayers, only the 
risks increase. The increase in risk is reflected in the statutory 
minimum for private capital to be held by Fannie Mae and Freddie Mac of 
2.5 percent for mortgages in portfolio and 0.45 percent for MBS's. 
Whether those differences in capital requirements accurately reflect 
true differences in the level of risk, however, is impossible to know 
because the Enterprises can vary the extent to which they hedge 
portfolio risks. Determining the adequacy of the Federal Home Loan 
Banks' capital is further complicated by the ability of members to 
redeem some capital at par. Redeemable capital is unlikely to be 
available to absorb the Banks' losses or to protect taxpayers. 



     An important purpose of the regulation of GSE's is to limit 
taxpayers' risks and the size of the subsidy. To do so, regulators must 
understand, monitor, and assess the risks of the Enterprises virtually 
to the same extent that their management does. But some dimensions of 
risk are not easily transparent. Even world-class regulators--well-
funded, well staffed, and politically independent--are unlikely to be 
able to maintain a complete understanding of the extent to which 
taxpayers are exposed to risks.
    Nonetheless, regulators can limit the GSEs' ability to leverage the 
value of the Federal guarantee. To do that, they need a range of 
capabilities to address the varied means by which the GSE's can 
increase the risk exposure of taxpayers. Those capabilities include 
being able to adjust capital requirements, to assess the extent to 
which the GSE's have retained interest rate and prepayment risks and 
the effectiveness of hedges against those risks, to hold management 
responsible for the adequacy of internal systems and controls, and to 
prevent a failed GSE from continuing to use the Federal guarantee.
    The regulators also need enough public support to enable them to 
exercise their authority to compel changes in risky behavior by the 
housing GSE's. Toward that end, increased public disclosure of the 
findings of regulatory oversight of the Enterprises could be useful. 
Freddie Mac has agreed to publicly report its fair-value, or mark-to-
market, net worth quarterly. That practice increases transparency and 
might be usefully adopted by all of the GSE's.
    The Congress could facilitate the regulators' difficult task by 
setting statutory boundaries on the GSEs' ability to increase the value 
of the Federal subsidy. For example, the Congress could legislate a 
higher margin of safety in the minimum capital standards. It could also 
act to limit the growth (or profitability) of GSEs' portfolio 
investments and move toward more-equal treatment of the Enterprises and 
their potential competitors. Some Members of Congress have proposed 
requiring SEC registration of GSE securities, for example. A May 2003 
CBO report on that topic found that such a requirement would be 
unlikely to have a significant adverse effect on the GSE's or on the 
mortgage markets. Similarly, in the absence of evidence that 
Presidentially appointed directors have a unique advantage in defending 
taxpayers' interests, the selection of directors might be left entirely 
to private shareholders.
    Action by the Congress to bolster regulators' ability to ensure 
safe operation by the GSE's would better protect taxpayers. 
Furthermore, the GSEs' public mission does not appear to require them 
to sacrifice safety and soundness. Certainly, from the taxpayers' 
perspective, having the GSE's pursue a low-risk strategy is strongly 
preferable to tolerating a risky one.
                               ----------
                   PREPARED STATEMENT OF JOHN D. KOCH
           Executive Vice President and Chief Lending Officer
                 Charter One Bank, NA, Cleveland, Ohio
        on behalf of America's Community Bankers, Washington, DC
                            October 23, 2003
     Mr. Chairman and Members of the Committee, my name is John D. 
Koch, Executive Vice President and Chief Credit and Lending Officer of 
Charter One Bank, NA in Cleveland, Ohio. I am also a member of the 
board of America's Community Bankers and chairman of its GSE Policy 
Committee. ACB appreciates this opportunity to testify on proposals to 
improve the regulation of the housing-related Government Sponsored 
Enterprises, Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. 
ACB members include State and Federally chartered savings institutions 
and commercial banks. Our members are both stock- and mutually owned. 
As community bankers, many are specialists in mortgage lending. They 
are actively involved in the secondary market through Fannie Mae and 
Freddie Mac and other secondary market participants. Charter One 
services over $15 billion in home mortgages for Fannie Mae and Freddie 
Mac. ACB members are also substantial stockholders in and borrowers 
from the FHLBanks.
    ACB has long supported the traditional role Fannie Mae and Freddie 
Mac serve in the secondary mortgage market. They have provided great 
benefits to homebuyers and mortgage originators. In fact, they have 
significantly increased their commitment to community banks over the 
last several years. ACB helped initiate these changes by entering into 
business relationships with both companies that enable community banks 
to be more competitive in the marketplace.
    Similarly, ACB members depend tremendously on the advances provided 
by the FHLBanks. Our bank's FHLBank advances total nearly $10 billion. 
These advances make it possible for community banks to make sound home 
loans that may not conform to the strict criteria of the secondary 
market. FHLBank advances also provide an alternative funding source for 
community banks that choose to keep loans they originate--whether 
conforming or not--in their own portfolios.
    In addition, ACB members own more than half of the stock issued by 
FHLBanks and hold significant amounts of mortgage backed securities and 
other debt issued by Fannie Mae, Freddie Mac, and the FHLBanks. Charter 
One's investment in FHLBank stock totals $700 million, by far our 
largest single investment.
    Clearly, the continued financial health of all of these entities is 
critical to Charter One and other ACB members and their communities. 
Therefore, ACB strongly supports this Committee's effort to improve the 
regulatory system for the GSE's.
Scope of the Agency
    The Administration has recommended that Congress establish a new 
agency that would regulate all of the housing GSE's. ACB agrees with 
the Administration that the regulatory structure for these entities 
should be substantially improved and supports proposals to create a new 
independent regulator for FHLBanks that is housed inside Treasury. 
However, ACB recognizes that we are involved in a fluid and dynamic 
legislative situation. For example, the Treasury Department has raised 
concerns about the establishment of a new independent agency within the 
Department. ACB differs with Treasury on this issue. As we emphasize 
later in our testimony, it is essential that the new regulator be 
independent. Therefore, as an alternative way to address Treasury's 
concerns, ACB would support formation of a new, independent regulator 
as a stand-alone agency.
    ACB continues to prefer a separate regulator for the FHLBanks. 
Nevertheless, ACB strongly supports an amendment drafted by 
Representatives Royce, Maloney, and Leach that would merge the Office 
of Federal Housing Enterprise Oversight and the Federal Housing Finance 
Board into a new, independent, and fully funded Treasury agency. We 
recommend that you strongly consider taking a similar approach in your 
legislation.
    The Royce Amendment recognizes the differences between the FHLBanks 
and Fannie Mae and Freddie Mac by establishing two deputy directors and 
maintaining separate funding for the costs of regulation. Under the 
amendment, the new agency would administer the unique statutory 
arrangements that apply to the FHLBanks and Fannie Mae/Freddie Mac.
    If the new agency does become the regulator for the FHLBanks, it 
should maintain the Banks' access to the capital markets and their 
current well-defined mission to support the mortgage finance, 
affordable housing, and community development activities of member 
banks. The advance programs of the FHLBanks ensure homebuyers have 
ready access to home mortgage financing through FHLBank members.
    ACB recognizes that the Finance Board has increased its commitment 
to safety and soundness regulation. However, we believe there is 
substantial room for improvement and change in the regulation of the 
FHLBank System. A merged agency would avoid a perception that any of 
these Government Sponsored Entities are subject to more effective 
regulation than any of the others. We also note that the FHLBanks, 
Fannie Mae, and Freddie Mac are all engaged in extensive interest rate 
risk management and believe a combined agency would be better able to 
supervise these risks.
    While dealing with concerns common to all of the entities, the 
legislation would have to ensure that the new regulatory structure 
recognizes the unique and successful business model of the FHLBank 
System. Unlike Freddie Mac and Fannie Mae, the System is a cooperative 
owned by its member institutions. The FHLBanks' stock is not publicly 
traded and does not fluctuate in value. In addition, each of the 
FHLBanks is jointly and severally liable to all the others. Each of 
these GSE business models has their strengths. Any revised regulatory 
system should continue to respect those differences, while advancing 
the common goal--to maintain their financial safety and soundness.
Agency Structure, Funding, and Independence
    The Administration recommends that Congress eliminate OFHEO and the 
Finance Board and move their functions into an independent agency 
housed in the Department of the Treasury. This structure works for two 
key regulators, the Comptroller of the Currency and the Office of 
Thrift Supervision. A key element behind each agency's success is their 
high degree of independence from the Treasury, which insulates them 
from concerns about political influence.
    Additionally, both the OCC and OTS enjoy--and OFHEO does not have--
the ability to fund its operations without resort to the annual 
Congressional appropriations process. ACB strongly endorses the 
repeated recommendation of OFHEO Director Falcon to eliminate this 
anomaly and allow the regulator of Fannie Mae and Freddie Mac to assess 
those companies without the cumbersome appropriations process. It is 
important that the final bill provide the new agency with a complete 
exemption from the appropriations process, similar to that provided to 
other financial regulators.
    Independence is the other characteristic of the various financial 
regulators that ACB strongly believes must also be in the regulator for 
Fannie Mae, Freddie Mac, and the FHLBanks. Again, this has served our 
financial system and consumers very well. If a new agency is created 
within Treasury, it should have autonomy in the following key areas:

 Appointment of Director. The director should be appointed by 
    the President and confirmed by the Senate for a fixed term and be 
    removable by the President only for good cause.
 Testimony. Congress should be able to count on receiving the 
    agency's unvarnished views on all issues it faces.
 Rulemaking. There should be no opening for politically 
    appointed officials to delay or prevent the agency from issuing 
    rules it believes necessary.
 Supervision and Examination. All parties involved will benefit 
    from a strict separation between political appointees and 
    supervisory and examination staff.
 Enforcement. The agency's enforcement actions must be 
    independent from any outside interference.
 Litigation Authority. The director should be able to act in 
    his own name and through his own attorneys rather than have the 
    Attorney General represent the agency.
 Employment Authority. The director should have the ability to 
    employ officers and employees under authority comparable to that of 
    other financial regulators.
Authority over Mission and Programs
    The Finance Board has authority over all aspects of the FHLBanks: 
Ensuring safety and soundness and that they carry out their statutory 
housing finance mission. The Royce Amendment would continue this 
approach under the new agency.
    ACB strongly endorses the Administration's position that the new 
agency should have similar authority to ensure that Fannie Mae and 
Freddie Mac are also carrying out their secondary market mission. This 
agency must have the authority to review both current and future 
programs of Freddie Mac and Fannie Mae. In particular, new activities 
should be subject to an application and approval process similar to 
what is in place for bank holding companies today. For over a decade, 
the Department of Housing and Urban Development has not exercised its 
current program approval authority. As a result, Fannie Mae and Freddie 
Mac have engaged in or attempted to engage in activities inconsistent 
with their secondary market responsibilities.
    For example, both entities have issued retail debt instruments in 
denominations of as little as $1,000. These are being marketed by third 
parties to consumers with considerable emphasis on their implied 
Federal Government backing, when there is no such guarantee. Fannie Mae 
and Freddie Mac have responded to this problem by significantly 
improving disclosures. However, we doubt the public is adequately 
informed and protected. In addition to principal risk, these notes 
carry interest rate and call risk that relatively unsophisticated 
investors do not understand. Of course, these risks do not exist for 
traditional deposit products, such as certificates of deposit. 
Nevertheless, these small-denomination notes unfairly compete with 
CD's, weakening community banks' ability to meet housing finance and 
other community credit needs.
    ACB is concerned that these debt programs may be part of an attempt 
to create a ``name brand'' image for Fannie Mae and Freddie Mac in the 
mind of average consumers. Their extensive retail advertising is 
further strong evidence that this is a major goal for these entities.
    This branding effort could help Fannie Mae and Freddie Mac's 
efforts to move into the primary mortgage market. In one example of 
this, Freddie Mac entered into an agreement with an online mortgage 
company that attempted to reduce primary mortgage originators to, at 
best, a nominal role in the process. An effective mission regulator is 
needed to prevent Freddie Mac and Fannie Mae from using their 
Government-provided advantages to supplant private firms that compete 
in the primary mortgage market.
    The Administration's proposal makes clear that HUD would retain its 
mission 
authority to set affordable housing goals for Fannie Mae and Freddie 
Mac. As Secretary Mel Martinez testified, HUD would actually gain new 
regulatory clout to 
enforce those goals. However, ACB does not support the Administration 
recommendation that HUD be authorized to set new sub goals. Sub goals, 
while 
perhaps assuring a certain result, may lead to GSE purchase behaviors 
with unexpected and potentially undesirable consequences.
    Some housing advocates have expressed concern that, if HUD does not 
retain all mission and program oversight over Fannie Mae and Freddie 
Mac, their commitment to housing, particularly low- and moderate-income 
housing will suffer. However, Secretary Martinez testified in strong 
support of the Administration's proposal to shift these 
responsibilities, other than affordable housing goals, to the Treasury. 
If Congress provides for a substantial degree of independence for the 
new agency and affirms the companies' housing mission, there should be 
no decrease in their support for housing. In fact, we believe Fannie 
Mae and Freddie Mac must continue to be challenged to increase 
homeownership by minority families. And, as mentioned, under the 
Administration's proposal HUD's role would be enhanced in the area of 
affordable housing.
Capital Requirements
    ACB strongly agrees with the Administration position that, while 
the existing capital regulation adopted by OFHEO should be the new 
agency's starting point for Fannie Mae and Freddie Mac, there should be 
no limit on its ability to adjust capital requirements for Fannie Mae 
and Freddie Mac if it finds that necessary. Capital is the foundation 
for the safety and soundness of our financial system. Therefore, the 
new agency must have complete authority to adjust all capital 
requirements as necessary, subject to rulemaking.
    The Finance Board already has this authority with respect to the 
FHLBanks. The Royce Amendment would maintain the new agency's authority 
to adjust the FHLBanks' capital requirements. The new regulator should 
respect genuine differences between the FHLBanks and Fannie Mae/Freddie 
Mac--including their very different capital structures. However, a 
regulator's ability to adjust capital levels is fundamental and must 
apply to all of the regulated entities.
    As Congress has recognized, the taxpayers are ultimately at risk 
when a major part of the financial system is undercapitalized. While 
there is no explicit Federal guarantee for Fannie Mae and Freddie Mac, 
it is impossible to believe the Government would stand aside if either 
of these companies faced serious difficulty. Requiring them to maintain 
adequate capital will provide vital insulation for the taxpayers.
    Community bankers are particularly sensitive to this issue. We are 
already concerned that the proposed Basel II Accords could result in 
lower or disparate capital standards for the large banks that will 
adopt the new system. We would be equally troubled if regulatory reform 
for Fannie Mae and Freddie Mac had a similar result. The capital 
requirements for Freddie Mac and Fannie Mae should reflect the specific 
financial risks facing each, including realistic treatment of 
counterparty risk and direct investment in mortgages.
Enforcement Authority
    The Administration recommends that the new agency be given 
enforcement authority comparable to that of the banking agencies. ACB 
supports this point of view. However, we recommend that Congress 
carefully examine the current enforcement authority for OFHEO and the 
Finance Board to determine exactly which additional powers are needed 
and which banking agency provisions are not appropriate to deal with 
the unique features of the housing GSE's.
Conclusion
    I wish to again express ACB's appreciation for this opportunity to 
testify on these important issues. We strongly support the Committee's 
effort to strengthen the regulation of Freddie Mac, Fannie Mae, and the 
Federal Home Loan Banks. We look forward to working with you as you 
craft legislation to accomplish this goal.
                               ----------
                  PREPARED STATEMENT OF DALE J. TORPEY
          President and CEO, Federation Bank, Washington, Iowa
       on behalf of the Independent Community Bankers of America
                            October 23, 2003
Introduction
    Chairman Shelby, Ranking Member Sarbanes, and Senate Banking 
Committee Members, the Independent Community Bankers of America (ICBA) 
appreciates this opportunity to present our views on proposals for 
improving the regulation of the housing Government Sponsored 
Enterprises (GSE's).
    I am Dale J. Torpey, President and CEO of Federation Bank, a $115 
million asset bank located in Washington, Iowa. I currently serve as 
Chairman of the Lending Committee of the ICBA. I am also currently 
Chairman of the Board of Directors of the Federal Home Loan Bank of Des 
Moines. My testimony today is delivered exclusively on behalf of the 
ICBA.
    Potential regulatory restructuring of the housing GSE's is a matter 
of critical importance to the community banking industry.
    As a general principle, we do not believe that the Treasury 
Department should direct the housing policy of our Nation just as it 
should not run the monetary policy of our Nation. In our view, should 
the Treasury Department be granted supervisory and regulatory oversight 
of either Fannie Mae/Freddie Mac or all three of the housing GSE's, its 
tax policy and fiscal policy responsibilities would likely present 
clear conflicts of interest with housing policy. ICBA also shares the 
concerns that have been expressed by others regarding the historical 
absence of expertise in housing policy at Treasury.
Regulation of the Federal Home Loan Banks
    Since the passage of the Federal Home Loan Bank System 
Modernization Title of the Gramm-Leach-Bliley Act (Title VI of P.L. 
106-102) in 1999, which liberalized membership in the Federal Home Loan 
Banks (FHLBanks) and expanded the categories of eligible collateral for 
FHLBank advances, thousands of community banks are using FHLBank 
advances as a competitive and flexible funding source. The ability of 
community banks to continue to utilize this increasingly important 
funding source is crucial to safe and sound asset-liability management, 
as well as their ability to meet the lending needs of their 
communities. Similarly, the fact that Federal deposit insurance 
coverage levels have not increased since 1980 has given community banks 
further incentive to turn to FHLBank advances as a stable, alternative 
source of funding to meet Main Street's lending needs.
    ICBA continues to hold the view that the FHLBanks should be 
regulated by a separate and independent agency--a status that the 
existing Federal Housing Finance Board (FHFB) already enjoys. Under the 
regulatory guidance of the FHFB, the FHLBanks have a near-impeccable 
record of providing well-collateralized advances to thousands of 
institutions. The FHFB also has taken important steps, and continues to 
take steps, to upgrade its examination and supervision capacities 
focusing on safety and soundness.
    At its Fall meeting earlier this month, the 110-member ICBA Board 
of Directors, with representation from nearly every State, discussed 
the issue of FHLBank regulation at length. The ICBA board voted 
unanimously to oppose including the FHLBanks in any proposed new 
supervisory and regulatory structure for Fannie Mae and Freddie Mac in 
the U.S. Treasury Department.
    The ICBA Board did not discuss the concept of a new, independent 
regulatory structure outside the Treasury Department for Fannie Mae, 
Freddie Mac, and the FHLBanks--a concept which has been voiced by some 
in recent days.
    The ICBA has long supported independent financial regulatory 
agencies--for example, agencies such as the Board of Governors of the 
Federal Reserve System, the Federal Deposit Insurance Corporation 
(FDIC) and the Securities and Exchange Commission (SEC).
    While not our first preference, the ICBA may not oppose the concept 
of a new independent regulator for all three housing GSE's outside the 
Treasury Department, depending on how key details are fleshed out. The 
Federal Home Loan Bank Act could potentially serve as the legislative 
foundation for such a structure. However, two key issues would have to 
be worked out for such a structure to gain widespread support. First, 
the specific regulatory powers of such an agency would have to be 
determined. We note that the FHFB and the Office of Federal Housing 
Enterprise Oversight (OFHEO) do not currently have the same powers. 
Second, the unique ownership, operational and capital structure, and 
mission of the FHLBanks, which is distinct from that of Fannie/Freddie, 
would have to be recognized and preserved in constructing the new 
agency.
Regulation of Fannie Mae and Freddie Mac
    Community banks are significant direct or indirect users of the 
Fannie Mae and Freddie Mac conduits into the secondary mortgage market. 
The sale of mortgages originated by community banks into the secondary 
market increases the liquidity of these locally owned- and operated-
financial institutions, allowing them to better serve the lending needs 
of Main Street America. Our system of homeownership is the envy of the 
world and it has been the stalwart of the American economy during 
economically challenging times in recent years. The current system has 
enabled us to reach record homeownership levels and to accommodate 
consumer refinancing needs in the recent low interest rate environment. 
This must not be overlooked as part of the process when considering GSE 
regulatory restructuring.
    Regarding proposals to bring the regulation of Fannie Mae and 
Freddie Mac under the Treasury Department, ICBA reiterates its 
staunchly held view that any such entity must be politically 
independent in order to be regarded as a world-class financial 
regulatory agency. We firmly believe that the traditional political 
independence of our Federal financial agencies has immeasurably 
strengthened the U.S. economic and financial system. Currently, the 
Office of the Comptroller of the Currency (OCC)and the Office of Thrift 
Supervision (OTS) are protected from the Treasury's political 
influence.
    We strongly urge Congress to make certain that any potential 
legislation contain appropriate firewalls and independence between 
Fannie and Freddie and the Treasury's politically-appointed 
policymakers. Politicizing regulation is an ever-present danger, and we 
believe it is paramount to maintain the independence of any new 
regulator overseeing safety and soundness and Fannie and Freddie's 
Congressionally mandated missions to support home ownership.
Other Key Issues
    In the letter of invitation for today's hearing, ICBA was also 
asked for its views on several other issues in the debate over housing 
GSE regulation.
    First, what is the appropriate capital regime for the housing 
GSE's? We support the continuing authority of each GSE regulator to 
establish, and modify, as necessary, the level of risk-based capital 
that the GSE's are required to hold. As market and risk factors change, 
the regulators must be able to adjust to these changes in a timely 
manner. However, ICBA does not support granting the GSE regulators the 
authority to modify statutory or minimum capital. Such new authority 
could confer on the regulators the authority to de facto adjust program 
levels by raising minimum capital, reducing the amount of resources 
available for program activities.
    Second, what should the funding mechanism be for the new regulator? 
To insulate the housing GSE regulators from undue political influence 
and enhance independence, ICBA supports removing funding of the GSE 
regulators from the appropriations process and funding them solely 
through a self-generated fee structure.
    Third, where should authority for new program approvals be placed? 
We believe that in order for the housing GSE's to continue to be 
innovative in the development and implementation of new products to 
meet the demands of the marketplace, there should be a smooth and 
seamless process for getting these products online. Clearly, if a 
FHLBank, Fannie Mae or Freddie Mac develops a program that is 
inconsistent with safety and soundness or with their Congressionally 
mandated missions, there must be a review process to make that 
determination. But there should not be disincentives for the GSE's to 
be innovative and adaptive to new market conditions. Our housing 
finance system has evolved rapidly over the recent past due to changing 
technology and changes in the demands of consumers. The FHLBanks, 
Fannie Mae, and Freddie Mac must have the flexibility to develop the 
housing finance products needed by consumers in a timely manner and not 
have new products, programs and activities be bogged down by 
bureaucracy.
    Fourth, what is the appropriateness of HUD's continuing role in the 
oversight of Fannie Mae and Freddie Mac? Because of its 
responsibilities and expertise, our preference is that HUD should 
continue to establish our Nation's housing goals and control the 
mission activities of Fannie/Freddie to achieve those goals.
Conclusion
    In closing, ICBA would urge the Committee to carefully and fully 
consider the issues associated with regulation of the housing GSE's 
before rushing to action. The ICBA has long supported world-class, 
independent regulatory agencies such as the FDIC and the Federal 
Reserve, both of which are governed by boards that are independent of 
the U.S. Treasury.
    There is no shortage of opinions and strongly held viewpoints on 
these issues. We concur with the sentiments expressed by a number of 
Members of this Committee that it is imperative that any regulatory 
restructuring be done right given its potential impact on the crucial 
housing sector of our economy and on community banks' continued ability 
to meet the lending needs of Main Street America.
    Thank you for the opportunity to testify. I would be pleased to 
answer any questions.
                               ----------
                PREPARED STATEMENT OF ALLEN J. FISHBEIN
                 Director for Housing and Credit Policy
                     Consumer Federation of America
                              on behalf of
              National Association of Consumer Advocates,
               National Community Reinvestment Coalition,
         National Congress for Community Economic Development,
   National Fair Housing Alliance, and Consumer Federation of America
                            October 23, 2003
    Good morning Chairman Shelby, Senator Sarbanes, and Members of the 
Committee. My name is Allen J. Fishbein, and I am the Director of 
Housing and Credit Policy for the Consumer Federation of America. I 
appreciate the opportunity to testify on proposals for improving the 
regulation of the Government Sponsored Housing Enterprises (GSE's). My 
written testimony today is also on behalf of the National Association 
of Consumer Advocates, National Community Reinvestment Coalition, 
National Congress for Community Economic Development, and the National 
Fair Housing Alliance.
    CFA is a nonprofit association of 300 proconsumer organizations, 
with a combined membership of 50 million, founded in 1968 to advance 
the consumer interest through education and advocacy. My own background 
in the area of GSE regulation includes my tenure at HUD, where I served 
as Senior Advisor for GSE Oversight. My responsibilities at HUD 
included assisting with the supervision of the rulemaking that resulted 
in establishment of the present affordable housing goals for Fannie Mae 
and Freddie Mae, along with the management of other areas of the 
Department's GSE regulatory oversight.
    As national consumer, community, and civil rights organizations 
committed to the promotion of fair and affordable housing for all of 
America's citizens, we watch with considerable interest the ongoing 
debate about possible changes to the regulatory structure for Fannie 
Mae and Freddie Mac and wanted to share a few of our observations.
    We appreciate those in Congress who desire to assure the adequacy 
of safety and soundness and mission-related requirements for the 
Government Sponsored Housing Enterprises--Fannie Mae and Freddie Mac 
(GSE's). We also urge that Congress be very careful in tinkering with 
the GSEs' basic overall regulatory structure. At a minimum, such 
changes to the regulatory structure should do no harm to the GSEs' 
housing mission. However, we also believe that the current debate 
provides an important opportunity to clarify those areas of the GSEs' 
affordable housing mission that should be expanded. Fannie Mae and 
Freddie Mac have fulfilled an important part of their mission by 
providing affordable housing capital for low- and 
moderate-income and minority households. Yet much remains for the GSE's 
to accomplish in expanding fair and affordable housing opportunities 
for the residents of our Nation's underserved communities, such as 
providing greater assistance to first-time minority, and low-income 
homeowners and securitizing multifamily rental mortgage products. 
Similarly, while the GSE's have been industry leaders in adopting 
policies to combat a number of predatory lending practices, such as 
their repudiation of the purchase of loans that included single premium 
credit insurance (SPCI), they have yet to address certain other 
egregious lending practices.
    More specifically, we believe that important improvements to the 
present affordable housing goals requirement are desirable. Clearly the 
establishment of these goals has served an important function, 
encouraging the GSE's to better serve the needs of underserved areas 
and low- and moderate-income housing households. In fact, both 
enterprises have consistently met or exceeded the goal levels set for 
them. Nonetheless, the three broad statutory goals in place do not 
permit HUD to focus sufficient GSE attention to addressing some of the 
neediest segments of the mortgage market, such as low-income, minority, 
and other underserved homebuyers, or certain rental and rural housing 
finance needs. Establishing an additional GSE home purchase goal, and 
providing HUD with supplemental authority to set subgoals for GSE 
activity for particularly pressing needs within the overall statutory 
goals, while not diminishing the ability of the GSE's to serve the 
needs of all consumers refinancing loans, would enhance the overall 
effectiveness of this important mandate.
    Also, reform of the GSE housing goals should include provisions to 
expand opportunities for public input into this important area of 
regulation. We favor improvements to the GSE public use database 
presently maintained by HUD to make the information available fully 
comparable with data reported by mortgage lenders under the Home 
Mortgage Disclosure Act. Opportunities for public comment should also 
be provided in the event that a GSE did not meet its annual performance 
requirement and HUD as a result required the GSE to submit a remedial 
plan.
    Our strong interest in affordable housing extends to other aspects 
of regulatory restructuring as well. We are particularly concerned that 
proposals to shift general charter oversight and new program approval 
authority away from HUD to the Treasury Department will detract from 
the regulatory focus on GSE performance of their housing mission. At 
the same time, funding the reasonable costs of this regulation through 
direct assessments of the GSE's, and not through the appropriations 
process, would go a long way to strengthening oversight capacity.
    We are also concerned with the deliberations around two regulatory 
areas, capital requirements and the program approval process. First, 
the GSEs' capital requirement is one of the most critical and sensitive 
issues. We recognize that the establishment of appropriate capital 
requirements may at time involve tradeoffs, but we fear that 
unnecessary increases in capital requirements, particularly the minimum 
requirement, could result in higher costs to homebuyers. Simply, we 
should not make it harder for minority and low-wealth families to be 
able to afford to become homeowners.
    Second, in evaluating any changes to the current program approval 
process, a delicate balance is required between a careful examination 
of whether a new GSE product serves its important public mission and 
the need to not over-burden these organizations' innovative efforts to 
provide new lending opportunities in the most difficult to serve 
communities. While there may be a need to improve the current approval 
process, we urge you to proceed cautiously, and resist efforts to over-
encumber this process.
    While this testimony focuses mainly on regulatory oversight of 
Fannie Mae and Freddie Mac, we also offer the following comments on 
regulation of the other housing GSE, the Federal Home Loan Bank System 
(FHLB System). We believe the FHLB System as it has evolved must also 
have clear and specific housing goals that challenge the lenders to 
better serve underserved populations. Should Congress decide to abolish 
the Federal Housing Finance Board, the system's regulator, and transfer 
authority to another agency, we strongly prefer that mission oversight 
be transferred to HUD, and that the Department also be provided with 
authority to establish new affordable housing requirements to ensure 
that activities undertaken by the FHLBanks are targeted to low- and 
moderate-income housing and other underserved community needs. These 
new requirements should build on the existing Affordable Housing and 
Community Investment Programs (AHP and CIP) and also work to increase 
FHLB member support for these and other affordable housing and economic 
development initiatives.
    In closing, we thank you for your work in attempting to strengthen 
the effectiveness of the GSE's to serve the housing needs of America's 
underserved populations. We urge that you support provisions to 
strengthen the housing goals requirement, but also proceed with caution 
and resist the urge to make changes to their status or their charter 
that might result in fewer affordable housing opportunities.
    Thank you again, Mr. Chairman, for the opportunity to offer our 
views on this important topic. I am happy to answer any questions that 
either you or other Members of the Committee may have.
                               ----------
                 PREPARED STATEMENT OF ROBERT M. COUCH
                 Chairman, Mortgage Bankers Association
                            October 23, 2003
     Mr. Chairman and Members of the Senate Banking Committee, the 
Mortgage Bankers Association appreciates this opportunity to express 
our views on the important issues surrounding improving the regulation 
of the housing Government Sponsored Enterprises (GSE's). The Mortgage 
Bankers Association (MBA) is the national association representing the 
real estate finance industry. We have approximately 2,700 member 
companies engaged in every aspect of real estate finance. MBA members 
originate loans in the primary mortgage market that Fannie Mae and 
Freddie Mac purchase. MBA, therefore, has a keen interest in 
maintaining the safety and soundness of our country's real estate 
finance system.
    Fannie Mae and Freddie Mac are the biggest participants in our 
country's secondary mortgage market. Their regulation has come under 
scrutiny lately, with many calls for improvement.
    Treasury Secretary John Snow and Housing and Urban Development 
(HUD) Secretary Mel Martinez presented the Administration's proposal 
for GSE regulatory reform in testimony before the House Financial 
Services Committee on September 10, 2003, and before the Senate 
Banking, Housing, and Urban Affairs Committee on 
October 16, 2003. The two Secretaries proposed to move safety and 
soundness regulation of Fannie Mae and Freddie Mac to a new agency 
within the Treasury Department. They further proposed to task the 
safety and soundness regulator with approving new and ongoing programs 
and activities, in consultation with HUD. And they proposed to 
strengthen the regulators' authority and funding.
    MBA reiterates its support of the Administration's proposals. MBA 
has long advocated strong and effective oversight of the GSE's. We 
believe effective safety and soundness regulation is critical because 
of Fannie Mae's and Freddie Mac's size and because of their importance 
to the housing finance system. MBA is pleased to see that the 
Administration and Members of Congress support strengthening the 
regulation of Fannie Mae and Freddie Mac.
    MBA supports the Administration's proposal to improve and 
strengthen the 
general regulatory, supervisory, and enforcement powers with respect to 
the GSE's. Further, MBA endorses giving the safety and soundness 
regulator appropriate flexibility in setting capital standards, instead 
of relying on a rigid, statutory stress test that does not allow the 
regulator to react adequately to changes in the financial marketplace. 
MBA also supports the Administration's proposal to fund GSE regulation 
independently, through assessments on Fannie Mae and Freddie Mac 
outside of the Congressional appropriations process.
    MBA also endorses the Administration's proposal on one of the most 
important aspects of safety and soundness, that is, program oversight. 
The GSEs' programs are a key determinant of their safety and soundness, 
and it is imperative that the programs be conducted safely and soundly. 
Only financially healthy, safe and sound GSE's can contribute to their 
housing mission. If, for example, a GSE were to embark on a program of 
purchasing especially risky loans, the GSE's safety and soundness would 
likewise be at risk. Or, if a GSE were to engage in a high-volume 
program that entails liquidity risks or systemic risks, the safety and 
soundness of such a program would be of critical concern to our housing 
and financial markets, and to a safety and soundness regulator. GSE 
programs and activities are intrinsically linked to safety and 
soundness.
    The safety and soundness regulator, for these reasons, is in the 
best position to evaluate the appropriateness of GSE programs. The 
regulatory approval system should be robust, and should have a clear 
definition of what requires regulatory review. Congress should draw a 
clear line between the primary and secondary mortgage markets. In no 
event should the GSE's be permitted to encroach upon the mortgage 
origination process. In no event should the GSE's be permitted to use 
their Government sponsored benefits to distort the competitive 
landscape of the primary mortgage market.
    MBA also believes that it is important that the regulator not 
micro-manage the GSE's, and that it not unduly constrain the GSEs' 
ability to innovate in a timely manner in response to marketplace 
needs. Regulatory approval for new programs must come in a timely 
manner, and should be based on clear and well-defined criteria.
    In exchange for the benefits of Government sponsorship, Fannie Mae 
and Freddie Mac have an affirmative obligation to meet certain housing 
goals. MBA very strongly supports the affordable housing goals for 
Fannie Mae and Freddie Mac because the goals require the GSE's to focus 
some of their activities on lower-income Americans and those living in 
underserved areas. MBA agrees that HUD is the appropriate agency to set 
and enforce the housing goals for Fannie Mae and Freddie Mac.
    The Mortgage Bankers Association strongly urges Congress to reform 
the oversight of Fannie Mae and Freddie Mac in this manner so that they 
can continue their role in supporting housing, especially affordable 
housing, in this country.
    The Mortgage Bankers Association appreciates the opportunity to 
present its views on these important issues. We would be happy to 
answer any questions the Committee may have.
                               ----------
                 PREPARED STATEMENT OF IONA C. HARRISON
                 Realty Executives-Main Street, U.S.A.
     on behalf of the National Association of REALTORS'
                            October 23, 2003
Introduction
    Chairman Shelby, Senator Sarbanes, and Members of the Committee, I 
am Iona C. Harrison, a broker with Realty Executives-Main Street, 
U.S.A. in Upper Marlboro, Maryland. I am here on behalf of over 950,000 
members of the National Association of REALTORS' to share 
our views on the important issue of GSE regulation and the housing 
finance system.
    For the record, REALTORS' want to thank Senator Shelby, 
Senator Allard and Members of the Committee for reporting the 
``American Dream Downpayment Act.'' The Senate Banking Committee 
unanimously approved this bill with two important amendments. First, 
the bill increases the FHA multifamily loan limits in high cost areas. 
Second, the bill provides a technical correction to improve the FHA 
hybrid ARM program. NAR is a strong advocate for this program. In fact, 
NAR lead a coalition of supporters who are hopeful that the bill will 
come to the Senate floor shortly. By adopting the American Dream 
Downpayment legislation Congress will send a strong message supporting 
the Administration on increasing homeownership opportunities in the 
United States. This legislation is evidence of the importance this 
Congress and Administration place on homeownership opportunity in the 
United States. NAR believes that a new independent safety and soundness 
GSE regulator combined with continued HUD authority over housing 
programs and mission will ensure that this commitment remains a high 
priority in future years.
GSE Regulatory Reform
    REALTORS' applaud Congress and the Administration for 
what we believe could 
become a measured, well-considered refinement to regulating the 
Government Sponsored Enterprises, Fannie Mae and Freddie Mac. The Bush 
Administration has outlined principles that will underscore the 
importance of the GSEs' mission, status, and safety and soundness 
oversight that make our housing finance system unique and so effective. 
Safety and soundness regulation would be lodged at the Treasury 
Department because of its financial expertise. REALTORS' 
support this move because it sends a clear message to housing finance 
and investor markets. But while safety and soundness regulation may 
move to the Treasury, REALTORS' strongly believe that the 
current housing mission should continue to be housed at the Cabinet-
level Department of Housing and Urban Development. We strongly believe 
that HUD should continue to speak for housing, new GSE program 
oversight, and the GSEs' critical mission supporting homeownership.
    Over the past decade the housing sector and American homeowners 
have benefited significantly from the strength of the Nation's housing 
finance system. At the core of our housing finance system are the 
secondary mortgage market and the Government sponsored mission of 
Fannie Mae and Freddie Mac. The National Association of 
REALTORS' supports a credible and vigorous GSE regulator. A 
strong regulator reinforces President Bush's and Congress commitment to 
housing and homeownership, promotes confidence in Fannie Mae, Freddie 
Mac, and the real estate and housing finance industries, and protects 
U.S. citizens against systemic risk. Although realtors support a strong 
regulator, we insist that regulatory reform does not imply and should 
not result in any weakening of the current housing finance system.
    Congress deemed the Government Sponsored Enterprise model as an 
appropriate vehicle to advance housing and housing policy as recently 
as 1992. Fannie Mae and Freddie Mac were chartered as private 
corporations with publicly traded stock with the mission to bring new 
mortgage products to the market, and to use innovation and technology 
to continue simplifying the mortgage process. In exchange for the 
Federal charter to facilitate the residential secondary mortgage 
market, certain advantages were provided to Fannie Mae and Freddie Mac. 
Since enactment of the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992 (Title XIII of Public Law 102-550), Congress, 
homeowners, the housing finance system, and the Nation's economy have 
all benefited tremendously. The unprecedented expansion of 
homeownership rates is undeniable testament to the efficiency and 
liquidity of the secondary mortgage market and the housing sector.
Administration Regulatory Recommendations
    In recent testimony to the Senate Banking Committee, Treasury 
Secretary John Snow and HUD Secretary Mel Martinez outlined the powers, 
duties, and authorities a new GSE safety and soundness regulator should 
have in a new agency within the Treasury Department and the 
relationship that HUD would have going forward. The proposed new 
supervisory agency would focus on safety and soundness, together with 
program and product approval, in consultation with HUD. Secretary Snow 
urged consideration of an agency that would be independent of the 
Congressional appropriations process, and that Treasury would have, at 
a minimum, clearance of new regulations and Congressional testimony.
    Secretary Martinez supported the Administration view that authority 
over new program approval be transferred from HUD to the new regulator 
in his testimony. Secretary Martinez advocated HUD retaining authority 
over the GSE affordable housing goals, and called for expanded 
authority to enforce the housing goals, impose civil penalties for 
failure to meet the housing goals, explicitly provide that the GSE's 
act to increase homeownership, and expand authority to set housing 
goals and sub goals.
    NAR would like to comment on key elements of the Administration's 
plan that are most relevant for the real estate industry.
Independent Regulator
    REALTORS' would agree that Fannie Mae and Freddie Mac 
should have an independent regulator for safety and soundness. We would 
recommend that the new regulatory agency in the Treasury Department 
should have necessary and sufficient firewalls to ensure its political 
and operating independence similar to those that currently exist for 
the Office of the Comptroller of the Currency (OCC) and the Office of 
Thrift Supervision (OTS) regulatory models.
GSE Capital
    In outlining the authority for the new regulator regarding GSE 
capital, Secretary Snow highlighted in his testimony a need for 
stability in capital standards. ``Capital,'' he said, ``is the 
fundamental element of the financial condition of an enterprise, and 
the capital standards should not become the subject of frequent 
change.'' REALTORS' agree with Secretary Snow on this 
general point regarding capital. These capital standards should be 
allowed to remain in place for a period of time sufficient to evaluate 
their effectiveness.
GSE Mission, Program and Product Review
    The Administration proposal to place GSE regulatory oversight and 
new program approval under the Treasury Department is a major change in 
regulatory oversight of the housing GSE's. REALTORS' 
expressed opposition to moving GSE housing mission oversight from HUD 
when the Administration's plan was first released. Our concern is that 
housing policy has not been the purview or expertise of the Treasury 
Department; this has been the purview of HUD. The housing and real 
estate industries naturally look to HUD to address the housing mission, 
programs and products, and affordable housing goals that are central to 
the GSEs' existence. In the new GSE regulatory regime we strongly 
believe that HUD should maintain its primacy in these areas.
    Secretary Martinez proposed that HUD continue to consult with the 
Treasury Department on new activities requested by the GSE's. 
REALTORS' recognize that new programs and products could 
have an impact on safety and soundness considerations. But 
REALTORS' believe that new program approval should remain at 
HUD with the same approval standards in current law. There is 
``substantial expertise,'' as stated by Secretary Martinez in his 
testimony on September 10 before the House Financial Services Committee 
regarding mortgage and housing markets programs. While 
REALTORS' have considerable respect for the financial 
expertise at Treasury, HUD expertise as our Nation's primary housing 
agency should not be relegated to a consultative role on matters of new 
programs approval or lines of business.
    Secretary Snow and Secretary Martinez outlined the Administration's 
principles in subtle terms. Consequently, REALTORS' are 
guarded about the direction of draft legislation that we understand 
will be the starting point for GSE regulatory reform. Significant 
revisions in the GSEs' role in the housing finance system could 
introduce uncertainties and unintended consequences that will have ill 
effects for the GSE's and the housing sector.
Federal Home Loan Banks
    Secretary Snow's recent testimony to this Committee reiterated a 
call to create a credible, single regulator for Fannie Mae, Freddie 
Mac, and the Federal Home Loan Banks. REALTORS' do not have 
position on regulating the Federal Home Loan Banks.
Targeted, Not Sweeping Reform
    REALTORS' firmly believe that targeted reform for the 
GSE regulatory system strengthens our housing finance system. We 
support a narrow bill that institutes safety and soundness regulatory 
reforms, and does no harm to the GSE housing mission, charter, or 
status. Given the fragility of the economy with mixed, weak signals 
about recovery, REALTORS' want to impress on lawmakers that 
safety and soundness concerns should not undermine the housing mission, 
programs and product innovations, or charter status of Fannie Mae and 
Freddie Mac. Targeted reform for the GSE regulatory system strengthens 
our housing finance system. REALTORS' expect that Congress 
will act judiciously to assure a critical role for HUD in GSE mission, 
program development and review. Congress should assure that under new 
regulatory oversight Fannie Mae and Freddie Mac would thrive and 
continue their critical roles in supporting American homeownership. In 
short order, these companies should have the best opportunities to help 
our citizens achieve homeownership.
Conclusion
    We applaud the Committee's efforts to build a more robust GSE 
regulatory structure. The National Association of REALTORS' 
believes that an overarching principle guiding any consideration of 
regulatory reform proposals should assure that reform not become a 
reason or justification for rewriting the GSEs' housing mission or 
weakening the housing finance system.
    Congressional intent and the Nation's homeowners have been well-
served since 1992 when the GSEs' charter, mission, and status were 
reaffirmed. What is needed is a strong, rigorous safety and soundness 
regulator, while HUD retains mission and new program oversight.
    The National Association of REALTORS' looks forward to 
reviewing the proposed legislation to reinvigorate GSE regulation. 
REALTORS' want to work with Congress to continue addressing 
housing and homeownership issues and supporting the mission and charter 
objectives of the housing GSE's.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                    FROM ARMANDO FALCON, JR.

Q.1. In your written statement, you proposed that any new 
regulator be given ``full discretion in setting capital 
standards.'' For the record, what is the value of having both a 
minimum capital standard and a risk-based capital standard? 
That is, what purpose does each standard serve?

A.1. Capital standards are designed to ensure that regulated 
institutions can survive periods of significant misfortune 
involving sizeable financial losses. In theory, a single 
standard that encompassed all relevant considerations would 
suffice to determine capital adequacy. In practice, that would 
be very difficult, and Congress has wisely required OFHEO and 
all depository institution regulators to implement both a 
leverage-based standard and a more finely tuned risk-based 
standard.
    Evaluation of capital adequacy entails a broad range of 
considerations including not only an institution's current book 
of business; but also the current and prospective risk 
environment, its business strategies and potential changes in 
those strategies, the strength of its customer and supplier 
relationships, the strength of its internal controls, potential 
fragility if the markets in which it buys and sells, the 
structure of those markets and potential changes in the way 
those markets function, the vulnerability of the institution's 
reputation, the systemic importance of the institution, and 
many other factors.
    Issues of practicality constrain the determinants of 
capital requirements to a small subset of these factors. Thus, 
for example, OFHEO's risk-based standard focuses on each 
Enterprise's, current book of business and two possible future 
risk environments. It requires sufficient capital to cover 
losses or current positions in extended, specific adverse' 
circumstances. This is a highly detailed rule that examines 
this aspect of capital adequacy in depth. It is important that 
the Enterprises be able to meet this requirement, but does not 
necessarily imply that capital is adequate. A high degree of 
protection against interest rate and credit risk can reduce the 
risk-based requirement to very low or zero levels, without 
addressing other risks.
    The minimum capital (leverage-based) standard is a fail-
safe mechanism that ensures a substantial amount of capital 
regardless of measured interest rate and credit risks. 
Incorporating all other risks into the risk-based standard 
would be problematic. They generally do not fit well into the 
scenario format because the range of possibilities is 
essentially infinite. Also, the magnitudes of other risks 
generally are not easily quantifiable, but rather are more a 
matter of judgment.
    A separate standard that encompasses these judgments makes 
sense. While it would be possible to add the two requirements 
to make a single rule that would produce an overall requirement 
that would be considerably more volatile than the current 
combination, and might usually be higher than necessary. So 
far, the judgment exercised by Congress in setting the ratios 
used to determine the minimum capital requirements has worked 
satisfactorily. However, institutions and their business 
environments change over time. An expert safety and soundness 
regulator is best able to judge, if and when changes, to a 
leverage-based ratio should be made. Accordingly, Congress 
should give the regulator of Fannie Mae and Freddie Mac the 
same authority it has given depository institution regulators 
to adjust all capital requirements if necessary.

Q.2. The Administration has suggested that the new regulatory 
agency should have more than the powers associated with 
conservatorship. Should one of the GSE's under your watch 
encounter serious financial difficulties, do you believe that 
the existing authority of your agency would be sufficient to 
manage the crisis?

A.2. OFHEO has strong conservatorship authority that it may 
bring to bear should an Enterprise under its jurisdiction 
encounter problems that merit appointment of a conservator. 
This authority, while sufficient to manage a crisis, does not 
provide all the tools a safety and soundness regulator should 
have. OFHEO has supported legislative clarification of its 
authority to support its interpretation of the law. 
Additionally, OFHEO has called for legislative action to 
provide receivership authority that is available to other 
Federal financial regulators. It should be noted that existing 
statutory law permits the charters of the Enterprises only to 
be revoked by Congress, thus receivership would enhance the 
ability to oversee the Enterprises, and assure the markets of a 
full range of remedies available to the safety and soundness 
regulator while preserving Congressional control over charter 
termination.

Q.3. OFHEO and the Finance Board clearly do not have the 
complete arsenal of Prompt Corrective Action tools that the OCC 
and other bank regulators have. In fact, the Finance Board has 
no statutory Prompt Corrective Action authority. Do you believe 
that a new regulator must have the same Prompt Corrective 
Action tools as the bank regulators?

A.3. Yes, and OFHEO has an array of Prompt Corrective Action 
tools. Modeled on bank regulations, the Prompt Corrective 
Action regulations are broad and tied to capital levels. 
However, OFHEO has proposed legislative enhancements that would 
conform OFHEO's statutory authorities even more closely to the 
bank regulators; that is, express authority to act on safety 
and soundness matters.
    It also should be noted that OFHEO has added to its Prompt 
Corrective Action rules a section on prompt supervisory 
response. This section provides an orderly procedure for OFHEO 
to act in cases where capital may not be impaired and provides 
both a description of key situations as well as an order for 
OFHEO actions. Thus, OFHEO has a regulatory structure that 
provides for action before capital levels are reached that 
trigger Prompt Corrective Actions.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 
                    FROM ARMANDO FALCON, JR.

Q.1. In your testimony, you suggested that the current minimum 
capital standard of 2.5 percent is sufficient to ensure the 
safety and soundness of the GSE's. However, you argued the new 
proposed safety and soundness regulator should have absolute 
discretion to change both the risk-based and minimum capital 
requirements, since, as you characterized it, the minimum 
capital standards acts as a ``fail-safe mechanism'' to capture 
risks that allegedly cannot be addressed in the risk-based 
role.
    Please explain in detail why the risk-based capital rule 
cannot address these alleged risks to the safety and soundness 
to the GSE's. If these risks cannot be quantified, on what 
basis would the regulator change the minimum capital 
requirements in order to act as a ``fail-safe mechanism?'' How 
would this basis for changing the minimum capital standard be 
different from the basis for determining the risk-based capital 
rule? Do you believe that it would harm the ability of Fannie 
and Freddie's regulator to perform its oversight functions if 
Congress placed restrictions on its ability to adjust the 
minimum capital standards? Why or why not?

A.1. Capital standards are designed to ensure that regulated 
institutions can survive periods of significant misfortune 
involving sizeable financial losses. In theory, a single 
standard that encompassed all relevant considerations would 
suffice to determine capital adequacy. In practice, that would 
be very difficult and Congress has wisely required OFHEO and 
all depository institution regulators to implement both a 
leverage-based standard and a more finely risk-based standard.
    Evaluation of capital adequacy entails a broad range of 
considerations including not only an institution's current book 
of business; but also the current and prospective risk 
environment, its business strategies and potential changes in 
those strategies, the strength of its customer and supplier 
relationships, the strength of its internal controls, potential 
fragility if the markets in which it buys and sells, the 
structure of those markets and potential changes in the way 
those markets function, the vulnerability of the institution's 
reputation, the systemic importance of the institution, and 
many other factors.
    Issues of practicality constrain the determinants of 
capital requirements to a small subset of these factors. Thus, 
for example, OFHEO's risk-based standard focuses on each 
Enterprise's current book of business and two possible future 
risk environments. It requires sufficient capital to cover 
losses or current positions in extended, specific adverse 
circumstances. This is a highly detailed rule that examines 
this aspect of capital adequacy in depth. It is important that 
the Enterprises be able to meet this requirement, but does not 
necessarily imply that capital is adequate. A high degree of 
protection against interest rate and credit risk can reduce the 
risk-based requirement to very low or zero levels without 
addressing other risks.
    The minimum capital (leverage-based) standard is a fail-
safe mechanism that ensures a substantial amount of capital 
regardless of measured interest rate and credit risks. 
Incorporating all other risks into the risk-based standard 
would be problematic. They generally do not fit well into the 
scenario format because the range of possibilities is 
essentially infinite. Also, the magnitudes of other risks 
generally are not easily quantifiable, but rather are more a 
matter of judgment.
    A separate standard that encompasses these judgments makes 
sense. While it would be possible to add the two requirements 
to make a single rule that would produce an overall requirement 
that would be considerably more volatile than the current 
combination, and might usually be higher than necessary. So far 
the judgment exercised by Congress in setting the ratios used 
to determine the minimum capital requirements has worked 
satisfactorily. However, institutions and their business 
environments change over time. An expert safety and soundness 
regulator is best able to judge if and when changes to a 
leverage-based ratio should be made. Accordingly, Congress 
should give the regulator of Fannie Mae and Freddie Mac the 
same authority it has given depository institution regulators 
to adjust all capital requirements if necessary.

Q.2. Do you believe the current separation of regulatory 
authority that gives the power to oversee new GSE programs and 
activities to HUD, and safety and soundness to OFHEO, has 
undermined your ability to oversee the safety and soundness of 
Fannie and Freddie? Why or why not?

A.2. The separate regulatory authority for new program review 
by HUD doesn't undermine OFHEO's safety and soundness 
authority.
    OFHEO has endorsed bringing new program authority into the 
safety and soundness regulator as this is the case with other 
financial regulators. This will also permit the examination and 
on-site expertise of OFHEO to be brought to bear in making 
decisions on new programs and potentially produce fuller and 
quicker review of new programs.
    All of these benefits may occur without any adverse impact 
on housing mission or safety and soundness. Congressional goals 
on Enterprise housing mission are in statute and must be 
followed by the safety and soundness regulator and indeed today 
in applying safety and soundness rules under its jurisdiction. 
OFHEO abides by Congressional housing policy in such areas as 
low- and moderate-income programs undertaken by the 
Enterprises.

Q.3. You testified that while you have been OFHEO Director, HUD 
has never approved (or declined to withhold approval) a new GSE 
program or product that you believed would have undermined 
Fannie and/or Freddie's safety and soundness. In light of this 
history, why do you believe that the authority to approve any 
new GSE programs or products must be included in the oversight 
authority of the GSE safety and soundness regulator? What is 
wrong with the current GSE program and product review system, 
which includes OFHEO in a consultative role?

A.3. HUD has addressed few new program proposals over the years 
since passage of the 1992 Act that required OFHEO to review the 
matters for safety and soundness consideration. Thus, our 
experience is not one of problems with the current situation 
insofar as safety and soundness is concerned, as noted in my 
response to Question #2 above.
    However, OFHEO's ``consultative'' role may create a 
potential conflict should a situation arise where HUD and OFHEO 
have differing views on a particular program. For the reasons 
stated in my response to Question #2, it is my belief that the 
benefits of a new structure are more than sufficient to review 
the existing separation of functions. It would be beneficial, 
as is the case with other financial regulators, to have 
independent authority to review new programs for charter 
compliance.

Q.4. At the July 17, 2003, GSE oversight hearing, you testified 
that OFHEO would conduct a special investigation of the 
accounting practices of Freddie Mac. The report of the 
investigation is now expected to be completed in November. Has 
the investigation provided you with any insights or further 
recommendations about how Congress might improve the oversight 
of the GSE's?

A.4. Yes, the investigation gave the Agency insights into 
additional authority OFHEO needs to be better able to 
accomplish its regulatory goals. These are included in the 
report of our special examination of Freddie Mac.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                    FROM DOUGLAS HOLTZ-EAKIN

Conservatorship/Receivership Authority
    The Administration has proposed that the new regulator have 
all the receivership authority necessary to direct the orderly 
liquidation of assets.
Q.1.a. What difficulties would you see in moving to 
receivership powers akin to those held by the FDIC?

A.1.a. One purpose of receivership is to prevent a failing 
institution from continuing to incur losses after its equity 
capital has been exhausted. In the case of Federally insured 
banks and Government Sponsored Enterprises, the Government has 
a direct interest in preventing failed institutions from taking 
on additional risks in an attempt to win back their losses. 
Another purpose is to transfer the function of the failed 
entity to a new service provider. For the most part, the FDIC 
seems to have adequate authority to ensure an orderly winding 
down of the affairs of a troubled bank without exposing the 
Government to excessive additional risks. I would note, 
however, that the housing GSE's are far larger than the typical 
failed bank and that their greater size may present special 
challenges to a receiver's attempts to limit risk and transfer 
operations to another firm or other firms. But with that 
caveat, the receivership powers of the FDIC would seem to be a 
reasonable starting point.

Q.1.b. What impact would receivership authority have on the 
ability of the GSE's to access the debt markets?

A.1.b. Providing receivership authority to a regulator might 
cause investors in debt securities to consider how they might 
be affected by the exercise of such authority and then to 
monitor the financial condition of the Enterprises more 
carefully. While that increased attention to financial 
fundamentals could reduce the price that investors pay for GSE 
debt, it would not be expected to interfere with access to the 
debt markets by financially sound GSE's.
    For a failed GSE, appropriate receivership authority would 
preclude access to the debt markets, except as necessary to 
ensure an orderly transfer of functions to another financial 
institution.
Office of Finance in the FHLBank System
Q.2. If the regulator for the Federal Home Loan Bank System 
were to be moved into the Treasury Department, should the 
Finance Board's Office of Finance also be moved, or how would 
you suggest handling the Office of Finance?

A.2. The Office of Finance, even though a part of the Federal 
Housing Finance Board, has no regulatory duty or authority. 
Rather, its role is to fund the lending operations of the Banks 
by issuing and servicing their debt securities as efficiently 
as possible. Given its purpose and function, it would be 
appropriate for the Office of Finance to continue to operate 
privately, outside of Treasury.

        RESPONSE TO A WRITTEN QUESTION OF SENATOR REED 
                    FROM DOUGLAS HOLTZ-EAKIN

Capital Standards
Q.1. In your testimony, you mention that regulators can limit 
GSEs' risk exposure to taxpayers by having the capabilities to 
adjust capital requirements and other tools. Currently, the GSE 
safety and soundness regulator can adjust the risk-based 
capital standard. Why does the minimum capital standard need to 
be changed in addition to the regulator being able to change 
the risk-based capital standard? Please explain in detail.

A.1. The risk-based capital standard is based on a complex 
computer-based effort to model the risk assumed by the GSE's. 
The minimum capital standard, by contrast, is intended to 
provide a margin of safety against unquantifiable risks, 
including systemic risks, and against errors and failures in 
the risk-based capital stress test. Indeed, the regulator who 
is responsible for setting the risk-based capital standard may 
be uniquely positioned to appreciate the limitations of that 
standard.
    Both standards could be useful in providing a measure of 
protection for taxpayers against the adverse consequences of 
assumed risk. Thus, I see no reason to restrict the authority 
of the safety and soundness regulator to setting capital 
standards based solely on quantified risks.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                      FROM DALE J. TORPEY

Oversight of the FHLB Housing Programs
Q.1.a. Your testimony addressed HUD's mission control for 
Fannie Mae and Freddie Mac. HUD, however, does not oversee the 
housing mission or affordable housing programs of the Federal 
Home Loan Banks. Do you believe that the Federal Home Loan 
Banks' affordable housing mission needs to be changed?

A.1.a. ICBA believes that the Federal Home Loan Banks have 
performed extremely well in accomplishing their affordable 
housing mission. According to the FHLBanks' Office of Finance, 
during 2002, the FHLBanks contributed some $286 million to the 
Affordable Housing Program. Since the program's inception in 
1990, the FHLBanks have awarded over $1.7 billion in AHP 
subsidies helping to create nearly 359,000 housing units for 
low-income families. ICBA does not see any need to make changes 
to this program.

Q.1.b. If a single regulator for the GSE's is created, should 
the FHLBanks' housing mission be treated differently than that 
of Freddie Mac and Fannie Mae?

A.1.b. Congress established different ways for the FHLBanks to 
fulfill their housing mission compared to those established for 
Fannie Mae and Freddie Mac. Congress gave Fannie Mae and 
Freddie Mac goals for the purchase of mortgage loans for 
certain geographic areas and for certain consumers based on 
income levels. These goals are consistent with the secondary 
market function of Fannie Mae and Freddie Mac. Congress, 
however, created a very different program, the Affordable 
Housing Program, for the FHLBanks. This program funnels a 
specified portion of the FHLBs' net income to their members so 
they in turn can help their customers qualify for affordable 
housing loans. ICBA sees the difference in these programs as 
complementing the differences in the function, operation and 
structure of the FHLBanks that serve primarily as a source of 
funding to their members, versus the secondary market function 
of Fannie Mae and Freddie Mac.
Prompt Corrective Action
Q.2. OFHEO and the Finance Board clearly do not have the 
complete arsenal of Prompt Corrective Action tools that the OCC 
and other bank regulators have. In fact, the Finance Board has 
no statutory Prompt Corrective Action authority. Do you believe 
that a new regulator must have the same Prompt Corrective 
Action tools as the bank regulators?

A.2. We believe that the GSE's should have strong regulatory 
oversight. ICBA has not yet concluded its analysis of the 
differences in regulatory powers of OFHEO and the Finance Board 
as compared to those of the bank regulators, and we have not 
yet determined if the GSE regulators should have the exact same 
powers as those of the bank regulators.
Program Approval Authority
Q.3. Do you believe that moving prior program approval from HUD 
to a new safety and soundness regulator would have any adverse 
impacts on the GSEs' housing mission?

A.3. ICBA testified that for the housing GSE's to continue to 
be innovative in the development and implementation of new 
products to meet the demands of the marketplace, there should 
be a smooth and seamless process for getting these products 
online. As we stated, if a FHLBank, Fannie Mae, or Freddie Mac 
develops a program that is inconsistent with safety and 
soundness or with their Congressionally mandated mission, there 
must be a review process to make that determination. We 
continue to believe that there should not be disincentives for 
the GSE's to be innovative and adaptive to new market 
conditions. Our housing finance system has evolved rapidly over 
the recent past due to changing technology and changes in the 
demands of consumers. The housing GSE's must have the 
flexibility to develop the housing finance products needed by 
consumers in a timely manner and not have new products, 
programs, and activities be bogged down by bureaucracy. Because 
of its responsibilities and expertise, we prefer that prior 
program review for Fannie Mae and Freddie Mac remain in the 
hands of HUD. We would also reiterate our strong concern that 
given the Treasury Department's existing tax and fiscal policy 
responsibilities, moving authority for housing policy to 
Treasury would likely present clear conflicts of interest. 
Also, as we testified, we share the concerns expressed by 
others regarding the historical absence of housing expertise at 
Treasury.
Capital Standards
Q.4. Could giving the GSE regulator, be it the current 
regulator or a new regulator, greater discretion over minimum 
capital standards have any adverse consequences on the mortgage 
market?

A.4. Congress has established the minimum capital standards for 
Fannie Mae and Freddie Mac, and the equivalent for the 
FHLBanks, while giving their regulators the responsibility to 
set risk-based capital standards. As ICBA testified, this 
should continue to be the case. Market factors and potential 
risks can change rapidly and it is appropriate for a regulator 
to have the ability to adjust risk-based capital standards and 
risk factors through the regulatory process. Congress should 
retain the authority to modify statutory or minimum capital or 
leverage standards as these standards can affect the amount of 
capital flowing to the housing sector.

        RESPONSE TO A WRITTEN QUESTION OF SENATOR HAGEL 
                      FROM DALE J. TORPEY

Minimum Capital
Q.1. In your written testimony, you state that ICBA supports a 
``politically independent,'' ``world-class'' regulator like the 
OCC and the OTS. However, you object to that new regulator 
having authority to adjust minimum capital, a power which is 
granted to the OCC and the OTS. Shouldn't a truly world-class 
regulator, like our Nation's bank regulators, have the 
authority to adjust minimum capital?

A.1. When Congress wrote legislation governing the housing 
GSE's, it set the minimum capital standards for Fannie Mae and 
Freddie Mac and the minimum leverage ratio for the FHLB's, and 
also gave guidance for their regulators to establish risk-based 
capital ratios. We believe this has worked well so far and see 
no reason for change. ICBA has been concerned that a 
politically influenced regulator would use the minimum capital 
or leverage standards as a way to increase or decrease the 
capital flowing to the housing sector for political reasons 
rather than to control risk. If regulators see that the risks 
facing the GSE's warrant increases in capital, they have the 
ability to require higher levels based on a methodical, risk-
measurement process. If warranted, regulators are able to set 
risk-based capital standards so that the entities hold more 
capital than would be required by minimum capital or leverage 
standards.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 
                      FROM DALE J. TORPEY

Regulatory Restructuring
Q.1. In your testimony, you argue that ``the FHLB's should 
continue to be regulated by a separate and independent agency'' 
and that the ``ICBA Board (has) voted unanimously to oppose 
including the FHLB's in any proposed new supervisory and 
regulatory structure for Fannie Mae and Freddie Mac in the U.S. 
Treasury Department.'' However, you also state that ``the ICBA 
may not oppose the concept of a new independent regulator for 
all . . . housing GSE's outside the Treasury Department.'' How 
could GSE regulatory reform legislation be drafted to address 
the differences between Fannie and Freddie and the FHLB's but 
remain consistent enough so as to establish a level playing 
field between the housing GSE's? Do you have any specific 
recommendations?

A.1. ICBA has only started to look at this very complex issue. 
We see many differences between the FHLB's and the other two 
housing GSE's and we have begun to identify them. For example, 
ICBA members place a great value on the regional structure of 
the FHLB System and would not want to see legislation that 
pushes the System toward consolidation so that its structure 
looks more like Fannie Mae's and Freddie Mac's for the ease of 
regulation and oversight. The FHLB System is a cooperative and 
its member users should continue to be eligible to hold seats 
on FHLB boards of directors. Yet, it is probably not 
appropriate for Congress to set aside a number of seats on the 
boards of public companies Fannie Mae and Freddie Mac for their 
seller/servicers. One idea that has already received some level 
of public discourse is the creation of a single, independent 
regulator for all three housing GSE's--but which would have two 
separate divisions, one for Fannie Mae and Freddie Mac, and the 
other for the FHLBanks. ICBA continues to study this and other 
ideas.
Cost of Funds
Q.2. Do you believe that if the FHLB System were not regulated 
by the proposed new regulating entity the cost of capital for 
the banks, relative to Fannie and Freddie, would eventually 
increase? Why or why not?

A.2. We do not believe that cost of funds will be materially 
impacted by who the regulator is. Fannie/Freddie and the FHLB's 
have long had different regulators and this has not been an 
issue. More important to the capital markets is whether or not 
GSE status remains intact, and other factors that might affect 
the bond ratings of the individual GSE's.

        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 
                      FROM ROBERT M. COUCH

Program Approval Authority
Q.1. Do you believe that moving prior program approval from HUD 
to a new safety and soundness regulator would have any adverse 
impacts on the GSEs' housing mission?

A.1. Moving prior program approval from HUD to a new safety and 
soundness regulator would strengthen the GSEs' housing mission. 
The GSE's are committed to their housing mission. Moving 
regulatory oversight of their programs will not change their 
commitment at all. It would merely ensure that they carry out 
their mission safely and soundly, something everyone supports.
    There is no question that the GSE's must operate their 
programs safely and soundly--they would fail in their housing 
mission otherwise, and that would be unacceptable to all. 
Safety and soundness is the core foundation upon which the 
entire GSE housing mission rests. GSE programs must be safe and 
sound for the very purpose of maintaining that core foundation.
    Some parties have expressed concern that safety and 
soundness review or oversight of GSE programs would interfere 
with the GSEs' housing mission. These parties are concerned 
that a safety and soundness regulator, such as an agency under 
the Treasury Department, would not be sufficiently concerned 
about the GSEs' housing mission. MBA does not share this view.
    In fact, we believe that Treasury has demonstrated 
repeatedly an ability to oversee program approval reviews 
without any adverse impact on housing. Treasury oversees all 
national banks and Federal thrifts in the country. The thrift 
industry, in particular, is a major participant in the housing 
industry, and the Treasury has successfully regulated thrifts 
since 1989. Treasury oversees new activities for thrifts, 
without any adverse affects on the housing industry, and with 
no interference with thrifts' ability to innovate and stay 
competitive. Further, Treasury's responsibilities include 
administering the Community Redevelopment Act for both banks 
and thrifts, ensuring that lending resources are available in 
communities.
Capital Standards
Q.2. Could giving the GSE regulator, be it the current 
regulator or a new regulator, greater discretion over minimum 
capital standards have any adverse consequences on the mortgage 
market?

A.2. A financial regulator needs appropriate discretion to 
carry out its duties--ensuring adequate capital standards is 
typically a core component of that role.
    Today, OFHEO has no discretion in setting minimum capital 
standards. The minimum capital requirement is set entirely by a 
statute enacted in 1992, and cannot change as the marketplace 
changes or as the GSE's change. Even in the case of a 
financially distressed GSE or of a market crisis, OFHEO has no 
authority to alter the minimum capital requirement.
    MBA believes that the GSE regulator should have the 
necessary discretion to determine appropriate capital 
requirements, commensurate with the goal of ensuring financial 
safety and soundness and prudent risk management. Fannie Mae 
and Freddie Mac today appear to be well-capitalized, so no 
imminent change is foreseeable. Ultimately, the mortgage market 
benefits if the regulator is empowered to act to prevent a 
crisis, rather than just respond to one.

        RESPONSE TO A WRITTEN QUESTION OF SENATOR HAGEL 
                      FROM ROBERT M. COUCH

Q.1. MBA has published an issue paper in which you suggest 
standards for determining when a GSE activity is outside the 
boundaries of the secondary mortgage market. Can you summarize 
this document for us, and do you think we should use it as a 
guideline for the regulator in evaluating Fannie and Freddie's 
programs, products, and activities?

A.1. MBA published an issue paper in 2001 entitled Defining the 
Boundaries of GSE Activity, available on our website at 
(control-click this link): http://www.mortgagebankers.org/ 
library/isp/2003_4/03-03.pdf. Below is a summary of the issue 
paper, followed by an answer to your question about it.
    This issue paper arose out of concern on the part of many 
MBA member mortgage lenders that Fannie Mae and Freddie Mac 
have begun to insert themselves into the primary mortgage 
market. The issue paper describes the important role the GSE's 
play in the secondary mortgage market, and compares and 
contrasts that to the role of the originating mortgage lenders 
in the primary mortgage market. Congress created Fannie Mae and 
Freddie Mac to provide liquidity in the secondary mortgage 
market. The GSE's work together with primary mortgage market 
lenders to provide the American public with our highly 
successful residential mortgage market.
    The GSE's enjoy legal and financial benefits of Government 
sponsorship, designed to ensure the GSE's provide secondary 
market stability and liquidity. If the GSE's were to use their 
Government sponsored competitive benefits to expand their 
activities into the primary market, their competitive advantage 
could permit them to dominate the primary market. Consumers 
would be the ultimate losers. Primary market domination backed 
by competitive advantages would stifle competition, raise 
mortgage prices, and limit consumers' financing options.
    Many believe that the GSE's have been moving into the 
primary mortgage market. They have, for example, acquired 
interests in a range of nonlender primary market participants, 
begun advertising heavily directly to consumers (who do not 
participate in the secondary market), and they have worked to 
increase their market share by enforcing loan delivery 
standards that favor their proprietary technologies for primary 
market activities, to the detriment and demise of private 
market technology providers.
    Current law is vague, leaving the GSE's vulnerable to 
criticism that the existing regulatory system is unable to 
provide adequate oversight of the GSEs' mission and programs. 
Current law prohibits both GSE's from mortgage loan 
origination, but does not 
define loan origination. The issue paper provides a detailed 
description of the differences between the primary and 
secondary markets. In brief, primary market participants work 
directly with consumers. The secondary market is investment-
related, involving a mortgage loan after it has been 
originated, and there is no consumer contact in the secondary 
market.
    The GSE charters were established decades ago. More 
recently, in 1992, Congress required the GSE's to meet 
affordable housing goals. Congress did not thereby alter the 
scope of the GSEs' mission and did not intend a wholesale 
rewrite of their charters. A link between meeting a housing 
goal and an otherwise-impermissible GSE activity does not 
justify GSE entry into the primary market. Every GSE initiative 
must promote liquidity in the secondary mortgage market.
    The issue paper further sets out standards and criteria for 
distinguishing between the primary and secondary markets. 
Generally, if an activity involves contact with borrowers or 
potential borrowers, or their agents or representatives, it is 
a primary market activity and is impermissible to the GSE's.
    MBA believes this issue paper would provide very useful 
guidance to Congress in considering Fannie Mae's and Freddie 
Mac's activities. MBA members are the lenders who originate the 
loans that Fannie Mae and Freddie Mac buy and guarantee. Our 
members have direct, hands-on experience working with the 
GSE's--that is what our members do every day. Further, MBA 
established this issue paper by convening a blue ribbon panel 
of industry leaders from among our members. The panel 
extensively analyzed and reviewed the spectrum of GSE 
activities and the primary mortgage market. The panel solicited 
and received extensive comment from both Fannie Mae and Freddie 
Mac in preparing this issue paper. The resulting issue paper is 
an expert, detailed, analysis of the distinctions between the 
primary and secondary markets, and an approach for determining 
whether particular activities are beyond the boundaries of the 
secondary market.
    It is important for Congress to address the boundaries of 
the secondary market. Currently, there are no clear boundaries, 
and the GSE's have been taking advantage of that lack of 
clarity to the detriment of the primary market. No regulator 
currently has the authority or capacity to address the problem, 
so it persists. MBA very strongly urges Congress to draw, and 
equip a regulator to enforce, very clear boundaries of GSE 
activity in the secondary mortgage market.







                        PROPOSALS FOR IMPROVING

                        THE REGULATORY REGIME OF

                    GOVERNMENT SPONSORED ENTERPRISES

                              ----------                              


                       TUESDAY, FEBRUARY 10, 2004

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:01 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order.
    This morning, the Committee meets to hold our third hearing 
on proposals to improve the regulation of Government Sponsored 
Enterprises. The intention of these hearings is to build a 
solid record as the Committee continues to pursue legislation 
to establish a strong and credible regulator for the GSE's.
    I would like to welcome Comptroller General David Walker 
from the General Accounting Office as our first witness this 
morning. Mr. Walker became the seventh Comptroller General of 
the United States and began his 15-year term when he took his 
oath of office on November 9, 1998. During Mr. Walker's tenure, 
the GAO has completed a number of important studies on the 
topic of GSE's. We are fortunate to have this body of work to 
draw from as we consider regulatory reform, and we look forward 
to discussing the broad array of issues with you today, Mr. 
Walker.
    Our second panel includes three witnesses: Mr. Alan Beller, 
Director of the Division of Corporate Finance and Senior 
Counselor to the Securities and Exchange Commission; Professor 
Richard Carnell, Associate Professor of Law at Fordham Law 
School; and Mr. James R. Rayburn, President of the National 
Association of Home Builders. These witnesses have 
distinguished professional backgrounds which will enable them 
to provide this Committee with sound insights on particular 
aspects of GSE regulation. Mr. Beller, the Committee will 
benefit from your expertise in the area of corporate financial 
disclosure as we consider how to improve transparency and 
ensure meaningful GSE financial disclosures.
    Mr. Carnell is a former Assistant Secretary for Financial 
Institutions at the Department of the Treasury and also a 
former Senior Counsel to this Committee. We will be 
particularly interested in your insights as to how to give a 
new GSE regulator the same stature and credibility as our bank 
regulators. Finally, Mr. Rayburn will provide us with some 
insights on any impact that GSE regulatory reform will have on 
our Nation's housing markets.
    Comprehensive regulatory reform deserves careful 
consideration, and this Committee will work very diligently to 
craft an appropriate reform package. The GSE's play a vital 
role in expanding homeownership, and I strongly support their 
mission. However, the Congress cannot sit idly by after the 
events of last year. It is our duty to maintain the continued 
strength of the U.S. home mortgage market. But we must also put 
in place, I believe, a GSE regulator that has the necessary 
independence, strength, and credibility to carry out its 
mandate. That mandate is to ensure that all the housing GSE's 
fulfill their public mission in a safe and sound manner. In 
order to create an improved regulatory structure, I believe we 
must have a full and open debate on a variety of issues, such 
as the structure of the regulator, authority for the program 
review, and capital requirements. These are not easy questions 
to resolve, but I am confident that this Committee can reach a 
consensus on these issues.
    I want to thank all the witnesses for appearing before the 
Committee today. We look forward to hearing your testimony and 
the discussion to follow.
    Mr. Walker, your written statement will be made part of the 
record--Jack, do you have an opening statement?

                  COMMENT OF SENATOR JACK REED

    Senator Reed. No, sir, I do not. I would just like to thank 
you for holding this important hearing and the witnesses for 
being here today.
    Chairman Shelby. Senator Sununu.

               COMMENT OF SENATOR JOHN E. SUNUNU

    Senator Sununu. No, Mr. Chairman. I just want to echo the 
remarks of my collegue.
    Chairman Shelby. Okay. Your written statement will be made 
part of the record in its entirety. You proceed as you wish.

                  STATEMENT OF DAVID M. WALKER

              COMPTROLLER GENERAL, ACCOMPANIED BY

                 TOM McCOOL, MANAGING DIRECTOR

          FINANCIAL MARKETS AND COMMUNITY INVESTMENTS

                 U.S. GENERAL ACCOUNTING OFFICE

    Mr. Walker. Thank you, Mr. Chairman and Senators. It is a 
pleasure to be here to talk to you today about oversight of 
Government Sponsored Enterprises. As you know, Government 
Sponsored Enterprises had combined obligations, including 
mortgage-backed securities and other debt obligations, of $4.4 
trillion as of September 30, 2003. In my view, our past 
experience in the savings and loan industry, the recent 
accountability breakdowns in the private sector, and the 
importance of gaining public trust and confidence in regulatory 
agencies that oversee our financial institutions and capital 
markets, these factors are directly relevant to the ongoing 
debate and appropriate regulatory oversight of GSE's.
    In our view, in order to ensure that GSE's operate in a 
safe and sound manner, it is essential that effective 
governance, reasonable transparency, and effective oversight 
systems are established and maintained. In particular, we 
believe the GSE's should lead by example in the area of 
corporate governance. The GSE regulators must be strong, 
independent, and have the necessary expertise in order to do 
their jobs, and GSE mission definitions and benefit measures 
need to be clearly established.
    However, our work has also found that GSE governance does 
not always reflect best practices, and some of these other 
areas require attention at this time as well. Furthermore, the 
regulatory structure for housing GSE's is fragmented, and 
serious questions exist as to the capacity of GSE regulators to 
effectively fulfill their responsibilities.
    To prevent the need for the Federal Government to ever have 
to provide financial support to a GSE and to minimize the 
financial risk of instability, it is critical to ensure that 
proper corporate governance, reasonable transparency, and 
effective oversight mechanisms are in place. Not only should 
GSE's be sensitive to good governance, but it is also all the 
more important that they lead by example in connection with 
accountability, integrity, and public trust issues.
    A regulatory system of GSE oversight must have the 
necessary strength, independence, and capability to protect 
against the significant risk and potential cost to taxpayers 
posed by the GSE's. We have consistently supported, and 
continue to believe in, the need for the creation of a single 
regulator to oversee both safety and soundness and mission 
issues associated with the housing GSE's. A single regulator 
could be more independent and objective than separate 
regulatory bodies and could be more prominent than any one 
alone. Further, a single regulator would be better positioned 
to consider potential trade-offs between mission requirements 
and safety and soundness considerations because such a 
regulator would develop a fuller understanding of the 
operations of these large and complex financial institutions.
    To be effective, the single regulator must have all the 
regulatory powers, enforcement authorities, technical 
expertise, and technological capabilities necessary to oversee 
GSE operations and compliance with their missions. In this 
regard, we believe that a hybrid executive director and 
coordinating board model, possibly similar to the one 
applicable to the Pension Benefit Guaranty Corporation, should 
be considered by the Congress.
    Irrespective of the regulatory model, without clearly 
defined measures of the GSE's benefits, it is not possible for 
Congress, accountability organizations, and the public to 
determine whether the Federal Government should be potentially 
subject to the financial risk associated with GSE activity. In 
some cases, there is a lack of measurable mission-oriented 
criteria that would allow for meaningful assessment of GSEs' 
mission achievement or whether the GSEs' activities are 
consistent with their public interest charters. In some cases, 
it is clear GSE's have contributed to their public missions for 
which they were initially created. In this regard, it is 
generally agreed that Fannie Mae and Freddie Mac's mortgage 
purchase activities have lowered the interest rates on 
qualifying mortgages below what they otherwise would have been.
    At the same time, additional studies may be necessary to 
more precisely estimate the extent to which GSE activities have 
benefited certain homebuyers, especially those who can least 
afford a home.
    In this and other areas, there is substantially greater 
uncertainty regarding the benefits of GSE activities, both 
individually, collectively, and as compared to private non-GSE 
lenders. As a result, more research is needed to clarify these 
issues.
    Additionally, the lines that initially existed between 
Fannie Mae and Freddie Mac, on the one hand, and the Federal 
Home Loan Bank System, on the other hand, have blurred over the 
years. This can lead to legitimate questions regarding how many 
GSE's do we need to get the job done. In some cases, the 
absence of specific criteria and guidance complicates the 
efforts to assess the need for and the benefits of GSE's.
    Finally, I would like to also point out that there are 
other limitations in the evidence and research on benefits 
provided by GSE activities. There is limited information as to 
the extent to which the Federal Home Loan Bank System's more 
than $500 billion in outstanding advances as of mid-2003 have 
facilitated mortgage activity. There is limited information 
available on the extent to which Fannie Mae and Freddie Mac's 
investments in nonmortgage assets, such as long-term corporate 
bonds, serve their public missions. And there is virtually no 
evidence available as to whether Farmer Mac's activities have 
benefited agricultural real estate markets.
    Without quantifiable measures and reliable data, Congress 
and the public cannot judge the effectiveness of GSE's in 
meeting their missions or whether the benefits provided by 
these entities are in the public interest and outweigh the 
potential financial risk.
    To improve the quality of information about GSE activities, 
we believe that the GSE's should have a single regulator 
dealing with safety and soundness and mission activities, and 
that additional research is necessary with regard to some of 
the items that I have noted in my statement.
    Mr. Chairman, that would conclude my opening statement. I 
would be more than happy to answer any questions that you and 
the other Senators may have.
    Chairman Shelby. Mr. Walker, the discussion, among other 
things, on the structure of a new GSE regulator has focused on 
two models: an independent bureau of the Treasury, like the 
OCC, for example, or a stand-alone independent agency, like the 
SEC or the FDIC or others.
    If the Congress chose to adopt the independent agency 
structure, how do we ensure that this regulator has sufficient 
stature and credibility to provide strong oversight of the 
GSE's?
    Mr. Walker. Well, obviously, the structure can be 
important. One has to ascertain what are the proper 
qualifications for a person who would end up leading and 
overseeing this entity whether or not they should be 
Presidential appointee with Senate confirmation, what type of 
authorities they should have, including from a regulatory 
standpoint and an enforcement standpoint. So, I think those are 
the substantive issues that one would have to look at.
    Mr. Chairman, I know there has been some controversy 
regarding the issue of whether or not to combine the safety and 
soundness mission issues. I think whether you go with an 
independent agency or whether you go with an entity within an 
existing department or agency, like the Treasury Department, it 
might merit considering having an executive director model with 
a coordinating board.
    Chairman Shelby. A board with prestige, right?
    Mr. Walker. Yes, a board with prestige. For example, you 
could have the Secretary of the Treasury, the Secretary of HUD, 
and other appropriate parties----
    Chairman Shelby. The Fed, the Chairman of the Fed.
    Mr. Walker. Potentially.
    Chairman Shelby. SEC Chairman, maybe.
    Mr. Walker. Potentially. But the idea is that, to the 
extent that you want to make sure that there are responsible 
authorities, knowledgeable parties who are concerned with and 
interested in safety, soundness, and mission, and who could 
help to make sure that all those issues were considered.
    Chairman Shelby. Could you describe some of the problems of 
Fannie Mae and the Farm Credit System during the 1980's, their 
underlying causes and the nature of the Government's 
assistance?
    Mr. Walker. I might get a little bit of help on that since 
that is before my time, Mr. Chairman, if you do not mind. This 
is Tom McCool, who is the Managing Director of our Financial 
Markets and Community Investment, with your indulgence.
    Mr. McCool. Mr. Chairman, yes, well, Fannie Mae was given 
forbearance. Fannie Mae was not actually given direct 
assistance, but they were in trouble and they were given 
forbearance from a capital and tax perspective. My 
understanding or my recollection is--it was actually before my 
time as well--that the Farm Credit System was actually given 
assistance as part of a bailout, and then it was also 
reengineered to hopefully be a more independent--the Farm 
Credit Administration was reengineered to be a more effective 
agency and a more stand-alone, arm's-length regulator.
    Chairman Shelby. Mr. Walker, your written testimony notes 
that OFHEO cannot place Fannie Mae or Freddie Mac into 
receivership. They can go in as a conservator, as I understand, 
which is different.
    Based on your analysis, do you believe that the existing 
statute authorizing the appointment of a conservator gives the 
regulator sufficient authority to resolve a troubled GSE?
    Mr. Walker. Based upon the past experience with the savings 
and loan industry, et cetera, we believe that consideration 
should be given to expand that beyond just a conservator, and 
in some usual circumstances to allow for receivership. That is 
not something that one would expect to happen. I would hope 
that it would not happen. But, on the other hand, we believe it 
is something that needs to be in the toolbox of the regulator.
    Obviously, that is something where it would be necessary to 
prescribe some type of guidance as to when and under what 
circumstances receivership would be used.
    Chairman Shelby. But you have to be ready for it.
    Mr. Walker. Correct. It should be in the toolbox, in our 
view, Mr. Chairman.
    Chairman Shelby. Would resolution procedures along the 
lines of those held by FDIC to form bridge banks or to deal 
with systemic risk issues also be advisable for a GSE 
regulator?
    Mr. Walker. We believe it is important for you to look at 
what types of authorities and tools other entities have, such 
as this, and really the question in our view would be: Why 
shouldn't they have it? In other words, the presumption would 
be that they should have these tools----
    Chairman Shelby. If you are going to have a regulator, you 
need a regulator. Is that correct?
    Mr. Walker. Right.
    Chairman Shelby. The last question I am going to touch on--
we have a lot of other people here--is the impact of earnings 
per share as a corporate goal. Doesn't every public company 
focus on earnings per share?
    Mr. Walker. They clearly do, Mr. Chairman.
    Chairman Shelby. Does this attention to earnings per share 
measurements impact the holdings in the GSE portfolios, in your 
judgment?
    Mr. Walker. It can. As you know, there are certain holdings 
that can enhance value and potentially moderate risk, and such 
investments have the potential to do that. And I believe, Mr. 
Chairman, that one of the challenges that we have, not just 
with GSE's but in corporate America, is too much focus on 
short-term earnings rather than earnings over the longer-term, 
along with sustainable earnings, and quality earnings.
    Chairman Shelby. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Thank you, Mr. Walker, for your testimony.
    Back in 1997, the GAO issued a report, ``Advantages and 
Disadvantages of Creating a Single Housing GSE Regulator.'' It 
rolls right off the tongue, a very good title. ``Our analysis 
of different regulatory structures indicate that an 
independent, arm's-length, stand-alone regulatory body headed 
by a board would best fit our criteria for effective regulatory 
agencies.'' Is that still your position today?
    Mr. Walker. We do believe there needs to be a single 
regulator to address safety, soundness, and mission 
considerations. I have now offered a possible hybrid model that 
we did not put forward in 1997 that I think the Congress should 
consider, an executive director but possibly a coordinating 
board involved with appropriate individuals to be able to help 
make sure that there is effective coordination of mission, 
safety, and soundness considerations.
    Senator Reed. What has changed since 1997 that would prompt 
this hybrid proposal?
    Mr. Walker. David M. Walker has become Comptroller General 
of the United States and has prior experience in dealing with 
entities that had these types of structures. It has worked 
pretty well. For example--and, by the way, the financial 
condition of the entity that I am going to talk about is not a 
model that we want to follow, but the Pension Benefit Guaranty 
Corporation has an executive director and has a board of 
directors comprised of the Secretary of Labor, the Secretary of 
Treasury, and the Secretary of Commerce. One of the reasons 
that that model was chosen was to be able to provide the 
executive director with the responsibility and authority to run 
this independent agency in a way to protect the public interest 
and to serve the mission purpose of the agency, at the same 
point in time recognizing that each of those three Cabinet-
level Departments had an interest in the activities of the PBGC 
and the board served as a mechanism for them to periodically be 
able to convene and discuss issues of major public 
significance.
    It is not an activist board, but it is a mechanism that 
worked fairly well during my tenure and helped to deal with 
major public policy concerns.
    Senator Reed. Well, I must confess, one of the concerns I 
have is the notion of independence, and when you have Cabinet 
Secretaries who are effectively the board of directors, they 
are subject--and regardless of the Administration--to the 
current winds that are blowing through this town. And that to 
me is not something that is going to reassure the investing 
public and the markets that the decisions are being made on an 
independent basis based upon the financial conditions of the 
housing market in this case.
    You know, I think with that model you run the risk--and I 
will not even get into the financial condition of the Pension 
Benefit Guaranty Corporation--of conditions which, if not 
realistically problems, appear to be problems to people.
    Mr. Walker. Senator, I would respectfully suggest that one 
might want to look at who would be the appropriate members of 
the board. In my personal opinion, clearly you would want to 
have the Secretary of the Treasury and the Secretary of Housing 
and Urban Development. But you may want other individuals, such 
as the ones the Chairman suggested, to be involved who tend to 
be somewhat more independent and/or have term appointments that 
could help provide that check and balance.
    Chairman Shelby. It also would bring prestige to this 
board, would they not?
    Mr. Walker. Yes, Mr. Chairman, depending upon what 
positions and who the parties are, it could.
    Senator Reed. Well, again, a contrary view might be that 
some of our boards work very well because they have a term, 
they are removed from the day-to-day politics, the individuals 
have been in several administrations. Again, I think we should 
be very, very sensitive to the notion of independence because 
of the signals it will send to the marketplace.
    Let me ask something else, too. There is the notion with 
these GSE's that there is an implicit subsidy to their 
activities because of their perceived benefit of not failing, 
we will step in. What is your view on that?
    Mr. Walker. Well, various studies have been conducted over 
time that speak of this implicit subsidy, one recently 
conducted by the staff of the Federal Reserve Board. I think 
there is a general view that some people presume that if there 
was a failure at one of these institutions, the Federal 
Government would step in.
    As you know, the Federal Government is not obligated to 
step in. There are no appropriated funds involved at the 
present point in time. But quite frankly the Federal Government 
is not obligated to step in for the Pension Benefit Guaranty 
Corporation either. Nonetheless, perceptions of this----
    Chairman Shelby. Or large banks.
    Senator Reed. Or large banks.
    Mr. Walker. Or large banks. Nonetheless, there is a broad-
based market perception that the Federal Government stands 
behind this entity, and that clearly has an impact.
    Senator Reed. I think your comments are useful because this 
perception is not exclusive to Fannie Mae and Freddie Mac. As 
the Chairman points out, I think most people in the market 
would assume we would not let our largest or second largest 
bank fail because of the consequences.
    Mr. Walker. That is correct. There are other important 
entities where the Government would be presumed to step in. 
Whether or not that will occur one can debate.
    Senator Reed. Thank you, Mr. Walker.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Walker, if we were to proceed with legislation that 
would establish a new independent regulator for both Fannie and 
Freddie and the Federal Home Loan Banks, it seems to me that 
one area of obvious difference is the statutory capital 
structure for the GSE's. Do you have any insight that you could 
share with us with regard to how we might contend with that 
difference in the legislation that would be developed?
    Mr. Walker. Tom, I would ask if you have any thoughts on 
that based on our past work.
    Mr. McCool. I think that, again, it is different to have a 
capital framework written in statute. If you look at OFHEO's 
capital statute versus the Finance Board or the bank 
regulators, OFHEO has the one that is written in statute. I 
think that our view would be that Congress can write a capital 
standard and put it in the statute, but it would be useful to 
give the regulator some ability to have the flexibility to go 
above that minimum in cases where either new risks arise or new 
situations arise that were not foreseen by the legislation.
    Senator Crapo. So are you saying that we would have the 
same structure for all entities, or would the new regulator 
have the ability to have different structures?
    Mr. McCool. I believe that, again, the point would be that 
you want a risk-based capital approach that dealt with the 
risks that the entities were undertaking, and whether they are 
Home Loan Banks or Fannie and Freddie, for example, if you 
combine their reuglation, they would all have the same risks 
although not in the same combinations. But you would want the 
same capital to be applied to the same risk.
    Mr. Walker. Senator, I think you may want to have a 
statutory structure or framework. At the same time, I think it 
is important for the regulator, as we note in our testimony, to 
have reasonable flexibility to be able to make judgments about 
what the appropriate capital requirements should be given the 
risk involved. And one would have to assess that issue in 
connection with each of the various entities that they are 
being regulated. So it would be based on the substance or the 
nature of what the relative risk is. If the facts were the 
same, you would get the same answer. But the facts may not be 
the same between these different entities.
    Senator Crapo. So how would we have a statutory capital 
structure but then have the regulatory flexibility? Are you 
saying we would define the capital risk by statute and then 
have the regulator determine how to apply that risk?
    Mr. McCool. Well, actually, let me back up. It may be that 
the best thing to do would be not to have a statutory capital 
structure and to give the regulator criteria for applying 
capital to risk, which, again, is more or less the way it works 
for bank regulators. The bank regulators do not have a 
statutory capital structure, but they are supposed to provide a 
capital structure that is consistent with the risks that the 
institutions undertake. So rather than define broad criteria, 
it might be best to give the regulator flexibility within the 
context of particular activities to define capital in 
accordance with the risk undertaken.
    Senator Crapo. Mr. Walker, do you agree with that?
    Mr. Walker. I do. We are saying the same thing in a 
different way.
    Senator Crapo. All right. Thank you very much.
    Chairman Shelby. Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Mr. Chairman.
    Let me just pursue that question. I want to make sure I 
understand this correctly. You are talking about flexibility 
with regard to the definition of the risk-based capital rules 
that the regulator would provide. Are you distinguished between 
absolute minimum capital requirements and risk-based capital? 
Or are you underscoring the need for flexibility with one or 
both?
    Mr. McCool. Again, currently there is a statutory minimum 
for Fannie and Freddie in terms of their leverage ratios or 
effectively their minimum capital standards. I think that one 
could put in place, again, minimum capital standards in 
legislation that were not necessarily risk based, but the point 
would be you would want to give the regulator the flexibility 
to set risk-based capital standards that were, again, 
consistent with the level of risk undertaken by the entities. 
So that if different entities did similar things, they would 
face similar capital charges. And if they did different things, 
the differences would be reflected in the capital charges.
    Mr. Walker. Senator, a different way of saying it you may 
want to establish the floor, but you may not want to establish 
the ceiling, and make sure that you have criteria such that the 
regulator can apply the facts and circumstances to determine 
what the appropriate capital requirement would be given 
applicable those facts and circumstances.
    Senator Corzine. I think that is actually one of the 
difficult judgments that we are going to have to make, and, you 
know, how do you then figure out what is the appropriate 
minimum capital standard. It is true, though, that banks 
operate off of a risk-based system than these more modern 
regulatory structures that people are trying to appropriate.
    Let me ask, are there any clear or are there any objective 
standards on why one might think that a regulatory agency 
should be in a group of regulatory elements? I heard you talk 
about structure and authorities, but you left out synergies. 
When one would consider the model of it being within the 
Treasury, one might say that having a stand-alone entity does 
not allow for the synergies of staying current with the latest 
financial knowledge base in the same way that you would if you 
were in a broader organization that had a culture of dealing 
with regulation or the common use of software and other 
elements that may be appropriate. You are going to have to 
build a whole bureaucracy that would not otherwise exist.
    Are there objective standards or objective metrics that you 
would use to justify one versus the stand-alone agency that 
might be outside of just the structural issues and authorities 
that you spoke to?
    Mr. Walker. I think there are certain issues, Senator, that 
have to be addressed irrespective of whether you are within a 
particular department or agency like the Treasury or whether 
you are independent. I mean, do you have a critical mass? Do 
you have the right type of skills and knowledge? Do you have 
the right type of authorities? Do you have enough credibility, 
if you will, and capability to get the job done?
    I do, however, believe there is a difference between 
coordination and integration, and if you are an entity that is 
an independent entity within a larger entity, then the odds are 
you are going to end up having more ongoing interaction and 
more questions being asked as to there are opportunities to do 
things in the same way or in a synergistic manner, and there 
could be some incremental benefit that could be achieved.
    But I think the more important issues are the critical 
mass, the capabilities, the credibility, and the authorities. 
Those are the more important issues, I believe.
    Senator Corzine. Did you feel when you looked at OFHEO 
whether it failed in matching up against or at least was weaker 
than it would have otherwise been against those criteria, 
whether structure, critical mass, authorities, and maybe even 
synergies where there might be checks and balances within the 
system?
    Mr. Walker. We believe that there would be a significant 
plus to combine the regulators, to have a single regulator for 
safety, soundness, and mission, and that that regulator needs 
additional authorities above and beyond what authorities that 
OFHEO does not have right now.
    Tom, do you have anything to add?
    Mr. McCool. Again, that part of the issue is that I think 
we believe that having the Federal Home Loan Banks and Fannie 
and Freddie in the same entity, being regulated by this entity 
would create synergies. It would allow you to provide more of a 
career track for examiners. It could grow from more simple home 
loan banks, up through more complicated home loan banks, up to 
Fannie and Freddie, and would allow more cross-matching across 
various types of expertise within, again, a regulator with more 
critical mass.
    Senator Corzine. But coming back to that, you get that 
critical mass by combining the different regulators. Then it is 
a separate issue as to whether or not you get any additional 
synergy--you get synergy that way. You get critical mass and 
synergy that way. Then there is a debate as to whether or not 
you are going to get that much more synergy because it happens 
to be within a department or agency. So the most synergy you 
are going to get is going to be through combining the potential 
regulators into one. You could get some more by having it 
within a department or agency.
    Thank you.
    Chairman Shelby. Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    Mr. Walker, as I understand it, the GAO has studied this 
issue and issued reports in 1991, 1993, and 1997. I might have 
missed one in there. In each of those cases, aside from the 
proposal that you spoke to Senator Reed about regarding the 
board structure and the directors that you have included this 
time, in each of those studies is it correct that the GAO, 
whoever the Comptroller happened to be, has recommended an 
independent regulator that has responsibility for overseeing 
safety and soundness, capital standards, the various business 
activities that these GSE's are involved in and regulating the 
mission? Have all of those things been consistent in all of 
these studies?
    Mr. Walker. Yes, Senator. Those are consistent 
recommendations throughout.
    Senator Sununu. And your recommendation is consistent with 
all of those other studies? It is not just because you are 
afraid to be different, is it?
    Mr. Walker. No. It is consistent, and in fact, we have had 
a number of serious subsequent events that have occurred since 
those reports, both within the public sector and the private 
sector that would lead me to believe it is even more important.
    Senator Sununu. I appreciate that. I am being a little 
facetious given your statements recently about other budgetary 
matters. I do not think anyone can claim you are not someone 
who is unwilling to speak their mind. And I appreciate that. I 
think that is extremely helpful for this Committee to have 
someone that is willing to at least step up on a somewhat 
political issue like this and speak their mind.
    You mentioned receivership and your feeling that some 
provision addressing receivership might be helpful or valuable. 
It is my understanding that this model was used in the S&L 
bailout and restructuring. Did it work reasonably well as a 
mechanism for the S&L crisis?
    Mr. Walker. Based on my experience--and I want to ask for 
Tom to comment because he was at GAO at the time--I believe it 
had mixed results with regard to what happened with the S&L 
situation.
    Mr. McCool. Right. But I think a lot of it had to do with 
when receivership was imposed as much as whether it was 
receivership versus conservatorship. I think what part of the 
issue has been, and to some extent still is, is the question of 
when you close down an institution. I think once you decide to 
close down an institution, receivership has a lot of advantages 
compared with conservatorship, but the question about when you 
make that call has always been an issue, and as I said, we have 
seen instances recently where it still is an issue.
    Senator Sununu. I mentioned the consistency in these 
evaluations by the GAO going back now more than 12 years, 
uniform 
recommendations that all the capital standards, all the 
business activities, all the mission-related activity as well, 
be included under an independent regulator.
    What about the issue of the type and the amount of 
nonmortgage-related assets held by the GSE's; should that fall 
within the scope of the independent regulator, and does your 
report include specific recommendations?
    Mr. Walker. We do reference the fact that that is an area 
that would be subject to oversight by these new independent 
entity. How does it relate to the related risk and the public 
purpose for these entities? Not a per se preclusion by any 
means, but it is something that I think the regulator has to be 
able to consider.
    Senator Sununu. Something that they should be able to 
consider.
    Senator Reed talked about or raised the concern of 
politics, and I think that is important, in the board 
structure, cabinet secretaries, Treasury, HUD, which you 
mentioned would naturally have an interest and an expertise 
here. But there are natural concerns because those are cabinet 
positions. In previous reports the GAO has recommended that the 
Chairman of the Federal Reserve be part of the board. Having 
the Chairman of the Fed as part of the board would seemingly 
address many of the concerns raised by Senator Reed. Is that a 
recommendation that you would stand by or support?
    Mr. Walker. I believe that is something the Chairman of the 
Federal Reserve may or may not want to do, but that would 
clearly be a positive step.
    I think the other thing, Senator, that one might want to 
consider--because I am on another board with the Chairman of 
the Federal Reserve right now dealing with the airline 
industry--the other thing you may want to consider is there are 
other board models out there that are hybrids. In addition to 
the one that I mentioned, I was a trustee of Social Security 
and Medicare for 5 years, and on that you have three cabinet 
secretaries and you have two people from the private sector who 
meet certain experience requirements. So in addition to the 
Chairman of the Federal Reserve and potentially others, you may 
want to think about whether or not you have some public members 
who are not Government employees.
    Senator Sununu. One final question about the mission. GAO, 
I think in the 1997 report, highlighted or discussed that when 
mission and safety and soundness regulations are performed by 
different regulators, even with some coordination there is the 
potential for the GSE's to try to pit the regulators against 
one another. Could you talk a little bit about examples, the 
specific examples where this had occurred, and whether that was 
behind your recommendation that it all be included in the new 
regulator?
    Mr. Walker. I will make a comment, then ask Tom for some 
specific examples. There is no question that to the extent that 
you have different regulators and they have different rules and 
different authorities, that there is going to be some human 
tendency to try to do that. That is just human nature. Our view 
is that for critical mass, for credibility, for capability, 
potentially for synergy and other purposes, that it makes sense 
to have one regulator for these types of entities.
    Tom.
    Mr. McCool. Again, I think that our experience with having 
a mission regulator without--under a different entity than the 
safety and soundness regulator, it was not so much that there 
were clashes, as that the mission regulator in the case of 
Fannie and Freddie, when it first set its goals in the mid-
1990's, did not have much financial experience and did not have 
much ability to understand what pushing the goals a little 
higher would lead to in terms of potential risk or potential 
loss in profit, and I think that is what we think a regulator 
that understands the whole thing can do and do a better job of.
    So our view, for example, is the first set of goals that 
HUD set were fairly conservative because they were operating 
without the full knowledge of everything that one regulator 
could have. Since then HUD has ratcheted up the goals and one 
could argue that the goals are maybe getting to where they 
should be, but without seeing the whole picture it is very hard 
to make that judgment. And we think a single regulator could do 
that.
    Mr. Walker. If I can come back real quickly, Senator. To me 
this is an issue like so many issues: It is a combination of 
value and risk. How can we try to maximize value and manage 
risk? In doing that I think you need to integrate the mission 
issues with the safety and soundness issues because there are 
tradeoffs. We are trying to achieve certain public purposes 
through these entities, and those need to be considered. But to 
the extent that you push the envelope too far one way, it can 
have an adverse effect on the other. So by integrating these 
issues I think you have a better chance of being able to make 
more informed judgments on the value/risk tradeoff.
    Senator Sununu. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman. I am 
sorry I was not here at the outset, and I want to join with 
others in welcoming the Comptroller General again. We always 
very much appreciate his appearances and his testimony. And Mr. 
McCool, it is good to see you again.
    Mr. Chairman, I do want to commend you for the very 
thorough and thoughtful way you are approaching this matter. 
This is the fourth hearing we have held on this issue. It is a 
very important issue, and I think we need obviously to build as 
strong and as thorough a record as we can as we consider moving 
ahead.
    Fannie Mae and Freddie Mac, along with the FHA, have been 
key players in making the mortgage market in this country the 
deepest and most liquid in the world, and actually it is the 
accumulation of housing wealth and the ability of homeowners to 
tap into that wealth because of the efficiency of our mortgage 
markets that have been a strong support for our economy.
    Most recently it is clear that the economy has been held up 
by people being able to draw on their housing wealth. So we 
have to be very careful, as we move ahead, that we do not 
impinge negatively on the secondary mortgage market to which 
Fannie and Freddie have contributed so much.
    One way to exercise that responsibility is to make sure 
these institutions are subject to strong, effective supervision 
and regulation, that they are within a framework that can 
assure their safety and soundness. I would apply the same 
thinking to the Federal Home Loan Banks. Of course, there is 
concern now about the adequacy of the supervision drawn to our 
attention by Freddie Mac's recent problems.
    I do, in fairness to OFHEO, want to say I do think they 
have responded appropriately, as I see it, to the Freddie Mac 
problems. They have moved ahead, and I am going to ask the 
Comptroller General whether they have a view on that particular 
current issue.
    But we do have these important questions as to whether the 
regulators have sufficient resources, expertise, and authority 
to provide the effective supervision. We are trying to balance 
two important goals: Increase scrutiny and more effective 
regulation, and commitment to the housing mission.
    I want to first ask the Comptroller General, what is your 
view about the adequacy of the housing mission of these 
institutions? How well is that being addressed? How important 
is it, and how do we ensure that if it is important that we are 
adequately addressing it?
    Mr. Walker. Senator, as you know, one of the primary 
reasons why these are GSE's is to promote homeownership in 
general, and also among those who can least afford to own a 
home. As Director McCool mentioned earlier, Housing and Urban 
Development has had the responsibility to set those mission 
goals, and they significantly increased what those goals were, 
I think in 1998, if I am not mistaken.
    I believe, as my testimony notes, that additional guidance 
might be necessary by this Congress on mission and what is 
trying to be accomplished. And I think that we have to keep in 
mind that in the case of Fannie Mae and Freddie Mac, they are 
public companies, and that therefore those who are on the board 
of directors of those entities have a fiduciary obligation to 
the shareholders.
    At the same point in time at least the statutory appointees 
who are being put on the board to protect the public interest, 
need to pay special attention to the public purpose of these 
entities, and that more needs to be done in order for them to 
be able to demonstrate, other than lowering the average 
mortgage by 25 to 40 basis points, what else is being done and 
to what extent are these GSE's are adding value above and 
beyond value that other GSE's are adding, and to what extent 
these GSE's are doing a better job than non-Government 
Sponsored Enterprises with regard to mortgage lending. I think 
there are some very serious issues that need to be explored 
further.
    Senator Sarbanes. How would you ensure that the housing 
mission was being adequately addressed in any structure that is 
developed here?
    Mr. Walker. That is why I think that you should consider 
this hybrid model. I really believe that it is important to 
consider some type of a hybrid model with regard to overseeing 
the regulator that provides the capability, the credibility, 
and the ability to look at both the public mission and also the 
safety and soundness issues. I believe that could help 
tremendously, in addition to other items that we laid out in 
the testimony.
    Senator Sarbanes. Mr. Chairman, I see my time is up. I have 
a couple more questions after the others finish.
    Chairman Shelby. Thank you.
    Senator Hagel.

                STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you.
    Mr. McCool, Mr. Walker, thank you for coming before us this 
morning.
    I want to begin, Mr. Walker, with part of the exchange you 
had with Senator Reed regarding the concept of too big to fail. 
In your view, have the housing GSE's and their relevance to the 
housing market approached the ``too big to fail'' position?
    Mr. Walker. Well, first let me say I do not think any 
entity is too big to fail, but I do think that we have to be 
careful to make sure that they do not fail because if one of 
these entities did fail, it would have a significant adverse 
ripple effect throughout the entire financial markets.
    But, Tom, would you agree?
    Mr. McCool. I agree. I mean that the question of whether 
something is too big to fail is fundamentally, ultimately a 
political call I guess is part of it. But to the extent you can 
keep it from becoming--reduce the prospects of failure by 
having effective oversight and regulation, that is where we 
need to focus our attention.
    Again, we have not had to deal with a ``too big to fail'' 
situation, at least in the financial sector in a while, and we 
do not know, for example, in the banking sector whether the new 
rules and procedures put in place by FDICIA will work. We hope 
they will or hope they will allow a large institution to be at 
least unwound in an effective way, if not protecting it from 
failure.
    But it is a concern because obviously when entities 
perceive themselves as too big to fail or are perceived as too 
big to fail, that has consequences for market discipline.
    Senator Hagel. Following up on your comments, your point 
about we need to do everything we can to assure that we do not 
get into a position like that. Would, for example, restricting 
the types and amounts of assets, be a useful regulatory tool, 
as we are thinking through possibilities as we start to develop 
a framework for a new regulator?
    Mr. Walker. I think that comes back to one of the questions 
that Senator Sununu and others mentioned, and that is, should 
the regulator have the ability to provide some type of 
restrictions on the amount or type of assets that they can hold 
including whether and to what extent derivatives are used to 
mitigate risk and to reduce risk, rather than to enhance 
earnings. I think these are things that should be within the 
portfolio of the regulator within reason.
    Chairman Shelby. Could you elaborate on that just a little 
bit? I know it is his time, but would you?
    Mr. McCool. Well, as we know, derivatives can be----
    Senator Sarbanes. The Chairman just gave him additional 
time.
    [Laughter.]
    Senator Hagel. My time is your time, Mr. Chairman. That is 
fine.
    Chairman Shelby. Senator Hagel and Senator Sununu both have 
taken a big interest in showing a lot of leadership in this 
are, so I think this is important to what you are touching on.
    Mr. Walker. I mean the fact of the matter is, derivatives 
can be used to mitigate or moderate risk through matching 
concepts and a variety of other things, or they can, if not 
properly used, serve to increase risk and volatility. We have 
seen examples of this in some of the recent failures in the 
private sector, where activities were being engaged in in order 
to increase earnings, but at substantial risk. It is important 
when you are dealing with an entity that is Government 
sponsored, of which there is a public purpose, that they be 
allowed reasonable flexibility to engage in certain types of 
investments and investment strategies, but hopefully, those are 
designed to moderate and mitigate risk rather than to enhance 
short-term earnings.
    Senator Hagel. Thank you. With regard to financial 
transparency--and we have dealt with that this morning in some 
detail, and there will be more of that exchange--what are your 
views as to mandatory compliance with prevailing SEC 
regulations?
    Mr. Walker. My understanding is at least some of the 
entities--I think it is Fannie Mae, if I am not mistaken--are 
voluntarily complying with--Fannie is voluntarily complying 
with some of the SEC requirements, and Freddie Mac is 
considering it, if I am not mistaken. These are public 
companies with significant shareholders with important public 
purposes, and I clearly believe that the concepts behind 
increased transparency are ones that these entities need to 
follow. Whether or not that means that they have to be subject 
to the same requirements under the 1933 and 1934 Act, there 
could be some issues with the 1933 Act, which I think the SEC 
representative can talk about, I think in substance they need 
to conform with the requirements. Whether or not it is by 
statute, that is up to the Congress.
    Senator Hagel. So you would say that they really should be 
mandatory?
    Mr. Walker. I would say they need to enhance their 
transparency, and one of the ways to do that is to subject them 
to these Acts.
    We have not taken a formal position on this in the past 
time? I think they need enhanced transparency, and I will not 
go as far as saying that they should be subject to the Act. 
That is for Congress to decide.
    Senator Hagel. Would then fair value disclosure be useful?
    Mr. Walker. Yes.
    Senator Hagel. Thank you.
    Chairman Shelby. Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thanks, Mr. Chairman.
    Welcome, General Walker. Good morning. Let me see if I 
understand what you said with respect to how you think the 
regulatory structure should be organized. Do I understand you 
believe that there should be an independent regulator, single 
independent regulator?
    Mr. Walker. That is correct, Senator.
    Senator Carper. Do you believe that a regulator should be 
housed within Treasury?
    Mr. Walker. It can either be within Treasury. There is some 
incremental synergy that could be attained that way, or 
independently, but we are not taking a position on that.
    Senator Carper. How would you recommend that we go about 
making that decision? What should we keep in mind as we try to 
decide?
    Mr. Walker. My personal view is the issues that are the 
most important are pulling together one single regulator that 
has responsibility for mission and safety and soundness, making 
sure that they have the appropriate amount of authorities, the 
appropriate capabilities in order to get the job done, and I 
think you can look to other models that are out there as to 
ones that have been totally independent in how they have 
worked, versus ones that have been within departments and 
agencies, and make a judgment based upon that.
    My view is, is that the issue that I think most people have 
talked about is how do you deal with balancing the mission and 
the safety and soundness issues. The reason that I threw out 
the idea of the possibility of a board structure is I think 
that is a good way to do that, and that could be accomplished 
whether it is within the Treasury Department or not. For 
example, the Pension Benefit Guaranty Corporation has a board 
of directors that I think could be built upon, and technically 
the Pension Benefit Guaranty Corporation is deemed to be within 
the Labor Department. It has separate facilities. It is within 
their budget, but in many ways it operates very independently. 
So look at past experience is what I would say, and what has 
worked and what has not worked.
    Senator Carper. I want you to talk with us--and you may 
have already done this, and if you have, I am going to beg your 
indulgence--but I would like to just pick your brain a little 
bit if I could with respect to who should be setting minimum 
capital levels? Should it be a regulator? Should it be 
something that Congress does through legislation? Talk to us 
about the pros and cons of doing either.
    Mr. Walker. One of the things we talked about earlier, 
Senator, is that the regulator needs to have the flexibility to 
be able to--
    Senator Carper. Wait a minute. Before you do that, just 
preface your response to my question by talking about the 
importance of the minimum capital levels. Why is it important?
    Mr. Walker. Minimum capital requirements are obviously very 
important in order to assure safety and soundness. It is one of 
the most fundamental elements to try to assure safety and 
soundness. In that regard, one of the things that we had talked 
about a little bit earlier was the possibility of Congress 
considering providing minimum requirements. In other words, 
setting the floor but not the ceiling, providing some guidance 
that the regulator would use, but allowing the regulator some 
flexibility to be able to employ risk-based concepts dealing 
with different entities to determine what the appropriate 
capital requirement should be, given the risk involved.
    Senator Carper. Do you see that as a compromise between one 
or the other? Is that a reasonable compromise?
    Mr. Walker. I see it as a reasonable and prudent course 
because the fact of the matter is, Congress may want to provide 
minimums. Congress may want to provide criteria or standards 
that the regulator must consider. Congress may want to assure 
that there is a regulatory process with appropriate 
transparency that the regulator must follow in setting these 
capital requirements. But I believe that the regulator is in 
the best position to make informed judgments, including 
exercising tradeoff considerations between mission goals and 
safety and soundness considerations.
    Senator Carper. Obviously, the Fannie Mae and Freddie Mac 
are a different breed of animal than the Federal Home Loan 
Banks, and with that in mind, how should we and how should this 
independent regulator approach the regulation of the Federal 
Home Loan Banks?
    Mr. Walker. Presumably, this single regulator would be 
responsible for overseeing all of these entities. It would be 
Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. 
Presumably they would all be subject to a minimum capital 
requirement, but that the regulator would, based on facts and 
circumstances basis, be able to decide what the appropriate 
capital requirement would be for each type of entity.
    Tom, I would ask if you want to comment.
    Mr. McCool. Again, the point would be that you would set 
capital requirements that were based on different types of 
risks and we know that the Federal Home Loan Banks have 
different types of risk than Fannie and Freddie, but they also 
have similar types of risks; it depends on the activity. Some 
of the banks do different things than other banks, and so even 
within this system, the Federal Home Loan Bank System, there 
are different types of activities that would require different 
capital depending on the risk level. The same principles would 
apply across the Federal Home Loan Banks and Fannie and 
Freddie.
    Senator Carper. Thank you very much.
    Chairman Shelby. Thank you, Senator Carper.
    Senator Chafee.

            STATEMENT OF SENATOR LINCOLN D. CHAFFEE

    Senator Chafee. Thank you, Mr. Chairman.
    Mr. Walker, you have testified that there should be some 
kind of hybrid oversight, and in the second panel, Mr. Rayburn 
is going to testify that he believes that the Department of 
Housing and Urban Development is the appropriate agency to 
regulate the mission of Fannie Mae and Freddie Mac.
    What is the best argument you could use to convince Mr. 
Rayburn that it is better to have a hybrid?
    Mr. Walker. My view is that the Department of Housing and 
Urban Development clearly has a stake, and they clearly need to 
be involved.
    I believe that the hybrid option is one way to help assure 
that they will be involved, that they will have a seat at the 
table, and at the same point in time, recognizing that one has 
to balance the mission with the safety and soundness issues, 
and that is the way to get it done. That is my personal view.
    Senator Chafee. Thank you.
    My other questions have been asked already, and that is the 
only one I had, Mr. Chairman.
    Thank you.
    Chairman Shelby. Thank you, Senator Chafee.
    Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman.
    As we go through these hearings, the issues become clearer, 
and I congratulate you for your usual job of being very 
thorough in this but moving toward a goal. And I think it is 
pretty well summarized, General Walker, by your comment that we 
have the mission issue, and we have the safety and soundness 
issue. We want to be sure that the regulator keeps everything 
safe and sound, but not in such a way as gets in the way of the 
mission. Senator Sarbanes talked about how successful we have 
been--the most successful of any nation on Earth in stimulating 
homeownership by virtue of this structure we have built--and we 
do not want to damage that.
    Senator Sununu made reference to the savings and loan 
crisis. I came to the Senate in the midst of that crisis and 
had some period of time outside the Senate where I watched the 
regulators close down sound S&L's as well as failed S&L's in 
their zeal to make sure that everything was safe. And there 
were shareholders who lost their life savings and viable 
businesses that were shut down in the zeal of the Federal 
regulators to make sure there were not anymore loan losses. And 
we saw an example of that at the back end, which I saw when I 
came to the Senate in two ways--number one, when they started 
liquidating all of the things that they took over, they found 
that a lot of them were worth a whole lot more than they had 
thought, and therefore, the Government got a lot back--the 
shareholders were out and injured, but the Government seized 
these things--``seized'' is not the proper legal word, but it 
is in effect what happened--in an effort to get safety and 
soundness, shutting down, and then having good assets as they 
came around to liquidate them, and the S&L final bill was not 
as big as projected because the Government had all those 
assets.
    And then, the other aspect of it was financial institutions 
in that period, when I was just coming on the Banking 
Committee, were reluctant to loan because they saw how badly 
beat up people were when they took any kind of risk--in the 
name of safety and soundness you cannot do that--and we had 
problems where we were saying you have to get some liquidity 
into the economy to get it going. And it took a year or more 
before banks began to raise their heads enough to say, ``We 
will start to make some loans again, but we are fearful from 
the reaction of the regulators.''
    I give you that history because that is basically what you 
are talking about. If we decide that safety and soundness is 
the holy grail, we can tighten this thing down to the point 
that no more loans are made, and yes, your money is safe--it is 
all sitting there in Government securities rather than in 
loans--it is safe, but we are not fulfilling the mission.
    So as we hold these multiple hearings, we come more and 
more to that point--how can we assure safety and soundness 
without being so paranoid on that subject that we shut down the 
mission and ultimately damage the benefit to society that these 
groups are doing.
    There are a number of issues here, and you have talked 
about that one, but I want to introduce two more and just get 
your reaction. You say these are public companies, which in the 
case of Fannie and Freddie, they are. The Federal Home Loan 
Banks are not. So that becomes an additional wrinkle that a 
regulator has to deal with.
    Furthermore, the Federal Home Loan Banks are so structured 
that there is a joint and several liability situation built in. 
All of the focus has been on the implied Government guarantee. 
I still do not understand what that is. It is either a 
guarantee or it is not, and if there is an implied guarantee, 
where do I go to collect the implied guarantee on an investment 
that I have that went bad. To which window do I show up and get 
cashed in if I have an implied guarantee that my investment is 
okay, but there is nothing in writing? But okay, are we talking 
about the implied guarantee for Fannie and Freddie, but you 
have joint and several liability, which is in stone for the 
Federal Home Loan Banks?
    The SEC obviously has a role to play in a publicly traded 
company like Fannie and Freddie, but what does the SEC have to 
do here when you bunch in the Federal Home Loan Banks? Talk 
about that mix for a little while.
    Mr. Walker. First, the implied guarantee. Let me start with 
that, since you mention it. There are a lot of entities that 
the Federal Government is involved with that do not have 
express guarantees by the Federal Government. They are not 
backed by the full faith and credit of the U.S. Government. One 
example is the GSE's. Another example is the PBGC, the Pension 
Benefit Guaranty Corporation. Its insurance system is not 
backed by the full faith and credit of the U.S. Government.
    Implied guarantees I think presume something that Senator 
Hagel talked about, this ``too big to fail'' concept, that 
whether there is a legal commitment or not, from a practical 
standpoint, many people speculate, maybe rightly, maybe 
wrongly, they speculate that if something really bad happens, 
that politically, there would be a move to step in and that 
therefore, that is the ``implied guarantee.'' It is not 
expressed, it is not a legal commitment.
    Senator Bennett. The mix of the GSE's, Freddie, Federal 
Home Loan Bank, joint and several liability, SEC, public 
company, nonpublic. How does that all work out?
    Mr. Walker. Thank you, Senator, for refreshing my memory.
    I think we have to look at each based on the facts and 
circumstances. You are right that the Federal Home Loan Banks 
are cooperatives. They are not public companies. So therefore, 
I think having them subject to SEC regulation is obviously not 
the issue.
    On the other hand, as it deals with mission, safety, and 
soundness, it seems that there are a lot of common denominators 
that a single, integrated regulator would be able to consider 
and apply as appropriate involved with the Federal Home Loan 
Banks versus Fannie Mae versus Freddie Mac.
    So there are certain elements that would apply. There are 
other elements that would not. But from the regulator's 
standpoint when you are dealing with mission, safety, and 
soundness, it seems to me there are a lot of common 
denominators, and there are synergies.
    Senator Bennett. I agree with that, and my time is up, but 
it just occurs to me that it may well be that if you put the 
Federal Home Loan Bank boards into this pot, you have to 
eliminate the joint and several liability arrangement that they 
currently have and thereby change the structure of them so they 
become more like the other entities that are in the pot.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Bennett.
    Mr. Walker, I have a couple of questions following up on 
Senator Bennett's questions for the record. One has to do with 
the organizational structure of the new GSE regulator, keeping 
in mind the differences among Fannie Mae, Freddie Mac, and as 
he has pointed out, the Federal Home Loan Banks and so forth.
    The other question would relate to corporate governance and 
the Finance Board. We would like that answered for the record, 
and we will get this to you in a few minutes.
    We have been talking about risk here and mission, safety 
and soundness. What we are trying to do as I understand it--and 
I have been on this Committee for 18 years; Senator Sarbanes 
dates me here--but we both sat through the debacle of the 
thrifts. Senator Bennett came in the middle of it, I believe, 
on the Committee.
    Senator Sarbanes. And helped us to straighten it out.
    Chairman Shelby. Absolutely.
    But at the same time, what we are trying to do is balance 
the mission of the GSE's, which we mostly agree is sound--that 
is, the housing policy for the United States of America and the 
people, and homeownership--and the safety and soundness of the 
GSE's as financial institutions.
    Is that what we are trying to do?
    Mr. Walker. I agree, to balance those interests.
    Chairman Shelby. Absolutely.
    And we have been talking a lot about failures here, but 
what we are really trying to get at if we create a powerful 
regulator is to preclude failure, to stay away from failure, in 
other words, to make sure that these institutions are going to 
be there for the future.
    Is that a fair statement?
    Mr. Walker. That is correct, Senator. We want to prevent a 
failure, and we want to learn from the lessons of the past.
    Chairman Shelby. How important, Mr. Walker, is it for the 
regulator, whoever the regulator would be in the future, to 
know what the models are at Fannie Mae, Freddie Mac, or the 
Federal Home Loan Bank board--in other words, wouldn't they 
have to know what is going on there? It is a very complicated 
situation. They would have to have the personnel to know, and 
they would have to be hands-on, to know what was going on, so 
to speak.
    One of the problems that I have gathered here is that it 
was PricewaterhouseCoopers, inside accountants, that brought 
the Freddie Mac situation to a head and not OFHEO. I agree with 
Senator Sarbanes that the leadership at OFHEO since the 
revelations at Freddie Mac and Fannie Mae have been very 
diligent.
    Go ahead.
    Mr. Walker. OFHEO has not historically had many people with 
expertise in accounting and reporting issues. They recognize 
the need to beef up in this area. They are taking steps to do 
that, and I think that that is appropriate that they do. In 
addition, in fairness to OFHEO, I will also note that one of 
the things I mentioned was about the need to have model 
corporate governance practices. OFHEO has taken steps to try to 
make sure that at least in the case of Freddie Mac, the CEO is 
separated from chairman of the board, which is a best practice 
in that regard, and they are trying to become more active 
there.
    Senator Sarbanes. May I----
    Chairman Shelby. If I can finish up, Senator Sarbanes, of 
the securities that Freddie Mac, Fannie Mae, and the Federal 
Home Loan Bank Board, create--and this is the securitization of 
the whole organization--who owns or buys most of those 
securities? Isn't it the banks? Don't a lot of the banks, as 
investors, invest in the GSE securities?
    Mr. Walker. That is my understanding, Senator.
    Chairman Shelby. Is that correct?
    Mr. McCool. Yes. They are purchased by mutual funds, they 
are purchased by banks, but a lot of other entities purchase 
them.
    Chairman Shelby. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Mr. Chairman, I just wanted to follow up 
on the other point.
    An independent, assured source of funding for the regulator 
is a very important aspect of this, is it not? You were 
mentioning OFHEO's difficulties, but is not that one of them 
and something that needs to be addressed in any effort to 
strengthen the regulatory structure?
    Mr. Walker. It is important to assure that they have an 
adequate amount of resources in order to effectively do their 
job, and that is one consideration that I think you are going 
to have to give as to how should they be funded and the means 
by which they should be funded.
    Senator Sarbanes. Now, in your report, you point out that 
the FHFB just had 10 examiners as of about 18 months ago to 
examine the 12 Federal Home Loan Banks, and they have initiated 
a program to increase it up to 30. Of course, I think the 
Comptroller has 20 or 30 people at one or another of the major 
institutions that they are involved in as I understand it.
    So it is really falling way short of what is needed, is it 
not?
    Mr. Walker. They are clearly going to have to take a look 
at what they need to get the job done versus the current 
resources they have, and they are likely to need additional 
resources.
    Senator Sarbanes. Do you have any perception that the 
Federal Housing Finance Board has actually been acting more as 
an advocate for increasing the powers of the bank system rather 
than its safety and soundness regulator?
    Mr. Walker. I do not.
    Tom.
    Mr. McCool. We have not taken a position on that, Senator.
    Senator Sarbanes. Some have argued--and actually, it has 
come up here today--that you cannot put the Federal Home Loan 
Banks into the same regulatory structure as Freddie and Fannie 
because there are important differences. I take it your 
position is that the similarities more than outweigh the 
differences, and therefore it is sensible to put them all under 
the same regulatory structure. Is that correct?
    Mr. Walker. That is correct, Senator. There would be some 
differences, but there are more commonalities than differences, 
and with regard to mission, safety, security, soundness, there 
are more similarities than differences.
    Senator Sarbanes. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sununu, anymore questions?
    Senator Sununu. No, Mr. Chairman.
    Chairman Shelby. Senator Hagel.
    Senator Hagel. No questions.
    Chairman Shelby. Senator Chafee.
    Senator Chafee. No questions.
    Chairman Shelby. Mr. Walker, we thank you, and we look 
forward to your answers to those last questions and any others 
for the record. We appreciate your appearance before the 
Committee and your insights into what we are trying to do.
    Mr. Walker. Thank you, Mr. Chairman.
    Senator Sarbanes. Mr. Chairman, could I note that the GAO 
has built up quite a body of expertise on this issue, and I 
would hope we could be able to draw on the Comptroller General 
for his counsel and advice as we move forward.
    Mr. Walker. We have great staff, and we are happy to help.
    Thank you.
    Senator Sarbanes. You have a good head of a great staff, 
too.
    Mr. Walker. Thank you.
    Chairman Shelby. Our next panel will be Mr. Alan Beller, 
Director, Division of Corporate Finance and Senior Counselor to 
the Commission on Securities and Exchange; Mr. Richard Carnell, 
Professor of Law, Fordham University Law School; and Mr. James 
R. Rayburn, President, National Association of Home Builders.
    Gentlemen, we appreciate your patience dealing with the 
first panel. Your written statements, we have for the record, 
and we have reviewed them. We would appreciate it if you would 
sum up as soon as your can your top points here today.
    We will start with Mr. Beller.

                  STATEMENT OF ALAN L. BELLER

           DIRECTOR, DIVISION OF CORPORATION FINANCE

            U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Beller. Thank you, Chairman Shelby, Ranking Member 
Sarbanes, and Members of the Committee.
    I am pleased to have this opportunity to testify before you 
on behalf of the Securities and Exchange Commission regarding 
the application of disclosure and reporting requirements of the 
Federal securities laws to Fannie Mae, Freddie Mac, and the 
Federal Home Loan Banks. These Government Sponsored 
Enterprises, or GSE's, issue marketable debt to the public. In 
addition, Fannie Mae and Freddie Mac have publicly held common 
stock and also issue guaranteed mortgage-backed securities. All 
of these entities and their securities are exempt from the 
registration and disclosure provisions of the Federal 
securities laws. None of the debt securities issued by any of 
these GSE's is backed by the full faith and credit of the 
United States.
    As to the Commission's historical views on GSE disclosure, 
since at least 1992, the Commission has expressed the view that 
because the GSE's sell securities to the public, including debt 
securities, and have public investors and do not have the full 
faith and credit backing of Government securities, their 
disclosure should comply with the disclosure requirements of 
the Federal securities laws. Mandatory compliance by the GSE's 
is the objective. Further, the disclosure quality that we seek 
for the GSE's can only result from becoming subject to the 
SEC's reporting system. The disclosure quality results not only 
from the Commission's rules, but also the Commission's and the 
staff's administration of these rules, including our review and 
comment processes and our enforcement program.
    A 1992 joint report of the Department of the Treasury, the 
Board of Governors of the Federal Reserve System, and the 
Commission on the Government securities market addressed 
attaining that objective through registration. However the 
means, mandatory registration or voluntary registration, for 
example, would appear to be less significant than the 
objective--mandatory compliance with SEC disclosure and other 
requirements.
    I would like to turn to a preliminary discussion of our 
registration requirements. For purposes of today's subject, two 
of the Federal securities laws are relevant--the Securities Act 
of 1933 and the Securities Exchange Act of 1934. Registration 
under the Exchange Act results in reporting companies providing 
for disclosure of detailed information relating principally to 
the company itself. Registration under the Exchange Act also 
subjects companies to the provisions of the Sarbanes-Oxley Act 
applicable to issuers.
    The Securities Act, by contrast, requires registration by 
issuers of transactions, namely public offerings of their 
securities. One result of registration under the Securities Act 
is required disclosure of essentially the same information 
regarding corporations as is required for reporting companies 
under the Exchange Act. Another result of registration under 
the Securities Act is disclosure regarding the securities being 
offered. Finally, because Securities Act registration 
statements are subject to review by the Commission staff, 
registration can affect the timing of offering transactions.
    With that summary, let me turn to Fannie Mae and Freddie 
Mac. On July 12, 2002, Fannie Mae and Freddie Mac announced 
that each would voluntarily register its common stock under the 
Exchange Act and thus become mandatorily subject to Commission 
reporting requirements. Fannie Mae's registration statement 
under the Exchange Act was declared effective on March 31, 
2003. Freddie Mac has stated that it intends to conclude the 
Exchange Act registration process after it completes its 
restatement and audit of the financial statements. I think 
Freddie Mac's latest information is that they intend to become 
subject to registration in 2005.
    The Office of Federal Housing Enterprise Oversight has also 
adopted rules requiring the officers and directors of Fannie 
Mae and Freddie Mac to file with the Commission the insider 
transaction reports required by the Exchange Act and requires 
the companies to file with the Commission all proxy documents 
that are also required pursuant to the Exchange Act.
    It has been our focus to date that investors who purchase 
and sell stock or debt of the GSE's are entitled to the 
corporate information required under the Exchange Act. 
Registration under the Securities Act would not result in 
disclosure of additional corporate information.
    Registration of securities transactions by Fannie Mae and 
Freddie Mac under the Securities Act, especially offerings of 
their mortgage-backed and other mortgage-related securities, 
does require consideration of factors not implicated by 
registration under the Exchange Act. The Commission did not 
recommend in 1992 removing the exemption from the Federal 
securities laws for the offer and sale of mortgage-backed and 
mortgage-related securities of Fannie Mae and Freddie Mac. We 
seek the achievement of the benefits for investors of 
registration under the securities laws, but we also recognize 
that these other factors need to be examined in connection with 
considering registration.
    First, as noted earlier, the review process of the Division 
of Corporation Finance of registration statements under the 
Securities Act means that the timing of offerings can be 
affected.
    Second, Fannie Mae's and Freddie Mac's mortgage-backed and 
other mortgage-related securities are backed by their 
respective guarantees. Exchange Act filings already would 
contain important corporate information necessary to analyze 
those securities as a credit matter.
    And finally, registration of offerings of the GSEs' 
mortgage-backed and related securities under the Securities Act 
may raise another significant and complex factor--the impact on 
the U.S. mortgage market--that we believe should be considered. 
In particular, a substantial portion, and recently a majority 
of the GSEs' mortgage-backed securities have been sold into the 
so-called ``To Be Announced'' or TBA, market. These 
transactions involve forward sales of mortgage-backed 
securities made up of pools of mortgages not yet identified and 
in many cases not yet even in existence. Therefore, in a TBA 
transaction, actual mortgage pool characteristics cannot be 
disclosed at the time of registration or offering. The TBA 
standards that those mortgage pools must meet, which have been 
established by market participants, are already available to 
the market independent of registration.
    In addition, we understand that the TBA market is used to 
set or ``lock in'' mortgage rates in the U.S. housing market. A 
decision to require registration under the Securities Act of 
offers and sales of mortgage-backed securities should therefore 
take into account whether and if so, how such registration 
might impact the mortgage market and especially the operation 
of the TBA market.
    I would now like to turn to the Federal Home Loan Banks. 
The Federal Home Loan Bank System was created in 1932 and is 
comprised of the 12 banks. The Federal Home Loan Bank System 
through the Office of Finance is one of the largest issuers of 
debt securities in the world into the public markets. 
Approximately $716.9 billion was outstanding as of September 
30, 2003.
    The Federal Home Loan Banks are exempt from the Federal 
securities laws because they are GSE's. In the absence of their 
GSE status, they would be required to register, and the fact 
that they issue only public debt and do not have public equity 
would not change their status as required to register as issues 
of public debt securities. The Banks, because they are exempt, 
are also not subject currently to the provisions of the 
Sarbanes-Oxley Act. In September 2003, the Federal Housing 
Finance Board proposed for comment a rule to require 
registration with the Commission by the Banks under the 
Exchange Act. The comment period for that rule ended on January 
15, 2004.
    The Federal Home Loan Banks have many of the same 
disclosure issues as any financial institution whose debt 
securities are issued to, and held by, the public. As discussed 
earlier, we believe investors in the Banks' debt securities are 
entitled to the same type of information as that provided by 
other issuers of public debt. As also discussed earlier, we 
further believe that the Commission's detailed disclosure rules 
and filing requirements, review and comment process, and 
enforcement mechanisms provide the best framework for 
disclosing information to which investors are entitled.
    As is the case with Fannie Mae and Freddie Mac, the focus 
to date for mandatory disclosure has been the corporate 
disclosure required under the Exchange Act. Registration of 
offers and sales of securities by the Federal Home Loan Banks 
under the Securities Act has not been the focus to date and is 
not the subject of the proposed Finance Board rule. In 
particular, as with Fannie Mae and Freddie Mac, disclosure of 
corporate information following Exchange Act registration is 
the same as would be required under the Securities Act.
    Because of the structure of the Federal Home Loan Bank 
System, including the Office of Finance, however, there are 
some issues that may be unique to the Banks that should be 
taken into account in considering registration. The staff of 
the Commission has met with members and staff of the Finance 
Board, representatives of the Banks, and a group of directors 
of certain Banks, in each case at their request, to discuss the 
issues that registration under the Exchange Act may raise.
    In addition, insofar as registration under the Exchange Act 
is being considered, we believe there would be no impact on the 
timing or other aspects of offering transactions as a result of 
registration.
    We have also indicated to the Banks that we would work with 
them to determine if there were certain requirements, such as 
the proxy rules, from which it should be clear the Banks are 
exempted because the publicly held securities that implicate 
registration and disclosure issues are their debt securities. 
This would produce the same results as would be the case for 
corporate issuers whose only public securities are debt 
securities. And there is a very significant number of very 
large corporate issuers who fall into that category.
    In addition to these items, there have been certain 
accounting-related issues that have been identified as 
significant for the Banks in terms of ascertaining our staff's 
view prior to any registration process. We have met with 
representatives and advisers of the Banks to resolve those 
issues, and the resolution is discussed in detail in the 
written testimony that I have submitted; I do not intend to go 
into those right now.
    In conclusion, the individual and institutional investors 
who hold debt securities of the banks depend for repayment on 
the Banks under their joint and several liability, and not a 
Government guarantee. We therefore believe that applying the 
Commission's disclosure requirements and processes is the 
preferred method of helping to ensure that these investors 
receive the materially accurate and complete disclosures they 
deserve. If registration by the Banks is pursued, we are 
committed to achieving that result with maximum protection for 
investors and maximum efficiency for registrants, consistent 
with our mission to protect investors.
    Thank you again for inviting me to speak here today on 
behalf of the Commission. I would be pleased to answer any 
questions that you may have.
    Chairman Shelby. Thank you, Mr. Beller.
    Mr. Carnell, welcome back to the Committee.

                STATEMENT OF RICHARD S. CARNELL

         ASSOCIATE PROFESSOR OF LAW, FORDHAM UNIVERSITY

               SCHOOL OF LAW, NEW YORK, NEW YORK

    Mr. Carnell. Thank you, Mr. Chairman.
    Mr. Chairman, Senator Sarbanes, Members of the Committee, I 
am pleased to have this opportunity to discuss how to improve 
the regulation of the housing GSE's and particularly how to 
structure a new GSE regulator.
    I commend you, Mr. Chairman, for your leadership in 
focusing attention on these issues, on the weaknesses of 
current law and the weaknesses of the current structure of 
OFHEO, and for your resolve to move legislation to correct 
these problems.
    A new GSE regulatory agency should regulate all three 
housing GSE's. It should be responsible for keeping GSE's safe 
and sound and for making sure that GSE's carry out their 
housing mission. It should have permanent funding. It should 
have the same safety and soundness authority as the Federal 
bank regulators, including authority to raise capital standards 
and take enforcement action. It should also be able to appoint 
a receiver for an insolvent GSE.
    I want to focus now on three specific issues--first, the 
governance of the new agency; second, the need to have an 
adequate mechanism for handling an insolvent GSE; and third, 
the double game that GSE's play in talking about their 
relationship to the Federal Government.
    First, governance of a new agency. In structuring the 
agency, the paramount goal should be to assure the agency's 
independence from the GSE's and thus to maintain the new 
agency's integrity, objectivity, and effectiveness. One 
approach would be to make the agency an autonomous bureau of 
the Treasury Department, like the OCC and OTS. The Treasury has 
an institutional commitment to safety and soundness and has the 
will and institutional credibility to stand up to the GSE's. 
The GSE's would find the Treasury harder to bully than any of 
the alternatives, including a new, independent agency.
    The GAO has suggested a hybrid approach with an executive 
director and a coordinating board. I would like to think more 
about that but also to offer some initial impressions.
    I like the idea that the coordinating board would consist 
of people with other major Government responsibilities. That 
will help you get capable people. If you want to find somebody 
for a board position that does not have other 
responsibilities--that is, where you are not the chair of the 
agency, and you do not have any other position in Government--
you are going to have trouble getting really qualified people 
to take those jobs and stay there. There is just not enough 
challenge.
    So if the coordinating board does consist of people like 
the Secretary of Treasury, the Secretary of HUD, the Chair of 
the SEC, and the Chair of the Fed, I think that is a 
composition that makes sense.
    I would caution, though, about trying to have the 
coordinating board actually run the agency. Big boards may 
sound good on paper, but they often work badly. Without a 
strong executive director, I do not think a five-member board, 
no matter who was on it, would be up to the job over time. I 
think it would be vulnerable to manipulation by the GSE's. I 
think that having so many members blurs accountability and 
impedes decisionmaking. So I think the executive director, if 
you went that route, should have considerable power to make 
policy.
    The second topic I want to address is receivership. Current 
law provides no adequate mechanism for dealing with Fannie and 
Freddie if they become insolvent, that is, if their liabilities 
exceed their assets. We have mechanisms like this for the 
Federal Home Loan Banks, we have it for business corporations. 
We do not have it for Fannie and Freddie. The Bankruptcy Code 
does not apply. OFHEO could appoint a conservator, but the 
conservator would have no power to resolve the shortfall 
between the liabilities and the assets.
    So this lack of an orderly receivership mechanism is a 
serious gap in current law, with potentially serious 
consequences for financial markets. Congress could fill the gap 
by authorizing the GSE regulator to commence a bankruptcy 
proceeding against an insolvent GSE, or it could take a 
different approach, like the banking law, and authorize the 
regulator to appoint a receiver to deal with it under a 
specialized body of law. That is what we do with the FDIC.
    I want to point out, by the way, that receivership is not 
something special to the thrift debacle. Bank regulators have 
done probably a thousand bank failures and a thousand 
receiverships in the last two decades, and that has worked well 
in that context.
    A receivership mechanism, by providing an orderly means for 
dealing with a failed GSE's debts, would help limit and contain 
the harm resulting from a GSE's failure.
    Third, I want to talk about what I call the GSEs' double 
game, about their relationship to the Government. Fannie and 
Freddie play an extraordinarily successful double game in 
dealing with this relationship. They deny that they have any 
legally enforceable Government backing. They leave the 
impression that they have no Government backing at all, yet at 
the same time, they also work to reinforce the market 
perception that the Government implicitly backs them.
    Critics of GSE's did not make up the idea of an implied 
guarantee. Fannie and Freddie themselves have propagated that 
idea for decades. For example, in my written statement, I give 
several examples. One of them is where Fannie Mae said in an 
official comment letter to the OCC, it emphasized the ``implied 
Government backing of Fannie Mae,'' and it goes on to say that 
this backing makes Fannie's securities ``mere proxies for 
Treasury securities.''
    Think about that. Fannie says its implied Government 
backing is so strong that its securities are almost as good as 
U.S. Treasury securities. So this double game lets the GSE's 
have it both ways. It is like telling Congress and the press, 
``Don't worry, the Government is not on the hook,'' and then 
turning around and telling Wall Street, ``Don't worry, the 
Government really is on the hook.''
    The GSE's play this game unchallenged, year after year. No 
reporter exposes it. No committee investigates it. No executive 
branch official criticizes it. So in a world of global 
information, the GSE's still get away with saying one thing to 
Washington policymakers and saying something fundamentally 
different to New York bond traders and financial analysts.
    Last week, Fannie Mae's CEO seemed to question the 
existence of any implied guarantee. I urge the Committee to 
follow up on this point, an important point, by having Fannie 
and Freddie answer three simple questions which I list in my 
written statement.
    For example, if Fannie and Freddie were to default on their 
debts, would the Federal Government have any moral obligation 
to ensure that Fannie and Freddie's creditors get paid? I think 
it would really move the process along to get some clarify 
here.
    Finally, I want to say a word about affordable housing.
    Chairman Shelby. Mr. Carnell, what were the other 
questions?
    Mr. Carnell. Oh, they are in my prepared testimony.
    Chairman Shelby. Share them with the audience.
    Mr. Carnell. Oh, certainly. I appreciate your interest, Mr. 
Chairman.
    Chairman Shelby. Absolutely.
    Mr. Carnell. The other questions are: Do capital market 
participants err in perceiving the Federal Government as 
implicitly backing Fannie and Freddie?
    And, do you believe that the Government in any way 
implicitly backs Fannie and Freddie?
    So they are related questions, but I think to get clear, 
unequivocal answers from the GSE's would be very beneficial.
    Finally, I would like to say a word about affordable 
housing. Fannie and Freddie receive very valuable benefits from 
the Government, but they do very little considering their size 
and special privileges that would otherwise get done.
    Studies have indicated that they do less, proportionately, 
than banks and thrifts. The basic problem is that the current 
affordable housing requirements are not targeted. Fannie and 
Freddie can satisfy these requirements by doing lots of middle 
class and lower middle class housing that they have a profit 
motive to do anyway.
    So as long as Fannie and Freddie retain their Government 
sponsorship, they should be required to do much more for 
affordable housing.
    Thank you, Mr. Chairman, and I will be glad to answer 
questions at the appropriate time.
    Chairman Shelby. Thank you.
    Mr. Rayburn.

                 STATEMENT OF JAMES R. RAYBURN

        PRESIDENT, NATIONAL ASSOCIATION OF HOME BUILDERS

    Mr. Rayburn. Good morning, Chairman Shelby, Ranking Member 
Sarbanes, and distinguished Members of the Committee.
    My name is Bobby Rayburn, and I am a builder of affordable 
housing in Mississippi, Louisiana, and Alabama. I am also the 
President of the 215,000-member National Association of Home 
Builders, which I represent today.
    Thank you for holding this hearing on the regulatory 
framework of the housing GSE's.
    NAHB believes that the focus of the GSE regulatory reform 
must remain, to use your words, Mr. Chairman, on their vital 
role of providing liquidity and stability for the Nation's 
housing finance system. This has been clearly demonstrated by 
housing's critical job-producing role as an economic engine in 
an otherwise faltering economy.
    It is safe to say that the record one million-plus new home 
sales last year would not have occurred without the liquid and 
vibrant secondary market that is supported by the housing 
GSE's. I want to emphasize that no one believes there is an 
imminent crisis within the GSE system. There is time to take a 
careful and thoughtful approach to these issues. An ill-
conceived change could seriously damage housing and the 
economy.
    Regulation of the GSE's involves two key aspects--one, 
enforcing compliance with safety and soundness principles, and 
two, ensuring unwavering mission orientation. The purpose of 
the safety and soundness regulation is to ensure that the 
housing GSE's are adequately capitalized and to ensure 
appropriate governance structures and procedures.
    NAHB would support transferring the safety and soundness 
oversight of the GSE's to a strong and credible regulator that 
possesses adequate authority and resources, such as the 
Treasury Department.
    The purpose of mission regulation is to ensure that the 
GSE's fulfill their Congressional mandate and operate within 
their charters. Safety and soundness is a very relevant element 
but should not dominate program oversight. That would severely 
retard the development of programs needed to fulfill the GSEs' 
housing mission.
    NAHB maintains the program approval activities that are 
currently conducted by HUD should not be transferred to the 
Treasury Department.
    Innovative solutions to increase homeownership will 
continue only if mission oversight is regulated by an agency 
which has a housing mission, housing expertise, and housing 
experience. We believe that HUD should also continue to set and 
enforce Fannie Mae's and Freddie Mac's affordable housing 
goals.
    We agree that more needs to be done to encourage the GSE's 
to increase their activities in some market segments and 
believe that the best way to do this is through the bonus point 
incentives within the existing goals. We have laid out some 
specific recommendations within my written statement, Mr. 
Chairman.
    Mr. Chairman, you also asked me to touch on the capital 
requirements of the GSE's. NAHB supports a strong capital 
system for GSE's. We also believe that there is a need for 
stability in capital standards. NAHB therefore cautions against 
any immediate changes in either the GSEs' risk-based or minimum 
capital standards.
    Over the longer-term, we believe that the safety and 
soundness regulator should have the flexibility to adjust 
capital standards as necessary. However, a significant increase 
in the GSEs' minimum capital standard requirements would not be 
justified unless there is a measurable change in their risk 
profile. Overcapitalization of the GSE's beyond a level of 
reasonable risk would have unintended consequences for the 
housing markets by reducing the level of capital for housing 
and increasing mortgage rates.
    You also asked for feedback on the idea of a stand-alone 
independent regulator. While not our first preference, NAHB 
would be open to exploring the concept depending on how the 
details are implemented. NAHB's primary concern in any 
regulatory scenario is that the mission regulator must have a 
housing focus and expertise. The safety and soundness regulator 
must have sufficient respect and authority to satisfy Congress 
and the capital markets. NAHB recommends such an agency should 
be governed by a board of directors rather than by a single 
agency head. In order to ensure a housing focus, the board must 
have a HUD representative among others with housing expertise.
    It is also imperative to recognize the differences between 
Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. This 
can be done by establishing two divisions and maintaining 
separate funding for the cost of regulation.
    In conclusion, NAHB appreciates the opportunity to share 
our views on the regulatory framework for the housing GSE's. We 
look forward to working with the Committee on fashioning a 
solution to the oversight of these important housing 
institutions.
    Thank you.
    Chairman Shelby. I will start with Mr. Beller. Thank your 
appearance and for your detailed statement a few minutes ago.
    Some people contend, Mr. Beller, that requiring the GSE's 
to register their debt under the Securities Act of 1933 would 
be impractical given the frequency with which the GSE's go to 
market.
    The concern has been raised that registration of securities 
under the Securities Act of 1933 would be disruptive to funding 
practices because they would have to wait for the SEC to 
approve their filings.
    Can you please comment on these concerns regarding the 
registration of GSE debt, and how has the SEC accommodated 
other large financial institutions that go to market on a 
regular basis? In other words, is that a real concern, or is 
that just something that people are putting out there?
    Mr. Beller. There are certainly issues that are implicated 
by Securities Act registration that are not implicated by 
Exchange Act registration, and that is I think one of the 
reasons the focus of attention to date has been on the Exchange 
Act regulation, because from our point of view, it is 
essentially issue-free with respect to the things you are 
talking about.
    Having said that, if the question is restricted to the 
straight debt, that is, the nonmortgage-backed debt of Fannie 
and Freddie, and to the debt of the Federal Home Loan Banks, 
their issuance would raise issues of timing. We do sometimes 
review registration statements. It is a fact of life that 
large, frequent corporate issuers face and live with on a 
frequent basis.
    I will say to you, I guess, one that our self-registration 
process has made it much easier for large, frequent issuers to 
access the markets on what they consider to be a timely basis, 
and there are many, many large issuers, including financial 
institutions who, if they are not in the market every day, are 
certainly in the market very frequently.
    We have in process some thoughts about modernizing our self 
system further that would accommodate large corporate issuers 
and the GSE's if they were to become registrants under the 1933 
Securities Act.
    But the timing issue is the principal question that I think 
one has to get comfortable with. My own view is that if you are 
talking about straight debt, it is manageable. The other side 
of that equation is you really do not get much more 
information, and as to the corporations themselves, you get no 
more information with Securities Act registration than you 
already get with Exchange Act registration given our integrated 
disclosure system.
    The final point I would make is that--and my testimony 
reflects this--we are in no way opposed to Securities Act 
registration. We believe in the benefits that the securities 
laws and our processes provide for investors. But we do believe 
when it comes to the mortgage-backed securities and the 
mortgage-related securities of Fannie Mae and Freddie Mac that 
we would note that the Commission recommendation in 1992 in the 
joint report did not extend to the mortgage-backed securities, 
and we believe that this Committee and the Congress in 
considering whether to extend Securities Act registration to 
those securities should properly take into account what the 
impact would be on the mortgage market and particularly on the 
TBA market. We are not experts in being able to determine that 
impact, but we do believe it is one of the subjects that should 
be on the table because of the importance of the TBA market 
particularly in setting mortgage rates.
    Chairman Shelby. Thank you.
    Professor Carnell, your statement earlier of having a 
strong executive regulator that would be able to run the 
regulatory structure, I totally, totally agree with you on. You 
reference maybe a three-person board. While we are doing these 
hearings thoroughly and measured, because this is important 
legislation, as you well know, I had thrown out the idea--and 
this is just an idea--of maybe having an independent board, 
having the Secretary of the Treasury on that board, having the 
HUD Secretary on that board because of the housing issue, 
having perhaps the Federal Reserve Chairman on that board and 
the SEC Chairman on that board. I believe that would be four. I 
did not think about it until we had the GAO Comptroller General 
here; he serves on some boards, and of course, we will discuss 
this ourselves.
    But I think it is very important, as you pointed out, to 
have a strong executive, to have, as Senator Sarbanes 
mentioned, and he is absolutely right on this, independent 
funding and maybe a five-person board.
    Do you want to elaborate a little?
    Mr. Carnell. Well, if you were going to go the route of a 
five-member board, I like your composition--that is, to have 
the Treasury and HUD on there, I think is fundamental. And of 
course, there would be an appointed chair, I presume, a chair 
appointed by the President an confirmed by the Senate, who 
would be the executive head of the agency.
    Chairman Shelby. Sure.
    Mr. Carnell. That would be my approach with a three-member 
board.
    If you were going to go to a five-member board, having the 
two additional people be from the SEC and the Fed I think is 
excellent, because these are people who have existing 
Government responsibilities.
    Chairman Shelby. Knowledge base, too.
    Mr. Carnell. Knowledge base, and those are prestigious 
agencies. Those are good jobs. So you are going to be able to 
get capable people to come and do that, as opposed to having 
somebody come to essentially be a drone, an extra couple of 
wheels on an agency, and if they try to do anything, they will 
be doing back door diplomacy with the GSE's or trying to 
micromanage the agency staff. It is just not a good idea.
    Chairman Shelby. We have talked all morning and in other 
hearings, and we will have some more hearings here before we 
move on proposed legislation, on the ambiguity in the 
Government, our relationship with the GSE. It is there, as you 
pointed out so aptly. I do not know how we resolve that 
ambiguity, but clear language is important.
    Mr. Carnell. One suggestion, Mr. Chairman, would be that in 
my testimony I point out how the existing disclaimers of 
Government liability that, for example, the GSE's have to put 
in their securities, and there are also disclaimers in law--all 
three of them are fundamentally flawed because they do not 
speak to the real question here. In other words, they look like 
they are answering the question, but they are answering a 
different question.
    So, I do not think they do what Congress meant for them to 
do.
    Chairman Shelby. Okay.
    Mr. Rayburn, in your testimony, you suggest that removing 
any of the GSEs' legal exemptions would diminish their ability 
to meet their mission. How would greater transparency of their 
financial activities impede the mission? It looks to me like it 
would strengthen their mission--if they have nothing to hide.
    Mr. Rayburn. Mr. Chairman, we are for transparency in this 
whole issue. I think the central focus here is an issue that 
this Congress decided already some 50, 60, 70 years ago when 
the Congress decided that housing should have a special 
preference, housing should have the utmost and have the ability 
of the American people to be able to get into homeownership and 
the creation of wealth.
    We are for a strong regulator. We are looking for a 
regulator also separately, as my testimony points out, that 
adheres to the mission of housing and housing affordability as 
well as additional affordable housing goals.
    Chairman Shelby. Well, a lot of us are committed to the 
housing goal, but we are also committed to safety and 
soundness, and I think that with balance, we can have both.
    Mr. Rayburn. One reason, Mr. Chairman, that we believe 
there should be a division or something outside of Treasury as 
far as mission and the affordable housing goals is because we 
believe that Treasury has a bias against housing, as has been 
proven over the years.
    Chairman Shelby. Well, my suggestion was an independent 
regulator outside of Treasury.
    Mr. Rayburn. But you put the Secretary of Treasury on 
there.
    Chairman Shelby. And also I would put some others on there 
with a lot of expertise. You would also create a strong 
executive.
    Mr. Rayburn. I think we could agree with that, and I have a 
concept paper here that I would like to leave with you----
    Chairman Shelby. We will take that.
    Mr. Rayburn. --but as long as the central mission of this 
whole process dealt with housing and affordable housing.
    Chairman Shelby. Okay.
    Mr. Beller, should Congress be wary--those of us up here--
of applying to the banks a disclosure scheme that was intended 
for public companies--in other words, the Federal Home Loan 
Banks?
    Mr. Beller. I think very strongly that you should not be 
wary or words.
    Chairman Shelby. Not be; okay.
    Mr. Beller. As I said before, we have very significant 
numbers of companies who are registered and report with us 
solely because they issue public debt securities--over 100.
    Senator Sarbanes. Mr. Chairman, could I pipe in right 
here----
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. --because I think that is a very 
important question. There have been these activities going on 
under certain rules, and it seems to me that the transition 
over is important.
    I have information here that says that, ``In the first 6 
months of 2003, the Federal Home Loan Banks went to the market 
7,000 times and raised $349 billion.''
    Chairman Shelby. Seven thousand times.
    Senator Sarbanes. ``A large market debt issuer and SEC 
registrant, GE, raised $42 billion in 249 bond issues. Ford 
Motor Company raised $8.5 billion in 236 bond issues. Total 
debt issuance in 2003--the U.S. Treasury, $625 billion, Federal 
Home Loan Banks, $550 billion, in 11,500 separate deals.''
    I am concerned about these figures with respect to the 
Federal Home Loan Banks. It is one of the things we are 
wrestling with. But it does seem to me that this order of 
magnitude of difference gives me some pause or concern with 
respect to your assurance that there is not a problem, that it 
is not something we need to think through and worry about.
    Mr. Beller. With respect to Exchange Act registration which 
would get investors the information about the Banks that we 
believe they deserve to have, the number of offerings and 
issuance is really not a relevant consideration. They would 
file annual reports, they would file quarterly reports, they 
would file current reports, as any other registrant. But the 
actual offering of securities would not trigger a registration 
requirement, and that is why I said earlier the Exchange Act 
registration issue is really issue-free as to straight debt.
    As Chairman Shelby pointed out, and as you are both very 
correctly focusing on, the issue of timing of offering 
transactions by the Federal Home Loan Banks, while I believe we 
could use our existing processes to make it manageable, does 
raise issues with respect to timing and filings the Exchange 
Act registration proposal does not raise, and at the same time, 
with Exchange Act registration, you are getting basically all 
the corporate information that you would get under Securities 
Act registration anyway.
    Senator Sarbanes. But you are drawing a distinction, then, 
or a line between--you would not apply, or at least have 
concern about just applying full-scale, what applies to a 
private corporation; is that right?
    Mr. Beller. We would have no issues applying Exchange Act 
registration and all the requirements of the Exchange Act to a 
debt-only issuer to the Federal Home Loan Banks.
    Senator Sarbanes. What would you have a problem with?
    Mr. Beller. We believe, as my testimony indicates, that 
this Committee and the Congress should consider, and we are 
happy to consider with you, the timing issues that would be 
raised by extending the registration requirement to Securities 
Act registration as well as Exchange Act registration.
    Senator Sarbanes. I see. Okay.
    Thank you, Mr. Chairman. Sorry.
    Chairman Shelby. These are very important questions, and I 
know Senator Sununu has been very patient, and I have a couple 
of other things I want to touch on.
    Financial statements of the Federal Home Loan Banks--could 
you touch on how the SEC would treat, if you thought this out, 
the combined financial statements of the Federal Home Loan 
Banks and what authority would the SEC have to address material 
misstatements in the combined financial statements?
    Mr. Beller. That is an issue that we have been thinking 
hard about and talking to the Finance Board about, because 
there is no registrant, there is no issuer with respect to the 
combined financial statements. They roll up the financial 
statements of the 12 Federal Home Loan Banks.
    What we have proposed to the Finance Board--the Finance 
Board has the right to review and approve the combined 
financial statements under its current regulations is a 
mechanism whereby they would--and I think this would be 
workable with any regulator who had that authority--in 
connection with their approval provide us with an opportunity 
to review and give comments on the combined financial 
statements and raise issues with them before they were approved 
based in large part, presumably, on our familiarity with the 
individual statements of the banks.
    I suppose the last thing I would say to that is that while 
there is no issuer with respect to the combined financial 
statements, they would nonetheless be subject to our antifraud 
jurisdiction and enforcement processes.
    Chairman Shelby. Thank you.
    Mr. Rayburn, one last question for you, if I could, on 
program approval versus regulation approval. In regard to the 
independence of any new regulator, your testimony argues for a 
high level of independence, which I support. You specifically 
suggest in relation to rulemaking--and these are your words--
``The agency's policy justifications for issuing regulations 
should be devoid of interference from politically appointed 
officials.'' You also argue that program approval should remain 
at HUD.
    I am curious as to why you believe the issues of safety and 
soundness should be insulated from political pressures, but 
program approval should not be. Why the difference--just for 
the record.
    Mr. Rayburn. Well, for example, the program approval left 
at HUD would do some of the good things that HUD has done in 
the new programs that have been approved with both Fannie and 
Freddie. The regulatory side is one that, while we certainly do 
not like interference with the political environment in 
anything--we would hope not to have that there; we would hope 
that those programs in regulation would be based on a just and 
fair system.
    But in addition to that, I think one of the most important 
things that still has to be said here--and I really want to 
take just a moment, Mr. Chairman----
    Chairman Shelby. Yes, sir.
    Mr. Rayburn. --and thank you for having me here today 
representing the Home Builders' Association, because I think 
thus far in your panelists, I am the only person who is a home 
builder who sees the face of America out there, and I 
appreciate that.
    Chairman Shelby. Your appearance here today on this panel 
is very important.
    Mr. Rayburn. Thank you.
    I want to share also with you that while we in the Home 
Builders try very hard to produce those 1.8 million units that 
we did last year, we are fulfilling a need not only in the 
environment of our country, but we are also fulfilling a need 
with the demand that is out there today. Today in our country, 
we have some one million immigrants coming in, we have 1.3 
million household formations, we have between 400,000 and 
500,000 units that get burned down, blown away, or torn down in 
this country every year. So the need and demand is going to be 
there for the next 10 years.
    If you create a regulator to regulate housing that the 
Congress has said is very important, and you have said the same 
thing, Mr. Chairman, and others here today, if you create a 
regulator that messes up the system, that as some would have it 
moves capital away from housing to other places, then you have 
really injured a key part of this economy as we know it today. 
Housing has propped up the economy for over 3 years now, and 
hopefully, the economics of what is taking place right now will 
kick in gear and take off. But I can assure you that we will 
continue to try to help, but we need your help. We need the 
help of those strong, vibrant GSE's, Fannie Mae, Freddie Mac, 
and the Federal Home Loan Bank System, and we need it done 
outside of politics as far as the regulation is concerned, but 
with help on the affordable housing goals and the 
allowance of new programs to take place in a very clean and 
unfettered environment.
    Chairman Shelby. I think we share the same goals.
    Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    Thank you, Mr. Rayburn, and to your point, which is an 
important one, we are not in the business, or our goal should 
not be to move capital toward housing or away from housing. 
What we want to focus on here is establishing a regulatory 
structure that makes sense, a regulatory structure that is 
focused, that has the powers it needs in order to ensure safety 
and soundness within this area of business, of finance, that 
affects the housing industry.
    I also appreciate your perspective in the real world. I do 
not know if you use those terms, but I like that term. You are 
out there in a business, taking risks, making decisions every 
day, and I think we should all appreciate that.
    How many members are there in the Home Builders?
    Mr. Rayburn. Two hundred fifteen thousand member firms and 
over 800-plus local and State associations, employing some 8 
million people in this country.
    Senator Sununu. You mentioned that you deal with affordable 
housing. I assume some of those members, deal let us say 
exclusively in single-family or higher-end stuff ?
    Mr. Rayburn. Certainly.
    Senator Sununu. And you even build on spec?
    Mr. Rayburn. Certainly.
    Senator Sununu. And you even build million-dollar houses on 
spec?
    Mr. Rayburn. Certainly.
    Senator Sununu. Some of them refuse to build on spec?
    Mr. Rayburn. Yes, sir.
    Senator Sununu. I know I have dealt with some that have 
refused to build on spec.
    Do any of them provide financing for their customers in any 
particular way?
    Mr. Rayburn. Some of our large production, high production 
builders do.
    Senator Sununu. Or, I suppose in a more personal or 
informal way, you can stretch out the payables and payment 
schedules; they set their own payment schedules with the people 
they are doing business with, don't they?
    Mr. Rayburn. I would say that a few do, not a lot--not with 
the housing finance system in this country the way it is today.
    Senator Sununu. Do all the members in your association have 
the same risk profile, or do these choices they make affect 
their business risk?
    Mr. Rayburn. I think choices affect everybody's business 
risk. I touched on moving capital away from housing and some of 
the programs that have come out in the last 10 years to 
positively affect the production of affordable housing. For 
example, Fannie Mae recently got approval from HUD after a 10-
year pilot program at HUD to do AD&C lending. AD&C is 
acquisition, development and construction lending. I know that 
I was around in the early 1980's and the early 1990's when 
construction financing dried up for one reason or another in 
this country.
    Senator Sununu. An interesting point. Naturally, the point 
I am making is in part that the business activities, the 
business lines that you are involved in, your business 
practices, all affect the risk and the safety and the soundness 
of an institution. You mentioned development and construction. 
There again is a good point. I assume getting involved in the 
financing of a commercial development on spec in Houston 
probably looks a lot different than getting involved in a 
commercial development in San Diego, Seattle, or Manchester, 
New Hampshire. Again, the business or program activity has a 
big impact on the safety and the soundness of whatever 
institution might be involved, whether it is a GSE or the 
Federal Home Loan Bank or an independent home builder like 
yourself.
    So it would seem to me that we would want the regulator 
responsible for the safety and soundness of these very 
important institutions to have some ability, not just some 
ability but the ability, to make good decisions about these new 
lines of business or program activities, but this is something 
that the Home Builders have opposed. Why is that?
    Let me be more pointed. It seems inconsistent to me that 
you would oppose putting this type of regulatory authority into 
the regulator responsible for soundness when you have the 
direct business experience that reinforces this perception that 
business activity, program activity, really does affect risk 
profile.
    Mr. Rayburn. Senator, we would always separate the two 
because of the fact that we want to keep housing as a central 
focus and mission. If you give veto power over the safety and 
soundness regulator, then all of a sudden, the safety and 
soundness regulator is controlling the production of housing in 
this country. If we are going to have a referendum on housing, 
then that is what we should do. But some of the GSE detractors 
have thrown up other issues.
    That is why we believe that the central focus on any 
regulator should not be tied to safety and soundness being 
inclusive of mission, programs, as well as the affordable 
housing goals.
    Senator Sununu. Even if those programs have a direct effect 
on risk profile and the safety and soundness of the 
institution?
    Mr. Rayburn. They should be considered by the safety and 
soundness regulator, but it should not have veto power over it, 
no, sir.
    Senator Sununu. But you do not want to give them any power 
to limit or regulate the areas of business or programs or lines 
of activity that these institutions can be involved in?
    Mr. Rayburn. I believe if Congress in its wisdom sets up 
this regulator in the right way that it can be done in a manner 
that it can be handled effectively and still keep housing's 
central focus and mission out there so the American public can 
continue to access the American Dream of homeownership.
    Senator Sununu. In your written testimony, you suggest that 
most of the proposals that you have seen ``often make no 
reference to the responsibility of the regulator to ensure that 
the GSE's fulfill their Congressionally mandated purpose.''
    Which of the proposals that are out there make no reference 
to the responsibility of the regulator to ensure that GSE's 
fulfill their mandated purpose?
    Mr. Rayburn. The proposal by the White House, as an 
example, that Treasury be the regulator. Everything would be 
inside Treasury, totally controlled by Treasury.
    Senator Sununu. I think you mentioned this earlier. How has 
Treasury proven its bias against housing?
    Mr. Rayburn. In the mortgage revenue bond program, there 
has been no increase in the single-family limit since 1994, 
even though we have repeatedly asked the Treasury to take a 
look at that and move it upward. It is causing a problem in so 
many areas in so many States.
    The Low-Income Housing Tax Credit Program on the 
multifamily production side, with what is called the TAM's, the 
Technical Advice Memorandums, we have repeatedly asked Treasury 
to take a look at those and solve some of the problems that are 
created by their going in and giving these private rulings and 
not letting it happen. Those are the examples, Senator.
    Senator Sununu. So you are citing the proposals in this 
case to put the regulator in Treasury, not necessarily the 
proposals to put it somewhere outside Treasury, as Senator 
Shelby has described in many of this proposals and remarks.
    Mr. Rayburn. That is correct.
    Chairman Shelby. Senator Sununu, your time is up. We will 
give you another round.
    Senator Sununu. I am sorry, Mr. Chairman. I am over time.
    Thank you very much, Mr. Rayburn.
    Chairman Shelby. Senator Sarbanes, thank you for your 
patience.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Mr. Rayburn, perception of your testimony today is that if 
you could be assured that an independent regulator would be 
balanced in terms of harmonizing safety and soundness in the 
housing mission, that would address a lot of your concerns, 
would it not?
    Mr. Rayburn. Yes, sir, it would. How would you do that?
    Senator Sarbanes. Well, I am going to try to follow along 
with you here now.
    Let me put some permutations to you. If you had the HUD 
Secretary on there, presumably as a champion for housing--
although that presumption is not always borne out, I regret to 
say, which is another problem--but if you had the HUD 
Secretary, the Treasury Secretary, and then had an independent 
chairman appointed by the President and confirmed by the 
Senate, which would create a dynamic to try to get somebody of 
stature, presumably, who would be able to balance these things 
out, and also wrote in some pretty strong housing mission goals 
or requirements, that might do it--I do not know. What is your 
reaction to that?
    Mr. Rayburn. It might.
    Senator Sarbanes. I think the thing that Rick Carnell 
wanted is a loaded deck for you all----
    Mr. Rayburn. I concur whole-heartedly, Senator.
    Senator Sarbanes. --a little bit for the housing mission, 
but we are struggling here to find some way to make sure we get 
safety and soundness and also get appropriate attention to the 
housing mission.
    First of all, would you regard the HUD Secretary and the 
Treasury Secretary as an even-Steven arrangement, a 
counterbalance one with the other?
    Mr. Rayburn. I do not know whom you give veto power to over 
what, but I would be interested to see on paper how you would 
structure this thing. But I would also point out something you 
said a while ago, Senator. You know, whether the HUD Secretary 
and what is taking place at HUD right now is really focused 
where it should be, I certainly cannot speak to, but I know 
that the Department of Housing and Urban Development is the 
only Cabinet-level agency that talks about housing at all, that 
is focused on housing.
    Even as late as yesterday, I was at HUD visiting with Under 
Secretary Bernardi on a number of different housing issues. I 
as President of NAHB this year, am appointing inside of our own 
trade association a housing task force that is going to look at 
the operations of HUD. Under Secretary Bernardi told me he 
would be glad to help us and participate, as Secretary Weicher 
did also, in our efforts, because we are on the front line, 
using the housing programs at HUD on an everyday basis. Whether 
it be the FHA insure mortgages, whether it be on the 
multifamily side or through the home grant programs of the 
CDBG, we are out there front-lining every day, working to find 
better ways to work with HUD as the central focus of housing in 
this country, as well as the GSE's, in order to be able to 
produce more and better affordable housing.
    Senator Sarbanes. Yes. Well, I have to say to you in all 
candor that my perception of HUD in recent times is that it has 
not been a very forceful advocate for housing, and in fact I 
think there are people within the HUD hierarchy who are really 
not carrying out the housing mission, they are constraining it.
    Mr. Rayburn. We hope to work to change that.
    Senator Sarbanes. In fact, the former Secretary Martinez 
came here with John Snow and in effect abdicated, I thought, 
the HUD Secretary's role as far as being a clear spokesman or 
advocate for housing. So, I think there is a problem, but that 
is a bigger question and must reflect where the Administration 
is placing its priorities. It still leaves us wrestling with 
the question of how do we get a regulator who adequately 
addresses the safety and soundness, but at the same time, we 
ensure that the housing mission receives appropriate attention 
and is not simply submerged in the process.
    Mr. Rayburn. We are looking for the same thing, Senator.
    Senator Sarbanes. That is why the Chairman is holding these 
hearings.
    Mr. Rayburn. But also I would like to point out in the 
entire process that in this country, we still have so many 
families and so many individuals who are left out of affordable 
housing and housing ownership in this country. This year, the 
theme of NAHB is going to be ``housing America's working 
families.'' Working families are defined as the teachers, the 
firemen, the policemen, the public service providers in the 
communities that you and I live in that teach our children, 
protect our streets, keep our homes safe, and provide the 
necessary services that we have to have in those communities 
that we depend on--but yet at night, they go to another 
community to live, 50, 60, 70 miles away a lot of the time, or 
they live in underhoused conditions, housing that does not meet 
their needs, is not something that most families would want to 
live in.
    Working with the Congress and working with HUD and our 
friends at the GSE's, we hope to continue to try to find more 
and better ways to help those working families in this country 
to become homeowners and move toward the wealth creation 
scenario that we would all like to see continued.
    So, Senator, we would like to see your continued help and 
support, sir.
    Senator Sarbanes. Mr. Chairman, let me just say in closing 
first that I welcome the Home Builders' initiative that you 
have just outlined for us about housing the working families. 
The Home Builders over the years have made a very important 
contribution, I think, to the economic and social strength in 
this country. First of all, you do it directly in helping to 
provide housing for our families. I think homeownership 
contributes to strong communities. Every study has shown that 
once people are invested in homeownership, their investment in 
their community, their concern for maintaining the community, 
strengthening the schools, and so forth and so on takes a 
significant leap forward. Of course, there is the broader 
macroeconomic impact of housing in this country and the 
strength that that brings overall to the economy.
    We are mindful of that mission. We are also, of course, as 
Chairman Shelby pointed out, having sat here through the 
savings and loan--well, I cannot find an adjective----
    Chairman Shelby. Debacle.
    Mr. Rayburn. I was on the business side of that, too, and 
it was not fun.
    Senator Sarbanes. --it was rough, it was rough, no question 
about it--so we want to make sure that----
    Chairman Shelby. Senator Sarbanes and I have a little 
institutional history here.
    Senator Sarbanes. Yes, we have some memory on that.
    Thank you very much for your testimony.
    Mr. Rayburn. Thank you.
    Chairman Shelby. I would just like to make a point. I did 
not read in Professor Carnell's statement that he is 
antihousing but he is sound housing.
    If we are committed--and we are--to a housing program for 
all Americans, we want to make sure that that has the financial 
footings underneath it. Otherwise, it will be a crisis, and we 
will have real problems, more so than we have ever seen. What 
we are trying to do is balance that, as I see it, to avoid 
that, to make sure that the institutions that finance our 
housing for the most part are sound and safe and mission-
oriented. That is my goal, anyway.
    Professor Carnell, do you want to touch on that?
    Mr. Carnell. It is certainly mine as well, Mr. Chairman.
    I might add that in 6 years as Assistant Secretary of the 
Treasury, I head no words spoken against housing. And if you 
think more broadly about what are the incentives for 
policymakers, housing has a special place in American policy, 
American values, and American politics. We have a large, well-
organized prohousing lobby. We have no antihousing lobby. There 
is no incentive for elected officials to be antihousing.
    And this notion that the Department of the Treasury is 
populated by these venomous gnomes who want people to be ill-
housed is simply untrue, and I would note that it is a way of 
talking that we saw from the savings and loan lobby 20 years 
ago when they were basically resisting being brought into 
modern regulation.
    So, I agree with you, Mr. Chairman, that we need to strike 
a balance here, and I just want to point out that I do not see 
the incentives for elected officials or major political 
appointees to be antihousing.
    Mr. Rayburn. As a follow-up----
    Senator Sarbanes. Do you think there is a place in the 
scale, short of being a venomous gnome who wants the population 
to be ill-housed, where someone might be perceived as not being 
a forceful advocate for housing?
    Mr. Carnell. Certainly that is possible. Mr. Rayburn 
pointed to some tax issues, and there are disagreements about 
how tax benefits should be adjusted. But I never saw these 
people.
    Senator Sarbanes. Yes. I do not have to see the Treasury 
people as venomous gnomes in order to maybe have a little 
concern about how sympathetic they are to an active housing 
program, do I?
    Mr. Carnell. I do not see them as unsympathetic. I 
understand your point about wanting balance. So in that sense, 
the answer to your question is yes. But you talked about, for 
example, if you had a multimember agency. If you have Treasury 
and HUD on there, I think you are going to have balance. It may 
be from one Administration to another, we may disagree with 
policies. In a democratic government, that is just something we 
have to deal with, that sometimes people with power are people 
who are not going to share our values. But I think that 
structurally, it makes sense and that there is balance there.
    Chairman Shelby. Mr. Carnell, what if we created a 
regulator whose term would be longer than, say, a 4-year term?
    Mr. Carnell. I think more than 4 years would be----
    Chairman Shelby. Give some independence, maybe.
    Mr. Carnell. --yes--and I would say, too, that something 
that has been done with some agencies is you just appoint 
somebody to fill the unexpired term of their predecessor. I 
would not suggest doing that here.
    Chairman Shelby. No, that is not a good situation.
    Mr. Carnell. You want more continuity. You want this to be 
a good job.
    Chairman Shelby. You have a temporary deal there, and it 
just does not bode well.
    Mr. Carnell. Exactly.
    Chairman Shelby. Mr. Rayburn.
    Mr. Rayburn. Senator, if I might follow up on that, I would 
share that we would welcome Mr. Carnell as well as all of the 
Treasury Department over on the prohousing side, but we would 
like a little proof----
    Chairman Shelby. Mr. Carnell is a Professor at Fordham Law 
School now.
    Mr. Rayburn. --I know, but his track record was over there, 
though--but we would like a little proof that that would take 
place, and it certainly has not based on their track record.
    Chairman Shelby. Well, gentlemen, we thank you for a 
spirited discussion and your insights into all of this.
    The hearing is adjourned.
    Thank you.
    [Whereupon, at 12:25 p.m., the hearing was adjourned.]
    [Prepared statements and response to written questions 
supplied for the record follow:]
              PREPARED STATEMENT OF SENATOR ELIZABETH DOLE
     As everyone knows, Fannie Mae and Freddie Mac were created to help 
more Americans own their own homes. Their mission--as set forth by 
Congress--is to promote home mortgage financing by bringing liquidity 
to the secondary mortgage market and making more funds available for 
Americans to buy homes. Today, their outstanding securities now exceed 
$4 trillion--or more than the entire U.S. public debt.
     In order to carry out this mission, Congress granted Fannie and 
Freddie privileges that have not been extended to other participants in 
mortgage financing. Among these privileges is a line of credit with the 
U.S. Treasury to which the GSE's could turn for short-term capital 
needs. This line of credit demonstrates this Nation's commitment to the 
mission of the institutions, and also the special relationship between 
these institutions and the Treasury.
     This relationship allows Fannie Mae and Freddie Mac to borrow 
money at a rate as much as 40 basis points below other well-capitalized 
financial institutions. In addition, the GSE's are exempted from State 
and local taxes and from registering with the SEC or paying the fees 
associated with such registration, exemptions not enjoyed by other 
privately held businesses and financial institutions. As a result of 
enjoying these advantages, Fannie and Freddie now have virtually 
unlimited market power in any activity they choose to enter.
     A growing consensus has recently emerged that Congress should 
establish a regulator over Fannie Mae and Freddie Mac with adequate 
resources, staff, and authority to monitor new and ongoing activities 
of the GSE's.
     A prime example demonstrating the need for such a regulator is the 
announcement by Fannie Mae last fall that an accounting error had 
resulted in a $1.1 billion understatement of shareholder equity. Upon 
reviewing reports, it appears this was an honest mistake made while 
complying with the Federal Accounting Standards Board's new rule number 
149. As a result of this announcement, and the subsequent reaction in 
the markets, over $4 billion of market capitalization disappeared 
overnight.
     Our financial markets also have additional concerns about Fannie 
Mae and Freddie Mac. For example, the ability of Fannie Mae and Freddie 
Mac to aggressively hedge against interest rate risks. While no one is 
questioning their ability to provide effective hedges--they 
successfully managed over $1 trillion dollars of interest rate swaps in 
2002--I would note that a great deal rests upon their ability to 
properly manage such risks and we need only to look at the last few 
months to see that both Fannie Mae and Freddie Mac make mistakes.
     Such concerns intensify market sensitivity, which will continue 
until Congress establishes a new regulator over these entities and its 
powers are implemented.
     As Fannie Mae and Freddie Mac continue to grow in order to 
carryout their missions, I believe we must have a regulator empowered 
with sufficient authority to prevent fraud and mistakes that can easily 
add up to the loss of billions of dollars, and thereby protect the 
American tax payers.
     Any new regulator must be able to determine whether or not new 
programs and products contemplated by the GSE's help them fulfill their 
mission or whether those areas cannot be filled by private industry. 
Further, such authority cannot be limited solely to safety and 
soundness concerns--it is certain that actions exist that are safe and 
sound, but which nonetheless are inappropriate for Fannie and Freddie 
to take.
     Last summer, Senators Hagel, Sununu, and I introduced S. 1508, the 
Federal Enterprise Regulatory Reform Act of 2003. Our legislation gives 
the regulator authority to approve new products and thereby ensure 
Fannie Mae and Freddie Mac 
remain focused on their core mission of promoting affordable home 
mortgage financing, especially for those Americans who have never owned 
their home before. I hope my colleagues will join us in support of this 
important initiative.
     Mr. Chairman, your dedication to this issue is greatly appreciated 
and I look forward to our continuing work on this important issue. The 
need for proper regulatory oversight of the GSE's is a high priority 
and I am committed to working through these issues with you.





                  PREPARED STATEMENT OF ALAN L. BELLER
               Director, Division of Corporation Finance
                U.S. Securities and Exchange Commission
                           February 10, 2004
Introduction
    I am pleased to have this opportunity to testify before you on 
behalf of the Securities and Exchange Commission regarding the 
application of disclosure and reporting requirements of the Federal 
securities laws to Fannie Mae, Freddie Mac, and the Federal Home Loan 
Banks. These Government Sponsored Enterprises (GSE's) issue marketable 
debt to the public. In addition Fannie Mae and Freddie Mac have 
publicly held common stock and also issue guaranteed mortgage-backed 
securities to the public. All of these entities and their securities 
are exempt from the registration and disclosure provisions of the 
Federal securities laws. None of the debt securities issued by any of 
these GSE's is backed by the full faith and credit of the United 
States.
Commission's Historical Views on GSE Disclosure
    Since at least 1992, the Commission has expressed the view that, 
because the GSE's, most prominently Fannie Mae and Freddie Mac, but 
also including the Federal Home Loan Banks, sell securities to the 
public and have public investors, and do not have the ``full faith and 
credit'' Government backing of Government securities, their disclosures 
should comply with the disclosure requirements of the Federal 
securities laws. The Commission participated with the Department of the 
Treasury and the Board of Governors of the Federal Reserve System in a 
1992 Joint Report on the Government Securities Market (1992 Report) 
that addressed these issues, among other things.\1\ Mandatory 
compliance by the GSE's with these disclosure requirements and the 
Federal securities laws is the objective. While the 1992 Report 
addressed registration, the manner by which mandatory compliance is 
achieved--including through voluntary registration with the 
Commission--may be less significant. Further, the disclosure quality 
that we seek for the GSE's can only result from becoming subject to the 
SEC's reporting system. The disclosure quality results not only from 
our disclosure rules but also the Commission's and the staff's 
administration of these rules, including our review and comment 
processes and our enforcement program.
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    \1\ Department of the Treasury, Securities and Exchange Commission, 
Board of Governors of the Federal Reserve System, Joint Report on the 
Government Securities Market, January 1992.
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Preliminary Discussion of Registration
    For purposes of today's subject, two of the Federal securities laws 
are relevant--the Securities Act of 1933 (Securities Act) \2\ and the 
Securities Exchange Act of 1934 (Exchange Act).\3\ The Exchange Act 
requires, or allows for, registration by issuers of classes of their 
public securities. Registration under the Exchange Act results in 
reporting requirements providing for disclosure of detailed information 
relating principally to the issuer. Under the Exchange Act and the 
Commission's rules, required information includes financial statements, 
management's discussion and analysis, description of business, 
information regarding directors and management and compensation, 
information regarding related party transactions and other 
information.\4\ This corporate information is the information on which 
the Commission and staff have focused in urging disclosure by GSE's. 
Registration under the Exchange Act also subjects reporting companies 
to the provisions of the Sarbanes-Oxley Act applicable to issuers.\5\ 
These provisions include CEO and CFO certification requirements, 
internal control requirements, prohibition on loans to insiders, 
restrictions on the use of proforma or non-GAAP measures and enhanced 
disclosure requirements, for example regarding off-balance sheet 
transactions.
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    \2\ 15 U.S.C. Sec. 77a et. seq.
    \3\ 15 U.S.C. Sec. 78a et. seq.
    \4\ See generally Regulation S-X, 17 CFR 210 and Regulation S-K 17 
CFR 229.
    \5\ Pub. L. 107-204 (2002) 116 Stat. 745 (2002).
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    The Securities Act, by contrast to the Exchange Act, requires 
registration by issuers of transactions, namely public offerings by 
issuers of their securities. One result of registration under the 
Securities Act is required disclosure of essentially the same corporate 
information as is required for reporting companies under the Exchange 
Act. Another result of registration under the Securities Act is 
required disclosure regarding the securities being offered.\6\ Finally, 
because the Securities Act registers securities offerings, review by 
the Commission staff of Securities Act registration statements can 
directly affect the timing of those transactions.
---------------------------------------------------------------------------
    \6\ Registration of sales under the Securities Act also results in 
an automatic requirement to file Exchange Act reports for at least some 
period of time.
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Fannie Mae and Freddie Mac
    On July 12, 2002, Fannie Mae and Freddie Mac announced that each 
would voluntarily register its common stock under the Exchange Act and 
thus become subject to Commission reporting requirements. This decision 
took the form of a public announcement, along with press releases 
issued by each company. Fannie Mae's registration statement under the 
Exchange Act was declared effective on March 31, 2003. Freddie Mac has 
stated it intends to complete the Exchange Act registration process 
when it completes its restatement and audit of its financial 
statements. As noted above, registration and reporting also trigger 
applicability of the provisions of the Sarbanes-Oxley Act that apply to 
reporting companies.
    The proxy and insider transaction reporting requirements of the 
Exchange Act (Sections 14(a) and 16(a)) by their terms specifically 
apply only to nonexempt equity securities. The classes of common stock 
of Fannie Mae and Freddie Mac remain exempt securities even if 
registered under the Exchange Act and thus not subject to either 
section. In order to obtain the disclosure that would be required by 
officers and directors of the companies under the insider transaction 
reporting requirements of the Exchange Act and compliance by the 
companies with the Commission's proxy rules, the Office of Federal 
Housing Enterprise Oversight adopted rules effective April 30, 2003 
requiring the officers and directors of Fannie Mae and Freddie Mac to 
file with the Commission all reports and forms that would be required 
by Section 16(a) and the companies to file with the Commission all 
reports required pursuant to Section 14(a).
    As I noted, Fannie Mae has registered its common stock under the 
Exchange Act. Fannie Mae is now fully subject to the Commission's 
disclosure rules and the requirements of the Sarbanes-Oxley Act. 
Freddie Mac has not completed the process. Fannie Mae has filed with 
the Commission its 2002 annual report on Form 10-K including audited 
financial statements, quarterly reports on Form 10-Q containing 
unaudited financial statements, its proxy statement relating to its 
annual meeting of shareholders and numerous current reports on Form 8-
K. In addition, officers and directors of Fannie Mae have filed dozens 
of Statements of Changes in Beneficial Ownership on Form 4.
    Our attention to date in seeking disclosure by the GSE's that meets 
our requirements has focused on corporate information. It has been our 
priority that investors who purchase and sell stock or ``straight'' 
debt (that is nonmortgage-backed debt) of the GSE's are entitled to the 
corporate information required to be disclosed under the Exchange Act. 
While Fannie Mae and Freddie Mac continue to be exempt from the 
requirements to register the offer and sale of securities under the 
Securities Act of 1933, the information about the corporation that 
would be required to be disclosed in a prospectus contained in a 
registration statement under the Securities Act is the same as Fannie 
Mae is, and Freddie Mac will be, required to provide as a result of 
their voluntary registration under the Exchange Act.
    Registration of securities transactions by Fannie Mae and Freddie 
Mac under the Securities Act, especially offerings of their mortgage-
backed and other mortgage-related securities, requires consideration of 
factors not present with the more easily accomplished registration 
under the Exchange Act. The Commission did not recommend in the 1992 
Report removing the exemption from the Federal securities laws for the 
offer and sale of mortgage-backed and mortgage-related securities of 
Fannie Mae and Freddie Mac. While we seek the achievement of the 
benefits for investors of registration under the securities laws, we 
recognize that these other factors need to be examined.
    First, as noted above, the review process of the Division of 
Corporation Finance of registration statements of transactions under 
the Securities Act means that the timing of transactions could be 
affected. This is not the case as a result of Exchange Act 
registration, which requires the filing of periodic and current reports 
with company information rather than filings tied to the timing of 
offerings.
    Second, because Fannie Mae's and Freddie Mac's mortgage-backed and 
other mortgage-related securities are backed by their respective 
guarantees, important information in analyzing these securities as a 
credit matter includes their financial and other corporate information. 
Exchange Act filings would contain this information without regard to 
Securities Act registration.
    As to other information regarding mortgage-backed and related 
securities, in late 2002, staff of the Commission, Department of the 
Treasury, and OFHEO conducted a joint study of disclosure regarding 
mortgage-backed securities with a view to ensure that investors in 
mortgage-backed securities are provided with the information that they 
should have. The task force issued a report in January 2003.\7\ The 
report notes that market participants found the mortgage-backed 
securities market extremely efficient. The report concluded that some 
additional disclosures would be both useful and feasible in the 
mortgage-backed securities market. These include:
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    \7\ Department of the Treasury, Office of Federal Housing 
Enterprise Oversight, Securities and Exchange Commission, Staff Report: 
Enhancing Disclosure in the Mortgage-Backed Securities Market, January 
2003.

 Loan purpose (that is, whether a purchase or refinance)
 Original loan-to-value (LTV) ratios
 Standardized credit scores of borrowers
 Servicer for the pool (this may not always be the seller or 
    originator)
 Occupancy status (owner-occupied or investor)
 Property type (for example, detached, condo)

    Both Fannie Mae and Freddie Mac have implemented these new 
disclosures.

    Finally, registration of offerings of the GSE's mortgage-backed and 
related securities under the Securities Act may raise another 
significant and uniquely complex factor--the impact on the mortgage 
market--that should be considered. In particular, a substantial 
portion, and recently a majority, of the GSE's mortgage-backed 
securities have been sold into the so-called ``To Be Announced,'' or 
TBA, market. These transactions involve forward sales of mortgage-
backed securities comprised of pools of mortgages not yet identified 
and in many, if not most, cases not yet in existence. The parameters 
which the securities and the mortgages in the pools must meet are set 
forth in standards established for the TBA market by market 
participants and discussed in the January 2003 report. Because actual 
mortgage pools are not established at the time of the forward sale 
transactions, there can be no disclosure of mortgage pool 
characteristics at the time of registration of the offerings. The TBA 
standards the mortgage pools must meet are already available to the 
market.
    In addition, we understand that the TBA market is used to set or 
``lock in'' mortgage rates in the U.S. housing market. A decision to 
require registration under the Securities Act of offers and sale of 
mortgage-backed securities should properly take into account whether, 
and if so, how such registration might impact the mortgage market and 
the operation of the TBA market. I believe that similar considerations 
formed at least a portion of the background for the conclusion 
expressed in the 1992 Report.
Federal Home Loan Banks
    The Federal Home Loan Bank System was created prior to enactment of 
the Securities Act and the Exchange Act and the creation of the 
Securities and Exchange Commission in 1934. The System was created in 
1932 to restore confidence to the Nation's financial institutions and 
improve the supply of funds to local lenders.\8\ The System is 
comprised of 12 banks. The Federal Home Loan Bank System through the 
Office of Finance is one of the largest issuers of debt securities in 
the world with $673.7 billion outstanding as of December 31, 2002. We 
believe that the holders of debt issued by the Office of Finance, for 
which the 12 Banks are jointly and severally liable, are entitled to 
the same type of information that is provided to investors in other 
public debt securities. Our interest is in assuring that public 
investors in this debt are provided with sufficient information when 
they are making their investment decisions.
---------------------------------------------------------------------------
    \8\ Federal Home Loan Bank Act, Pub. L. No. 72-304, 47 Stat. 725 
(1932)
---------------------------------------------------------------------------
    The Federal Home Loan Banks are also exempt from the Federal 
securities laws. The Banks prepare financial statements based on 
regulations of the Federal Housing Finance Board, which refer to 
Commission disclosure regulations. However, the staff of the Commission 
does not review these financial statements or any other disclosure 
documents of the Banks. The Banks are also not subject to the 
provisions of Sarbanes-Oxley Act of 2002 applicable to issuers, as 
discussed above. However, the Banks are subject to general antifraud 
restrictions prohibiting false or misleading statements of material 
facts or the omission of material facts necessary to make the 
statements made, in light of the circumstances under which they are 
made, not misleading. In September 2003, the Finance Board proposed for 
comment a rule to require registration under the Exchange Act by the 
Banks with the Commission. The comment period for that rule ended 
January 15, 2004.
    The Banks, although Federally chartered entities, have many of the 
same disclosure issues as any financial institution whose securities 
are issued to, and held by, the public. Consolidated obligations for 
which each Bank is either primarily or secondarily obligated are sold 
to the public in underwritten offerings. As discussed above, we believe 
investors in those debt securities are entitled to the same type of 
information as that provided by other issuers of public debt. As also 
discussed above, we further believe that the Commission's detailed 
disclosure rules and filing requirements and the staff review and 
comment process provide the best framework for disclosing information 
to which investors are entitled.
    Because the debt of the Banks does not carry the full faith and 
credit backing of the United States and investors in the Banks' debt 
must therefore look only to the Banks for repayment of the debt, 
disclosures by the Banks should give the holders of its debt a 
materially complete and accurate picture of the Banks' financial and 
operational situation to evaluate an investment. As is the case with 
Fannie Mae and Freddie Mac, the focus for disclosure has been the 
corporate disclosure required for a reporting company that registers 
under the Exchange Act. Registration of offers and sales of securities 
under the Securities Act has not been the focus and is not the subject 
of the proposed Finance Board rule. In particular, as with Fannie Mae 
and Freddie Mac, corporate disclosure resulting from Exchange Act 
registration is the same as would be required as a result of Securities 
Act registration.
    Because of the structure of the Federal Home Loan Bank System, 
including the Office of Finance, however, there are some issues that 
may be unique to the Banks. Staff of the Commission has met with 
members and staff of the Federal Housing Finance Board, representatives 
of the Banks and a group of directors of certain Banks, in each case at 
their request, to discuss the issues that registration under the 
Exchange Act may raise.
    Very early in our discussions with all of these parties, we sought 
to clearly and carefully address concerns raised by the Banks about 
whether registration would require the structure of the System to 
change. The Commission has no regulatory interest in changing the 
structure of the System. Registration under the Exchange Act of each of 
the 12 Banks would not alter the structure of the Federal Home Loan 
Bank System. In addition, insofar as registration of a class of each 
Bank's securities under the Exchange Act is being considered, there 
would be no impact on the timing or other aspects of offering 
transactions as a result of registration.
    Because our focus on disclosure relates to the debt issued by the 
Banks and not to their common stock, Commission staff had initially 
considered with the Finance Board and the Banks the possibility of the 
Banks registering a class of debt securities. Under the Exchange Act 
the corporate disclosure required of a company is the same whether the 
security registered is debt or common stock. However, registration of 
equity could implicate additional requirements for the Banks, such as 
the proxy rules. Therefore Commission staff suggested the Banks 
register a class of debt securities. In our discussions with the Banks, 
each Bank expressed a preference for registering a class of its stock, 
if any security was to be registered under the Exchange Act. Because 
the corporate disclosure is the same, this is acceptable to us. Staff 
have also indicated to the Banks that we would work with them to 
determine if there were certain requirements, such as the proxy rules, 
from which it should be clear the Banks are exempted because the 
publicly held securities that implicate registration and disclosure 
issues are their debt securities. This would produce the same result as 
would be the case for corporate issuers whose only public securities 
are debt securities.
    In addition to these items, there have been four accounting related 
issues that have been identified as significant for the Banks in terms 
of ascertaining our staff's view prior to any registration process. We 
have met with representatives and advisers of some of the Banks to 
resolve these issues. Those issues include: The accounting treatment of 
the payment to REFCORP, the role of the combined financial 
statements of the 12 Banks, the accounting classification of redeemable 
capital stock, and the accounting treatment related to the joint and 
several nature of the Banks' obligations:

 The Financial Institutions Reform, Recovery, and Enforcement 
    Act of 1989 \9\ obligated the Banks to make an annual $300 million 
    payment to the U.S. Treasury until 2030 for the partial payment of 
    interest on bonds issued by the Resolution Funding Corporation, or 
    REFCORP. The Gramm-Leach-Bliley Act \10\ in 1999 changed how 
    REFCORP payments are calculated and due. Each Bank is now obligated 
    to pay 20 percent of earnings annually until these amounts for the 
    whole system are equivalent to a $300 million annual annuity with a 
    final maturity date of April 15, 2030. The Banks view the REFCORP 
    payments as similar to a tax and accordingly, no obligation for 
    future payments is recorded on their balance sheets. The Commission 
    staff has indicated to the Banks that we would not object to this 
    current presentation of the treatment of REFCORP payments.
---------------------------------------------------------------------------
    \9\ Pub. L. No. 103-73 (1989).
    \10\ Pub. L. No. 106-102 (1999).
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 Each Bank is a separate corporation with its own management, 
    employees, and board of directors. The Office of Finance, which is 
    an agent for the Banks, prepares combined financial statements of 
    the 12 Banks for public distribution. The financial statements are 
    not consolidated because there are separate and distinct 
    stockholder groups for each Bank with no common management or 
    ownership at the system level. The Commission staff believes that 
    the correct way to proceed is to have individual Banks register. 
    Because of the structure of the System, there is no issuer tied to 
    the combined statements to register under the Exchange Act. 
    Commission staff believes, however, there are policy reasons for us 
    to have an opportunity to review and comment on the combined 
    financial statements which are distributed to investors. Under 
    Finance Board regulations the Board determines whether the combined 
    financials statements comply with their requirements.\11\ Staff 
    have proposed that we would have arrangements with the Finance 
    Board so that their reviews would give the Commission staff the 
    opportunity to review the combined financial statements and provide 
    the Finance Board comments, if any. None of the Banks would have 
    additional responsibility for the combined financial statements as 
    a result of registration under the Exchange Act or the staff's 
    proposed arrangements with the Finance Board regarding the combined 
    statements.
---------------------------------------------------------------------------
    \11\ 12 CFR 985.6(b).
---------------------------------------------------------------------------
 The Gramm-Leach-Bliley Act required each of the Banks to 
    create a new capital structure. That Act allows each Bank to create 
    two classes of stock, one with a redemption period of 6 months and 
    the other with a redemption period of 5 years. The Banks are in the 
    process of implementing their new capital plans. Because the stock 
    will be redeemable, the issue arose as to whether the stock could 
    be included as permanent equity on the financial statements of the 
    Banks. Because all of the stock of each of the banks is 
    ``puttable,'' the Commission staff will not object if it is not 
    separated from the equity section of the balance sheet. This would 
    be similar to the treatment of the equity for co-ops currently 
    registered under the Exchange Act. The face of the financial 
    statements would need to indicate the stock is ``puttable'' and the 
    notes to the financial statements would include disclosure on how 
    the puts work and on how much of the stock is in excess of the 
    amount required to be held by member banks which is generally based 
    on the member bank's activity. We have indicated to the Banks that 
    we will continue to have dialogue with them on the proper 
    accounting treatment in the event a stockholder puts the stock to a 
    Bank.
 The Commission staff has also had discussions with the Banks 
    regarding the appropriate treatment of the joint and several nature 
    of the Consolidated Obligations. Staff has indicated to the Banks 
    that it would not object to each Bank 
    reflecting on the face of its balance sheet as long-term 
    indebtedness only the amount of Consolidated Obligations for which 
    that Bank has received proceeds and is therefore viewed by the 
    Banks as primarily liable. The Banks would also disclose the total 
    amount of outstanding obligations. The Commission staff has also 
    indicated to the Banks that it would not object to their accounting 
    treatment for the contingent liability related to each Bank's 
    guarantee of the remainder of the outstanding Consolidated 
    Obligations for which it is not primarily liable.
Conclusion
    The individual and institutional investors who hold debt securities 
of the Banks depend for repayment on the Banks and not a Government 
guarantee. We believe that applying the Commission's disclosure 
requirements and processes is the 
preferred method of helping to ensure that these investors receive the 
materially accurate and complete disclosure they deserve. We believe 
that the Commission's detailed disclosure rules and filing 
requirements, and our staff review and comment process, provide the 
best framework for disclosing that information. We have a long history 
of reviewing the disclosure of companies in many diverse industries and 
we regularly review the complex debt and equity structures of these 
companies. We have not initiated any process to seek voluntary 
registration by the Federal Home Loan Banks of their securities, but we 
do believe that our rules and registration would provide the desired 
result. If registration by the Banks is pursued, we are committed to 
achieving that result with maximum protection for investors and maximum 
efficiency for all registrants consistent with our mission to protect 
investors.
                PREPARED STATEMENT OF RICHARD S. CARNELL
      Associate Professor of Law, Fordham Univeristy School of Law
                           New York, New York
                           February 10, 2004
    Mr. Chairman, Senator Sarbanes, and Members of the Committee, I am 
pleased to have this opportunity to discuss ways to improve the 
regulation of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank 
System.
    As Government Sponsored Enterprises, these entities are privately 
owned, profit-oriented corporations that have Congressional charters 
and receive an array of Federal benefits not available to businesses 
generally. More importantly, capital market participants believe that 
the Government implicitly backs each GSE--and would not let the GSE's 
creditors go unpaid. This perceived implicit guarantee is the GSEs' 
most important and most distinctive characteristic. It enables the 
three housing GSE's to borrow $2.2 trillion at rates below those 
available to even the most creditworthy fully private borrowers.
    For years the GSE's assured us that they met the highest standards 
of corporate governance, fully complied with generally accepted 
accounting principles, provided disclosure at least as good as what the 
Federal securities laws required, faced tough and effective safety-and-
soundness regulation, and were so well run that no one had any business 
requiring them to do anything they did not want to do. Recent scandals 
and other developments cast doubt on these claims and on the adequacy 
of GSE regulation. The Administration has proposed major reforms of 
such regulation, including the creation of a new GSE regulatory agency. 
Treasury Secretary Snow has rightly called for ``a strong, credible, 
and well-resourced regulator'' with ``powers . . . comparable in scope 
and force to those of other world-class financial regulators, fully 
sufficient to carry out the agency's mandate, with accountability to 
avoid dominance by the entities it regulates.''
    In my testimony today, I will:

 identify six fundamental questions Congress faces in 
    structuring a GSE regulator;
 offer suggested answers to those questions;
 describe the double game by which the GSE's deny that they 
    have ``full faith and credit'' Government backing--in ways that 
    leave the impression that they have no Government backing at all--
    even as they work to reinforce the market perception of implicit 
    Government backing;
 refute the GSEs' attempt to liken FDIC-insured banks to GSE's 
    and to argue that we should not concern ourselves with GSE 
    subsidies because the Government gives banks greater subsidies; and
 examine ``systemic risk''--particularly the argument that if a 
    GSE got into financial trouble, the Government would have no choice 
    but to rescue it, lest its failure unacceptably damage the 
    financial system.
Structuring the Regulator
    In designing (or redesigning) a regulatory agency, Congress faces 
six fundamental questions:

 Jurisdiction: Who will the agency regulate?
 Mission: What objectives should the agency seek to achieve?
 Governance: Who will run the agency, and under what ground 
    rules?
 Resources: How will the agency pay its expenses?
 Legal Authority: What legal tools will the agency have to do 
    its job?
 Incentives: What incentives will the agency's officers and 
    employees have?

    I will first briefly analyze OFHEO's structural weaknesses in light 
of these questions. I will then discuss how to structure a new GSE 
regulatory agency, considering the first five questions in turn and (in 
so doing) noting how the answers given to those questions will affect 
the agency's incentives. For the new agency's incentives will be 
crucial to the agency's success or failure.
OFHEO's Structural Weaknesses
    Congress created OFHEO with significant structural weaknesses. 
Specifically, the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992 (1992 Act) created a small, hyper-specialized 
agency--with uncertain funding and overly narrow powers--to regulate 
two huge, relatively homogeneous firms with great political clout. The 
Act housed that agency in a department with no institutional commitment 
to safety and soundness, little credibility to spare, and little 
ability to protect OFHEO against pressure from Fannie and Freddie. I 
summarize some of these structural weaknesses and their consequences in 
the table following this page. Building these weaknesses into OFHEO was 
a bit like keeping a watchdog hobbled, muzzled, and underfed.
Jurisdiction
    The new agency should regulate Fannie, Freddie, and the Federal 
Home Loan Bank System, taking over the functions currently performed by 
OFHEO and the Federal Housing Finance Board.\1\
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    \1\ I will argue below that the new agency should, ideally, also 
become responsible for overseeing Fannie and Freddie's housing mission, 
taking over functions currently performed by HUD.
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    Having a single agency regulate all three housing GSE's would have 
several advantages over the current system. The General Accounting 
Office identified and aptly summarized these advantages in its 
excellent report, Government Sponsored Enterprises: Advantages and 
Disadvantages of Creating a Single Housing GSE Regulator (1997), on 
which I will draw extensively in this part of my testimony.



    First, and most importantly, a single regulator would have more 
independence from the firms it regulates. The Federal Home Loan Bank 
System has a different business model and different interests than 
Fannie and Freddie. These differences should create what the GAO called 
``a healthy tension in the oversight of the [GSE's] that could help 
prevent the regulator from being `captured' by the GSEs'' (that is, 
from identifying with and primarily serving the GSEs' interests).
    A similar ``healthy tension'' in State thrift regulation yielded 
major benefits during the thrift debacle of the 1980's. The most severe 
losses among State-chartered, Federally insured thrifts occurred in 
States (for example, Texas and California) with hyper-specialized 
regulators that supervised only thrifts. States whose banking 
commissioners also regulated thrifts had a much better record of 
keeping thrifts healthy and avoiding costly failures. This difference 
in outcomes reflected a difference in regulators' incentives. Hyper-
specialized thrift-only regulators proved overly reluctant to rein in 
risky practices, close insolvent thrifts, and require sick thrifts to 
recapitalize. Such strong measures would have risked alienating thrifts 
(the regulators' main constituency) and putting the regulators out of 
business. By contrast, State officials who regulated both banks and 
thrifts had greater liberty to take tough but necessary action against 
troubled thrifts. State-chartered banks demanded such action. Moreover, 
these officials knew that their agencies could, if necessary, survive 
without a thrift clientele. So regulating both banks and thrifts gave 
these officials more freedom to do their jobs well. Similarly, 
regulating all three housing GSE's would give the new GSE regulator 
more freedom to do its job well than if it regulated only Fannie and 
Freddie or only the Federal Home Loan Banks.
    Second, an agency regulating all three housing GSE's would be 
larger and (in the GAO's phrase) ``more prominent in Government'' than 
OFHEO and the Finance Board. This increased stature ``could help 
attract and retain staff with the special mix of expertise and 
experience needed to examine and monitor these sophisticated GSE's.''
    Third, a single housing GSE regulator could achieve ``some 
economies and efficiencies'' by having staff ``share expertise in such 
areas as examinations, credit and interest rate risk monitoring, 
financial analysis, and economic research'' and by combining 
``[a]dministrative support functions.''
    Fourth, such an agency could achieve greater consistency in 
regulating the three housing GSE's.
    The main disadvantage of creating a single regulator would be quite 
modest: What the GAO called ``the short-term disruption that would come 
with any type of change.''
Mission
    OFHEO and HUD currently divide regulation of Fannie and Freddie, 
with OFHEO responsible for safety and soundness and HUD responsible for 
housing mission. The Finance Board, by contrast, has both types of 
responsibility for the Federal Home Loan Bank System.
    Giving the new GSE regulator both safety and soundness and mission 
responsibilities would have three advantages. First, it would promote 
accountability by both the regulator and the GSE's. Divided 
responsibility creates ``the potential for the GSE's to try to pit the 
regulators against each other'' (as the GAO's 1997 report noted) or to 
tell each regulator that a given matter--which may raise both mission 
and safety and soundness issues--falls only within the authority of the 
other regulator. Second, giving a single agency both responsibilities 
would simplify compliance by the GSE's. Third, insofar as GSE policy 
must take account of both mission and safety and soundness, giving one 
agency both responsibilities would promote better-informed 
decisionmaking.
    Accordingly, I would support combining both responsibilities in one 
agency if that can be done under sound governance (discussed below). 
But sound governance is so critical that it should not be compromised 
to obtain the more modest benefits of combining the two 
responsibilities. In any event, the GSE's should have to limit their 
activities to the secondary market and obtain the new agency's approval 
before commencing new activities.
Governance
General Approach
    The paramount goal in structuring a new GSE regulatory agency 
should be to assure the agency's independence from the firms it 
regulates. The housing GSE's are powerful, aggressive, and politically 
effective. They are adept at capturing or cowing regulators. But a 
sound governance structure--combined with other reforms (such as having 
one agency, with permanent funding and adequate legal authority, 
regulate all three housing GSE's)--can help the agency avoid such 
capture or intimidation.
    Two possible governance structures offer the best prospects for 
maintaining the agency's integrity, objectivity, and effectiveness.
    The first approach would make the agency an autonomous bureau of 
the Treasury Department.\2\ The Treasury has an institutional 
commitment to safety and soundness, and has the will and the 
institutional credibility to stand up to the GSE's. The GSE's would 
find the Treasury harder to bully than HUD, OFHEO, the Finance Board, 
or a new independent agency. I believe that a Treasury-based GSE 
regulator would also diligently carry out its responsibilities for the 
GSEs' housing mission. The myth of the Treasury as hostile to housing 
and eager to choke off housing finance is just that: A myth, 
popularized decades ago by thrift lobbyists intent on keeping thrift 
regulation a lax, cozy backwater. The Treasury's Office of Thrift 
Supervision (OTS) has performed both safety-and-soundness and housing-
mission responsibilities for over 14 years, without antihousing bias 
(and with greater competence than the independent agency it replaced).
---------------------------------------------------------------------------
    \2\ My confidence in the Treasury may reflect my own association 
with that department from 1993 through 1999. Yet I had concluded years 
before--at the time of the thrift debacle--that the Treasury was the 
best place to house GSE regulation.
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    The second approach would place the new agency under a three- or 
five-member board. The board would include one representative each from 
the Treasury and HUD. It would also include either one or three 
appointed members nominated by the President and confirmed by the 
Senate. An appointed member would serve as chair of the board and 
executive head of the agency. The Treasury, HUD, and the appointed 
member(s) would each bring their own perspectives and expertise to 
bear.
    I view a three-member board \3\ as preferable to a five-member 
board. A larger board would (other things being equal) have more 
difficulty making decisions and be more vulnerable to capture or 
manipulation by the GSE's. Moreover, the two additional appointed 
positions on a five-member board would probably offer too little 
challenge to attract and retain the most talented, energetic people. 
The chair would head the agency, and the Treasury and HUD members would 
have their own responsibilities. But how would the two extra appointed 
members occupy themselves? Would they end up half-idle, hobnobbing with 
the GSE's, intriguing against other board members, or attempting to 
micromanage the agency's staff ? The prospect of such high-level 
underemployment would hinder the recruitment and retention of able, 
independent individuals.
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    \3\ The Pension Benefit Guaranty Corporation provides a precedent 
for a three-member board that draws a majority of its members from 
executive departments. The PBGC board consists of the Secretaries of 
Labor, Treasury, and Commerce. 29 U.S.C. Sec. 1302(d).
---------------------------------------------------------------------------
Regulatory Autonomy
    The Administration has opposed making the new agency a bureau of 
the Treasury unless the agency must clear its regulations and 
Congressional testimony through the Treasury. The Administration gives 
two reasons for requiring such clearance--and thus treating the new 
agency differently than the Treasury's Office of the Comptroller of the 
Currency (OCC) and Office of Thrift Supervision.\4\ First, because the 
new agency would regulate only a few firms, all very large, it would be 
particularly vulnerable to ``capture'' by those firms. This 
vulnerability (in Secretary Snow's words) ``makes the oversight of 
overall policy development by the Treasury Department vital.'' Second, 
``it is vitally important that the Treasury Department be able to 
monitor the new regulator's policies to ensure that such policies are 
not reinforcing any such market misperception of an implied 
guarantee.''
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    \4\ The Treasury cannot ``delay or prevent the issuance of any rule 
or the promulgation of any regulation'' by the OCC or OTS. No one can 
require clearance of those agencies' Congressional testimony. 12 U.S.C. 
Sec. Sec. 1, 250, 1462a(b)(4).
---------------------------------------------------------------------------
    I concur in both arguments: A specialized GSE regulatory agency 
would be acutely vulnerable to capture; and the Treasury should be able 
to monitor a Treasury 
bureau's policies to ensure that they do not reinforce market 
misperception of an implied guarantee. But these arguments do not 
necessarily show that Treasury clearance of regulations and testimony 
is essential--or that autonomy of the general type enjoyed by the OCC 
and OTS would not work. Both the OCC and OTS are (in the words of the 
OTS statute) ``subject to the general oversight of the Secretary of the 
Treasury.'' 12 U.S.C. Sec. Sec. 1, 1462a(b)(1). This oversight offers 
some protection against capture and should help ensure the agency's 
policies do not reinforce the market misperception. Insofar as the 
Treasury remains concerned about the misperception, the Treasury itself 
can speak out any time, which would correct the misperception far more 
effectively than vetting regulations and testimony. Moreover, the GSEs' 
aggressiveness and political clout--and the new agency's consequent 
need for support--would give the agency reason to consult and cooperate 
with the Treasury even if the agency did not need formal Treasury 
clearance of regulations and testimony.
    Requiring Treasury clearance of the new agency's Congressional 
testimony could cause delay, as Treasury officials who might otherwise 
have little interest in the Agency's work scrutinized the testimony to 
make sure it would not embarrass the Treasury Secretary or the 
Administration. One persistently tardy participant in a clearance 
process can make testimony persistently late despite the other 
participants' best efforts. Note, moreover, that if the Secretary 
cannot control the agency's testimony, then it is harder (although not 
impossible) to blame the Secretary for that testimony.
    A stronger case exists for Treasury clearance of the new agency's 
regulations (although I do not regard such clearance as essential). 
Such clearance would help guard against capture. It need not cause 
delay, as regulation-writing takes time and rarely has the short 
deadlines typical in preparing Congressional testimony.
    In any event, Treasury clearance of regulations should not derail 
GSE reform legislation. Congress can develop middle-ground options, 
such as (1) setting a time limit on Treasury review, or (2) permitting 
the new agency to proceed with a proposed regulation unless the 
Treasury expressly disapproves the regulation within a specified time 
period and publishes specific written reasons for its disapproval. Such 
an intermediate option would make Treasury review of the Agency's 
regulations more than merely advisory, while providing safeguards 
against delay or unreasoned disapproval.
Resources
    Like the OCC and OTS, OFHEO pays its expenses using fees collected 
from the firms it regulates; it receives no general tax money. But 
unlike the OCC and OTS, OFHEO needs an annual appropriation to set and 
collect such fees. Fannie and Freddie have used the appropriations 
process both to pressure OFHEO (just as thrifts used the process to 
pressure the old Federal Home Loan Bank Board) and to limit OFHEO's 
capacity to undertake more rigorous scrutiny of the GSE's. To reinforce 
the new agency's independence from the firms it regulates, Congress 
should end this reliance on appropriations.
Legal Authority
Capital, Enforcement, and Prompt Corrective Action
    The Federal Housing Enterprises Financial Safety and Soundness Act 
of 1992 drew on banking law to strengthen the safety and soundness 
regulation of Fannie and Freddie. The 1992 Act required new capital 
standards. It included Prompt Corrective Action provisions to encourage 
the GSE's to correct capital deficiencies. It authorized OFHEO to take 
administrative enforcement action against unsafe practices. But at the 
insistence of Fannie and Freddie, the 1992 Act unwisely tended to deny 
OFHEO authority possessed by bank regulators. As a result, OFHEO has 
(in Tom Stanton's phrase) ``a parody of the authority of the Federal 
bank regulators.'' The limits on OFHEO's authority contrast sharply 
with the goal of creating ``a strong, world-class regulatory agency'' 
with powers ``comparable in scope and force to those of other world-
class financial regulators.''
    Bank regulators have broad authority to prescribe capital 
standards, including authority to impose new standards or toughen 
existing standards. 12 U.S.C. Sec. Sec. 1831o(c)(1), 3907(a). OFHEO, by 
contrast, faces major constraints on the form and content of capital 
standards, including an extraordinarily complex Congressionally 
dictated stress test. Sec. Sec. 4611-4612. The new regulator needs 
authority to raise capital standards in light of experience.
    OFHEO has much weaker enforcement authority (Sec. Sec. 4631-4636) 
than Federal bank regulators (Sec. 1818), as shown in the table 
following this page. For example, bank regulators can issue a cease-
and-desist order against any ``unsafe and unsound practice.'' OFHEO can 
issue such an order only if the conduct jeopardizes a GSE's capital. 
Bank regulators can bar any officer, director, or employee of an FDIC-
insured institution from working at that or any other Federally insured 
institution if the individual committed misconduct (for example, 
breaking the law) that (1) enriched the individual or caused loss to 
the institution, and (2) involved personal dishonesty or demonstrated 
willful or continuing disregard for institution's safety and soundness. 
OFHEO has no such authority. Bank regulators can impose civil money 
penalties of up to $25,000 per day for lawbreaking that enriches the 
violator or breaches the violator's fiduciary duties. OFHEO cannot 
impose civil money penalties on these grounds. Bank regulators can 
impose civil money penalties of up to $1 million per day for (1) 
knowingly breaking the law or breaching fiduciary duty, and thereby (2) 
substantially enriching the violator or causing the institution 
substantial loss. OFHEO cannot impose civil money penalties on these 
grounds.



    Fannie and Freddie face Prompt Corrective Action rules 
(Sec. Sec. 4614-4619, 4622) conspicuously weaker than those governing 
FDIC-insured depository institutions (Sec. 1831o). For example, an 
undercapitalized bank cannot increase its total assets unless (1) the 
bank has an acceptable capital restoration plan, (2) the asset growth 
comports with the plan, and (3) the bank's capital ratio increases at a 
rate sufficient to enable the bank to become adequately capitalized 
within a reasonable time. Sec. 1831o(e)(3). Yet no statute bars Fannie 
and Freddie from continuing to grow while undercapitalized, even if 
they have no capital restoration plan or if the growth conflicts with 
such a plan (Sec. 4615). The Prompt Corrective Action statute 
authorizes growth restrictions only against a significantly or 
critically undercapitalized GSE, and makes such sanctions purely 
discretionary. Sec. Sec. 4616(b)(2), 4617(b), (c)(2). Similarly, a bank 
cannot pay dividends if the bank is or would become undercapitalized, 
whereas even an undercapitalized GSE may be able to pay dividends as 
long as the dividends are not so large as to render the GSE 
significantly undercapitalized. Sec. Sec. 1831o(d)(1)(A), 4515(a)(2).
    The GSE enforcement and Prompt Corrective Action rules should be 
strengthened in line with their banking counterparts.
Receivership
    There are two basic ways to deal with a firm if its liabilities 
exceed its assets and it cannot pay its debts as they become due: 
Liquidation and reorganization. Liquidation involves selling the firm's 
assets and using the proceeds to pay creditors. Reorganization involves 
scaling back the firm's liabilities, such as by turning some of the 
firm's debt into equity.
    Liquidation or reorganization mechanisms exist for most firms. A 
court can liquidate a business corporation under Chapter 7 of the 
Bankruptcy Code or (with enough creditors' approval) reorganize the 
corporation under Chapter 11. The FDIC can liquidate or reorganize an 
insolvent FDIC-insured bank or thrift. The Federal Housing Finance 
Board can liquidate or reorganize a Federal Home Loan Bank.
    But in the case of Fannie and Freddie, no adequate legal mechanism 
exists for dealing with a GSE if its liabilities exceed its assets. The 
Bankruptcy Code does not apply.\5\ Although OFHEO can appoint a 
``conservator'' to take control of the GSE, the conservator cannot 
require creditors to exchange debt for equity or to accept less than 
full payment of their claims.\6\ Thus if the GSE's assets fall short of 
its liabilities, the conservator has no power to resolve the 
shortfall.\7\ The insolvent GSE would remain adrift in legal 
uncertainty until Congress enacted special legislation.
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    \5\ Specifically, the Bankruptcy Code does not permit Fannie or 
Freddie to become a debtor in a bankruptcy proceeding, whether 
voluntarily or involuntarily. As Federal instrumentalities, Fannie and 
Freddie are ``governmental units'' under Sec. 101(27) of the Bankruptcy 
Code and thus under Sec. 101(41) are not a ``person.'' Under 
Sec. 109(a) only a ``person'' can become a ``debtor'' in a bankruptcy 
proceeding. See 11 U.S.C. Sec. Sec. 101(27), (41), 109(a).
    \6\ Under 12 U.S.C. Sec. 4620(a), a conservator generally ``shall 
have all the powers of the shareholders, directors, and officers of the 
Enterprise under conservatorship and may operate the Enterprise in the 
name of the Enterprise.'' But a firm's shareholders and managers have 
no power to require creditors to exchange debt for equity or to accept 
only partial payment of their claims.
    Nor does Sec. 4620(f) authorize OFHEO to write down creditors' 
claims. Under Sec. 4620(f) OFHEO ``may require a conservator to set 
aside and make available for payment to creditors any amounts that the 
Director determines may safely be used for such purpose.'' Using this 
authority, OFHEO could require a conservator to make larger or earlier 
payments to creditors than the conservator might otherwise make. But 
the statute in no way suggests that by accepting such payments 
creditors would waive their right to eventual payment in full.
    \7\ A conservator might, in theory, attempt to get all of the GSE's 
creditors to agree to scale back their claims. But obtaining the 
creditors' unanimous consent would be impracticable given the large 
number of creditors and the incentive for some creditors to threaten to 
veto the deal unless they received favored treatment.
---------------------------------------------------------------------------
    This lack of an orderly ``receivership'' mechanism--that is, 
mechanism for using the insolvent GSE's assets to satisfy the GSE's 
creditors--is a serious gap in current law, with potentially serious 
consequences for financial markets. So long as the gap remains, the GSE 
regulator will not truly have powers ``comparable in scope and force to 
those of other world-class financial supervisors, fully sufficient to 
carry out the agency's mandate.''
    Congress can fill the gap in at least two ways: (1) by authorizing 
the GSE regulator to commence a bankruptcy proceeding against an 
insolvent GSE; or (2) by 
authorizing the regulator to appoint a receiver to deal with the GSE 
under a specialized set of rules such as those applicable to failed 
banks. Either approach can do the job.
    Regulating GSE's but having no receivership mechanism is like 
investing in an elaborate fireprotection system--complete with 
firewalls, smoke detectors, heat sensors, alarm bells, and sprinklers--
but failing to mount a crucial fire door on its hinges. Like firesafety 
measures, GSE safety and soundness regulation serves dual purposes. 
Firesafety measures protect a building by preventing and extinguishing 
fires there; they also protect other buildings by inhibiting the spread 
of fire. Similarly, GSE regulation seeks not only to keep the GSE's 
themselves safe but also to protect the financial and housing sectors 
from damage that might result from a GSE's failure. Bank regulation 
serves similar purposes and did so even before Federal deposit 
insurance: Seeking both to protect banks' depositors and other 
creditors and to prevent bank failures from causing broader economic 
harm. A receivership mechanism, by providing an orderly means for 
dealing with a failed GSE's obligations, would help limit and contain 
the harm resulting from a GSE's failure.
The GSEs' Double Game
In General
    In managing their relationship to the Federal Government, the GSE's 
play an extraordinarily successful double game: They deny that they 
have any formal, legally enforceable Government backing, even as they 
work to reinforce the market perception of implicit Government backing. 
Let us look more closely at the two parts of the double game.
    First, the GSE's emphatically deny that they have any formal, 
legally enforceable Government backing--in itself, a valid point. But 
the GSE's make this point in ways designed to convince the uninitiated 
that the GSE's enjoy no Government backing at all (an implication 
directly conflicting with the second part of the double game). The 
GSE's stress that ``Every one of our debt securities clearly states, in 
plain English, it is not backed by the full faith and credit of the 
Government.'' \8\ They argue that they operate ``with entirely private 
capital'' and that their activities ``are entirely supported by [their] 
revenue . . . and the capital of private investors and are not in any 
way guaranteed by the Federal Government.'' \9\
---------------------------------------------------------------------------
    \8\ Franklin D. Raines, Remarks at Conference on Money Markets and 
the News: Press Coverage of the Modern Revolution in Financial 
Services, March 19, 1999.
    \9\ Fannie Mae, FM Watch Observer: Glossary of Terms, www.fmwatch-
observer.com/glossary.html (emphasis added).
---------------------------------------------------------------------------
    Second, the GSE's work to reinforce the perception of implicit 
Government backing. Consider three examples involving Fannie. In the 
first example, Fannie sought legislative history stating that Fannie 
and Freddie ``are implicitly backed by the full faith and credit of the 
U.S. Government.'' \10\ In the second example, Fannie attacked Treasury 
Under Secretary Gensler as ``irresponsible'' and ``unprofessional'' 
when he testified before a House Subcommittee on March 22, 2000, that 
``the Government does not guarantee [GSEs'] securities.'' \11\
---------------------------------------------------------------------------
    \10\ When I worked for this Committee on a Glass-Steagall repeal 
bill in 1987-88, Fannie asked that I include such language (emphasis 
added) in a draft section-by-section analysis, which I declined to do.
    \11\ K. Day, Remarks Put Pressure on Fannie, Freddie Bonds, 
Washington Post, Mar. 24, 2000, at E1; J. Kosterlitz, Siblings Fat and 
Sassy, 32 National Journal 1498 (2000).
---------------------------------------------------------------------------
    In the third example, Fannie argued in a 1998 letter to the Office 
of the Comptroller of the Currency that ``all GSE issued securities 
merit'' more favorable treatment under the Federal banking agencies' 
risk-based capital standards than all ``AAA-rated [non-GSE] asset-
backed securities.'' Thus the mere fact that a GSE issues a security 
makes that security more creditworthy than any non-GSE security. An IOU 
issued by a financially troubled GSE (such as the Farm Credit System 
before its 1987 bailout) would, under Fannie's reasoning, still be more 
creditworthy than a top-tier asset-backed security guaranteed by the 
Nation's healthiest fully private corporation. Fannie based this 
argument squarely on what it calls ``the implied Government backing of 
Fannie Mae'':

        GSE issues generically, and Fannie Mae-guaranteed MBS in 
        particular, are viewed by the capital markets as near proxies 
        for Treasury securities in terms of credit worthiness.

    . . .

        Fannie Mae standard domestic obligations, like Treasuries, 
        typically receive no rating on an issue-by-issue basis, because 
        investors and the rating agencies view the implied government 
        backing of Fannie Mae as a sufficient indication of the 
        investment quality of Fannie Mae obligations. . . .\12\
---------------------------------------------------------------------------
    \12\ Letter from Anthony F. Marra to OCC, Feb. 3, 1998 (emphasis 
added).

    Thus Fannie contended that in assessing credit quality, investors 
and rating agencies do not (and presumably need not) look beyond ``the 
implied Government backing of Fannie Mae,'' which in Fannie's view 
renders Fannie's securities ``near proxies for Treasuries.'' These 
assertions are all the more remarkable in that Fannie made them in a 
formal comment letter to a bureau of the Treasury. We may reasonably 
infer that when Fannie meets with rating agencies and securities 
analysts--out of earshot of Government officials--it makes arguments at 
least as strong as those quoted above.
    This double game lets the GSE's have it both ways. In effect, the 
GSE's tell Congress and the news media, ``Don't worry, the Government 
is not on the hook''--and then turn around and tell Wall Street, 
``Don't worry, the Government really is on the hook.'' The GSE's play 
this game unchallenged, year after year.
    Fannie's CEO, Franklin D. Raines, recently seemed to question the 
``theory . . . that there is an `implied guarantee' that the Government 
would repay our creditors if we failed.'' In a February 6 speech at the 
American Enterprise Institute, Mr. Raines declared:

        [S]ome assert that we have an ``implied guarantee'' that the 
        market relies on. Yet it is not clear what an implied guarantee 
        means. We do not know who is making the implication or exactly 
        what is being guaranteed. Indeed, Treasury Secretary Snow has 
        testified that there is no implied guarantee.

        I believe that the true value of our charter does not rest on a 
        Government guarantee of our obligations--implied or otherwise.

        Instead, our charter signifies that the Government places such 
        a high value on our mission of expanding homeownership and 
        affordable housing, that it goes to extraordinary lengths to 
        ensure that the private management of our operations is closely 
        supervised, and that our private capital is matched to our 
        risks, even under extraordinary circumstances--all to ensure 
        our continued success.

        This is the pact that the Federal Government has with 
        investors. It does not cost taxpayers anything. And so far, it 
        has worked very well. This pact ensures that it is private 
        capital that is at risk, not the taxpayer. [Emphasis added.]

    I urge the Committee to follow up on this statement by having 
Fannie and Freddie answer three simple questions:

 Do capital market participants err in perceiving the Federal 
    Government as implicitly backing Fannie and Freddie?
 Do you believe that the Government in any way implicitly backs 
    Fannie and Freddie?
 If Fannie and Freddie were to default on their obligations, 
    would the Government have any moral obligation to assure that 
    Fannie and Freddie's creditors got paid?

    
    
Ineffective Statutory Disclaimers
    In seeking to limit the taxpayers' exposure to the GSE's, Congress 
has enacted three disclaimers of liability. But the phrasing of these 
disclaimers, far from hindering the GSEs' double game, fits it neatly.
    First, the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992 declares ``neither the Enterprises [that is, 
Fannie and Freddie] . . . nor any securities or obligations issued by 
the Enterprises . . . are backed by the full faith and credit of the 
United States.'' 12 U.S.C. Sec. 4501(4). But this disclaimer merely 
restates the obvious: That the Government has no formal, legally 
enforceable liability for the GSEs' securities. It does not disclaim 
implicit backing, nor does it signal that market participants err in 
perceiving such backing. It thus avoids the real issue.
    Second, a statutory section entitled ``Protection of taxpayers 
against liability'' declares that the 1992 Act ``may not be construed 
as obligating the Federal Government, either directly or indirectly, to 
provide any funds'' to Fannie or Freddie ``or to honor, reimburse, or 
otherwise guarantee any obligation or liability'' of Fannie or Freddie. 
Sec. 4503. This disclaimer also avoids the real issue. No one argues 
that the 1992 Act created implicit backing where it did not already 
exist. Market participants had long believed such backing to exist 
under the GSEs' charters. Congress did not act to correct that 
perception.\13\
---------------------------------------------------------------------------
    \13\ The second disclaimer also replicates the weakness of the 
first disclaimer in declaring that the 1992 Act ``may not be construed 
as implying that any such enterprise . . ., or any obligations or 
securities of such an enterprise . . . are backed by the full faith and 
credit of the United States.'' Sec. 4503.
---------------------------------------------------------------------------
    Third, each firm's securities must include ``appropriate language . 
. . clearly indicating'' that the securities ``are not guaranteed by 
the United States and do not constitute a debt or obligation of the 
United States or of any agency or instrumentality thereof'' other than 
the GSE in question. Sec. Sec. 1455(h)(1), 1719(b), (d)-(e). This 
requirement repeats the fundamental weakness of the first disclaimer: 
It disclaims formal, legally enforceable liability, even as it fails to 
disclaim implicit backing. ``Indeed, the disclaimer itself hints at a 
special Federal relationship; completely private firms do not need to 
disclaim Federal backing because no one believes such backing exists.'' 
\14\
---------------------------------------------------------------------------
    \14\ Ronald C. Moe and Thomas H. Stanton, Government Sponsored 
Enterprises as Federal Instrumentalities: Reconciling Private 
Management with Public Accountability, 49 Pub. Admin. Rev. 321, 323 
(1989).
---------------------------------------------------------------------------
    No one argues that the Government has any formal, legally 
enforceable liability for the GSEs' securities. Thus the disclaimers 
ignore the real issue: Whether the Government, although not legally 
bound to rescue the GSE's, would nonetheless do so (for example, 
because it felt a moral obligation for their debts or feared that a GSE 
default might damage the Nation's financial system).
Subsidy Denial
    The GSEs' double game helps the GSE's argue that they get little or 
no Government subsidy. Yet no one can honestly dispute that Fannie and 
Freddie receive 
valuable benefits not available to businesses generally. These benefits 
include exemption from most State and local taxes and exemption from 
the registration and reporting requirements of the securities laws. The 
benefits also include a conditional line of credit at the U.S. Treasury 
and special rules relating to the GSEs' securities--for example, rules 
that: Equate those securities with U.S. Treasury securities for some 
purposes; permit issuance and transfer of those securities over the 
system used for issuing and transferring U.S. Treasury securities; and 
fail to limit FDIC-insured banks' investments in those securities. This 
special treatment strongly abets the market perception of implicit 
Federal backing. The Congressional Budget Office's reports and 
testimony demonstrate the great value of these special benefits.
    Yet Fannie, in particular, insists that it receives no subsidy. 
Relying on a narrow dictionary definition to the effect that a 
``subsidy'' is ``monetary assistance granted by a Government to a 
person or private commercial enterprise,'' Fannie asserts: ``Fannie Mae 
does not receive a penny of public funds. To the contrary, last year 
our Federal tax liability was $1.6 billion. True subsidies also are 
tangible. Fannie Mae's Government benefits are not.'' \15\ Fannie's 
reasoning--that a subsidy involves only a tangible payment of money by 
the Government--produces absurd results. If Congress were to exempt 
Fannie from ever again having to pay any corporate income tax, that 
would supposedly not be a subsidy because it involves no cash 
payment to Fannie. Similarly, if a foreign government gave an energy-
intensive, capital-intensive export industry unlimited access to free 
electricity and no-interest loans, that would supposedly not be a 
subsidy, either. These examples highlight the unreality of Fannie's 
arguments.
---------------------------------------------------------------------------
    \15\ Timothy Howard, Fannie Mae's Benefits to Home Buyers: The 
Business Perspective, 37 Fed. Reserve Bank Chi. Ann. Conf. Bank 
Structure & Competition 68, 69 (2001).
---------------------------------------------------------------------------
Curbing the Double Game
    I suggest that any GSE legislation:

    (1) correct the faulty statutory disclaimers of Federal liability 
for Fannie and Freddie (discussed above);
    (2) correct sloppy language in the Secondary Mortgage Market 
Enhancement Act of 1984 stating that for some purposes Fannie and 
Freddie securities ``shall be considered to be obligations issued by 
the United States,'' 15 U.S.C. Sec. 77r-1(a)(1)-(2);
    (3) prohibit any GSE from representing that the U.S. Government 
directly or indirectly backs the GSE (except in discussing formal, 
legally enforceable obligations of the Government) with the intent to 
induce anyone to rely on that representation in connection with the 
purchase or sale of any security; and
    (4) prohibit any Government agency or official from characterizing 
GSE securities as Government securities.
Properly Comparing Banks and GSE's
    Fannie and Freddie often argue that the Federal Government gives 
FDIC-insured banks \16\ benefits comparable to, or even greater than, 
those it gives Fannie and Freddie; that concern about subsidies to 
Fannie and Freddie is accordingly unwarranted and even hypocritical; 
and that any greater financial success shown by Fannie and Freddie 
simply reflects their greater efficiency.
---------------------------------------------------------------------------
    \16\ For simplicity I use ``banks'' to refer to all FDIC-insured 
depository institutions, including thrift institutions.
---------------------------------------------------------------------------
    Let us start with the issue of efficiency. Fannie and Freddie have 
lower overhead than banks because they do a different business than 
banks. Most banks do a predominantly retail business. To deal directly 
with large numbers of small customers, they have more offices and 
larger staffs than they otherwise would. By contrast, Fannie and 
Freddie do a wholesale business, which enables them to have lower 
overhead.
    Now let us turn to the issue of relative subsidy. FDIC insurance 
has a different set of costs and benefits than the Government's 
sponsorship of Fannie and Freddie. You might expect FDIC insurance to 
provide a greater net subsidy.\17\ After all, FDIC insurance is 
established by law and carries the Government's full faith and credit. 
Yet the Government's perceived implicit backing of Fannie and Freddie 
actually tends to provide a greater net subsidy than FDIC insurance, 
for six structural reasons.\18\
---------------------------------------------------------------------------
    \17\ The gross subsidy represents the total value of the special 
benefits provided by the Federal Government--benefits not available to 
businesses generally or even financial institutions generally. The net 
subsidy represents the difference between the gross subsidy and the 
offsetting costs that the entity must incur as a bank or GSE--costs not 
imposed on financial institutions generally.
    \18\ I have set forth these arguments more fully in The Structure 
of Subsidy: Federal Deposit Insurance Versus Federal Sponsorship of 
Fannie Mae and Freddie Mac, in Serving Two Masters, Yet Out of Control: 
Fannie Mae and Freddie Mac 56-83 (2001).
    Most of these structural reasons hold true for the Federal Home 
Loan Banks, which also enjoy exemption from the Federal income tax. But 
the Federal Home Loan Banks do face the possibility of receivership, 
and must pay 10 percent of their net income to an affordable housing 
program and another 20 percent toward interest payments on debt 
securities issued to help finance the thrift clean-up. 12 U.S.C. 
Sec. Sec. 1430(j), 1433, 1441b(f)(2)(C), 1446.
---------------------------------------------------------------------------
    1. Unlimited Coverage. Federal deposit insurance applies only to 
deposits and then only up to a $100,000 limit. The FDIC can protect a 
failed bank's uninsured deposits and nondeposit creditors (such as 
bondholders) only under very narrow circumstances. By contrast, the 
Government's perceived implicit backing of GSE's has no limits: It 
applies to all of a GSE's obligations, with no dollar ceiling.
    2. No Receivership Mechanism. When an FDIC-insured bank fails, the 
FDIC becomes receiver for the bank: It takes control of the bank, 
gathers the bank's assets, and pays the bank's creditors in a specified 
order of priority. The bank's depositors must get paid in full before 
the bank's other creditors can get paid at all. If the bank's 
liabilities exceed its assets, its shareholders lose their ownership 
interest, its nondeposit creditors normally incur a partial or total 
loss, and its uninsured depositors often incur some loss. Similarly, 
when an ordinary nonfinancial company fails, it is liquidated under 
Chapter 7 of the Bankruptcy Code. The bankruptcy court appoints a 
trustee, who takes control of the company, gathers its assets, and pays 
creditors in a specified order of priority. The lack of any 
receivership mechanism for Fannie and Freddie reinforces the market 
perception that the Government would assure full payment of each firm's 
creditors.
    3. No Cross-Guarantees to Protect Taxpayers. Federal deposit 
insurance involves strong safeguards designed to ensure that banks--
rather than the taxpayers--bear any losses incurred in protecting 
insured depositors. Banks must normally pay premiums large enough to 
ensure that the FDIC's insurance funds have at least $1.25 in reserves 
for each $100 of insured deposits. This obligation to pay premiums 
gives each insurance fund a claim on the capital and earnings of all 
banks insured by that fund--and in effect creates a network of indirect 
cross-guarantees among FDIC-insured banks. Thus each member of the Bank 
Insurance Fund is liable for ensuring that the FDIC can protect insured 
depositors at every other BIF member bank. As long as the fund can 
replenish its reserves, its existence precludes any loss to the 
taxpayers.
    No similar cross-guarantees reduce the Government's risk-exposure 
to Fannie and Freddie. The two GSE's pay no insurance premiums and have 
no insurance fund. The two GSE's do not even cross-guarantee each 
other. If one GSE failed, the survivor would have no responsibility to 
pay the failed GSE's creditors.
    4. Special Deals Instead of General Rules. To a much larger degree 
than banks, Fannie and Freddie reap the benefits of special, company-
specific laws and avoid the discipline of generic law. Instead of 
operating under laws applicable to thousands of businesses, the two 
GSE's often get to operate under statutes designed for them alone.
    5. Protection from Effective Competition Subsidizes GSE 
Shareholders. Federal and State regulators routinely issue bank 
charters to qualified applicants. Once chartered, a bank can typically 
engage in a wide range of activities statewide and even nationwide. No 
longer does each bank charter require special legislation. No longer do 
regulators grant charters sparingly so as to limit competition with 
existing banks. Entry into banking is relatively easy, and banking law 
affords banks little protection against competition. Thus, if banks 
receive a net Federal subsidy, they should generally face enough 
competition to force them to pass the subsidy through to their 
customers.
    Fannie and Freddie, by contrast, enjoy significant protection 
against competition. Their Government sponsorship reduces their 
borrowing costs and increases the value of their guarantees to such an 
extent that no fully private firm can compete against them effectively. 
And only Congress can charter a competing GSE. By impeding competition 
with Fannie and Freddie, these constraints on entry increase the 
potential for the two GSEs' Government benefits to end up in the hands 
of their shareholders rather than their customers.
    6. Free Ride. Banks must normally pay for deposit insurance. They 
must also comply with an array of restrictions and requirements not 
applicable to businesses generally. But Fannie and Freddie pay no fee 
for their Government sponsorship. They make no payments to an insurance 
fund or affordable housing fund. They need not provide public benefits 
that impose significant costs on their shareholders. HUD's affordable 
housing goals are so weak that Fannie and Freddie can meet them without 
doing more for affordable housing than banks do. I believe that the two 
GSE's would have a profit motive to do their affordable housing 
business in any event, even without a Government subsidy.
    Considering the great value of the benefits Fannie and Freddie 
receive from the Government, they should be doing far more to increase 
homeownership at the margin (for example, by the lower-middle class, 
the working poor, and members of certain historically disadvantaged 
minority groups).
Systemic Risk
    GSE's are often characterized as ``too big to fail''--meaning that 
if they neared default on their debts, the Government would have to 
rescue them lest their failure unleash ``systemic risk'' that would 
gravely damage the Nation's financial system and economy.
    Discussions of systemic risk (whether in the GSE or the bank 
context) often have a tone of inevitability. But systemic risk is not a 
force of nature like earthquakes, hurricanes, and tornados. It results 
from human decisions: For example, decisions by market participants and 
Government officials about how to structure the financial system, what 
risks to take, and how to respond to problems. If investors expect the 
Government to protect them from the full pain of downside scenarios, 
they will tend to take greater risks than they otherwise would have 
taken. Thus ``too big to fail'' and ``systemic risk'' are to a large 
extent circular: They have their roots in prevailing expectations, and 
they easily become self-fulfilling prophecies. Insofar as investors 
expect the Government to rescue troubled GSE's, market discipline on 
GSE's will weaken, which will tend to increase the risk that the GSE's 
ultimately will get into financial trouble.
    If a GSE's troubles coincide with a broader financial crisis, 
Government officials will face additional pressures to rescue the GSE. 
For if during the crisis those officials seriously upset established 
expectations, they may create contagious uncertainty about the 
Government's willingness to meet other expectations. A crisis is thus a 
particularly inopportune time for attempting to reeducate market 
participants about the scope of the Government's undertakings. So if 
the Government 
tacitly accepts ``too big to fail'' expectations during good times, it 
may find itself constrained during a crisis to rescue a GSE against its 
better judgment.
    But the circularity of systemic risk also has a positive side: If 
the Government acts in a timely way, it can correct ``too big to fail'' 
expectations. Congress did just that in the FDIC Improvement Act of 
1991 (FDICIA) by curtailing the practice of treating FDIC-insured banks 
as ``too big to fail.'' \19\ FDICIA's ``least-cost resolution'' rule 
allows the FDIC to protect a failed bank's uninsured depositors and 
nondeposit creditors only if doing so is the ``least costly to the 
deposit insurance fund of all possible methods'' for meeting the FDIC's 
obligation to insured depositors. 12 U.S.C. Sec. 1823(c)(4). The rule 
has a narrow systemic-risk exception, which has never been used.\20\ 
Before FDICIA, the FDIC was spending extra money from the deposit 
insurance fund to protect uninsured depositors at banks as small as 
$500 million in total assets. But less than 1 year later, when an $8.8 
billion bank group in a swing State failed just a few days before the 
1992 Presidential election, the FDIC did not protect uninsured 
depositors and financial markets took that action in stride. By giving 
clear and timely notice of the new policy, Congress had succeeded in 
changing market participants' expectations. Proper and timely 
Government action can thus reduce the potential for systemic risk.\21\
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    \19\ In context of a failed FDIC-insured bank, ``too big to fail'' 
treatment involves spending extra money from the deposit insurance fund 
to protect deposits above the $100,000 limit on deposit insurance 
coverage. It may also involve extra spending to protect nondeposit 
creditors.
    \20\ The systemic-risk exception becomes an option only if 
recommended to the Secretary of the Treasury by two-thirds majorities 
of both the Federal Reserve Board and the FDIC's Board of Directors. 
The Secretary can make the exception only if the Secretary determines, 
``in consultation with the President,'' that least-cost resolution of a 
given institution ``would have serious 
adverse effects on economic conditions or financial stability.'' The 
Secretary must document the determination. The General Accounting 
Office must review and report on the exception, including the potential 
for it to diminish market discipline and encourage unsound risk-taking. 
To recoup the additional cost of deviating from least-cost resolution, 
the FDIC must levy a special assessment on insured depository 
institutions. Sec. 1823(c)(4)(G). Congress designed these rules to 
promote accountability and make the process sufficiently unpleasant 
that systemic-risk exceptions would be made rarely (if at all) and 
never lightly.
    \21\ By engineering a bailout of Long Term Capital Management in 
1998, the Federal Reserve Bank of New York squandered some of FDICIA's 
hard-won gains. Yet the dramatic change in how the FDIC dealt with 
failed banks during the early 1990's shows that progress can be made in 
curtailing too big to fail treatment.
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    Effective safety and soundness regulation of the GSE's can further 
reduce that risk. Yet we should beware of relying excessively on 
regulation. Regulation did not prevent the U.S. banking system from 
collapsing in 1933. Regulation did not prevent the 1980's thrift 
debacle, with its $125 billion cost to the taxpayers. Regulation did 
not prevent the bank failures of the 1980's and early 1990's, which 
depleted the FDIC's Bank Insurance Fund. Nor, more recently, did OFHEO 
detect Fannie and Freddie's accounting problems, even though it had 
examiners scrutinizing each GSE year-round. The failings of regulation 
underscore the need to maintain market discipline on the GSE's and 
other large financial institutions.
Miscellaneous
Ending the Government's Role in Appointing GSE Directors
    Under current law, Federal officials appoint some members of each 
housing GSE's board of directors. For both Fannie and Freddie, the 
President appoints 5 of each GSE's 18 directors. 12 U.S.C. 
Sec. Sec. 1452(a)(2)(A), 1723(b). The Federal Housing Finance Board 
appoints 6 of each Federal Home Loan Bank's 14 directors. Sec. 1427(a).
    The Administration rightly proposes to end governmental appointment 
of GSE directors (and, as an initial step in that direction, has 
indicated that it will no longer appoint directors of Freddie). 
Government-appointed directors face a conflict of interest. They 
presumably have some duty to serve the public. Yet under corporate law 
they presumably also have fiduciary duties to their corporation's 
shareholders. These duties conflict whenever the shareholders' 
interests run counter to some broader public interest: For example, 
when the shareholders' interest in maximizing profits conflicts with 
the public interest in protecting the taxpayers or promoting affordable 
housing. In 1988, Freddie's directors concluded that their fiduciary 
duties compelled them to side with the shareholders against the 
taxpayers.\22\ In any event, government appointments to GSEs' boards of 
directors have served more as political plums than as vehicles for 
upholding the public interest.
---------------------------------------------------------------------------
    \22\ The three members of the old Federal Home Loan Bank Board--
appointed by the President and confirmed by the Senate--served ex 
officio as Freddie's board of directors. Freddie's preferred share 
price had more than doubled in response to a proposal to allow anyone 
to own Freddie shares. (By severing Freddie's historic link to the 
thrift industry, the proposal would free Freddie to increase its 
profits by amassing a large portfolio of mortgage-backed securities.) 
Senate Banking Committee Chairman William Proxmire developed a plan to 
grant the relief desired upon payment of a fee to reduce the taxpayers' 
bill for the thrift clean-up. But Freddie's management convinced 
Freddie's directors that their fiduciary duties compelled them to 
oppose the Proxmire plan.
---------------------------------------------------------------------------
    Ending such appointments--so that GSE shareholders would elect all 
GSE directors--would remove the conflict of interest. By strengthening 
shareholders' control over each GSE, ending such appointments could 
also help shareholders hold management more accountable and thus 
promote better corporate governance.
Complying with Securities Laws
    The GSEs' statutory exemption from the registration and reporting 
requirements of the Federal securities laws is an anachronism and 
deserves to be repealed. The exemption sends the wrong signal: That 
GSE's are so ``special,'' so close to the Government, that investors in 
their securities have no need for the protections afforded by those 
requirements.
Opportunities for Immediate Administrative Action
    Regulators can and should act now to improve the regulation of 
Fannie and Freddie.
    First, to help avoid unhealthy concentrations of credit risk among 
FDIC-insured banks, the Federal banking agencies should prescribe 
guidelines for banks' credit exposure to individual GSE's and to GSE's 
generally.\23\
---------------------------------------------------------------------------
    \23\ Regulators could, for example, prescribe rules or guidelines 
under Section 305(b)(1)(A)(ii) of FDICIA, which requires risk-based 
capital standards to ``take adequate account of . . . concentration of 
credit risk.'' Regulators could also issue more specific examination 
standards.
---------------------------------------------------------------------------
    Second, the Securities and Exchange Commission should prohibit 
mutual funds whose portfolios consist largely of GSE securities from 
mislabeling themselves as ``Government'' or ``U.S. Government'' 
funds.\24\
---------------------------------------------------------------------------
    \24\ The SEC prohibits a mutual fund from having ``name suggesting 
that the Fund . . . [is] guaranteed . . . by the United States 
Government.'' 17 CFR Sec. 270.35d-1. But many mutual funds that invest 
predominantly in GSE securities nonetheless call themselves ``U.S. 
Government Securities Funds.'' To take what is probably an extreme 
example, the Pacific Capital U.S. Government Securities Cash Assets 
Trust had 98.8 percent of its assets in GSE securities as of September 
30, 2003; it evidently held no U.S. Government securities at all. See 
http://www.aquilafunds.com/ourcompany/moneyfunds.htm (semi-annual 
report), at 9.
---------------------------------------------------------------------------
    Third, the Federal Reserve Board should proceed with its proposal 
to curtail so-called ``daylight overdrafts'' by GSE's.
    Fourth, HUD should tighten its scrutiny of the GSEs' mission, using 
its authority to review activity-expansion, prescribe affordable-
housing goals, and interpret relevant statutes.
Conclusion
    The GSE's argue as though the present is always the wrong time to 
enact any reform that they do not want, such as reform that benefits 
taxpayers or homebuyers rather than the GSEs' managers and 
shareholders. In the GSEs' view, either (1) there is no acute problem 
warranting reform, or (2) reform now would crimp housing markets and 
risk destabilizing the financial system. But now is the right time to 
act--to correct the deficiencies in GSE regulation before a crisis hits 
or another scandal breaks.
                               ----------
                 PREPARED STATEMENT OF JAMES R. RAYBURN
            President, National Association of Home Builders
                           February 10, 2004
Introduction
    The 215,000 members of the National Association of Home Builders 
(NAHB) appreciate the opportunity to present their views to the Senate 
Committee on Banking, Housing, and Urban Affairs on the regulatory 
framework for Fannie Mae, Freddie Mac, and the Federal Home Loan Bank 
(FHLBank) System, including safety and soundness oversight, new program 
approval, and the establishment and enforcement of affordable housing 
goals. These housing-related Government sponsored Enterprises (GSE's) 
are critical components of the Nation's housing finance system and are 
largely responsible for the efficiency and resiliency of that system, 
as reflected in the tremendous advances recorded in the availability 
and affordability of mortgage products for homebuyers and providers of 
rental housing. The success and value of our housing finance system has 
been clearly evident in recent years, as the housing sector sustained 
economic performance while other areas of the economy faltered.
    Considering the complexity of the housing finance marketplace and 
the risks at stake, the task of restructuring the regulatory framework 
of the housing-related GSE's is a daunting one. However, NAHB believes 
that two governing principles should guide the debate. First, the 
regulatory framework for the GSE's must be credible and effective to 
ensure these organizations fulfill their mission in a safe and sound 
manner. Second, the public/private partnership of the housing finance 
system is sacrosanct; any other changes to the current system should 
not disrupt the efficient operation of the mortgage markets and the 
impediments to the development of effective programs to address the 
Nation's housing needs. With these concepts as a foundation, NAHB 
offers the following recommendations.
    NAHB maintains its previously asserted position that the Department 
of Housing and Urban Development (HUD) is the appropriate agency to 
regulate the mission of Fannie Mae and Freddie Mac, including approving 
new programs and establishing and enforcing affordable housing goals. 
However, if Congress chooses to 
explore the option of creating an independent regulator with oversight 
for all the housing-related GSE's, we implore Congress to ensure that 
the regulator has a thorough understanding of and extensive involvement 
in housing-related issues. We do not believe that the Department of the 
Treasury, which is well-suited as a safety and soundness regulator, has 
sufficient expertise and involvement in housing issues to serve as a 
housing-related GSE program regulator.
Background
Housing and the Economy
    The housing market has been an engine of growth in recent years, 
sustaining the economy during a difficult stretch. That performance 
continued in 2003, with new home sales reaching a record performance of 
more than a million closings. Single-family home construction has been 
robust and totaled 1.5 million units in 2003. Multifamily activity has 
been more subdued, but still posted a respectable showing, pushing 
total housing starts above the lofty 1.8 million units threshold.
    While low interest rates and favorable demographics have spurred 
demand, these results would not have been possible without the support 
of the finance system for housing. The bedrock of that system is a 
liquid and vibrant secondary market that is the product of the 
activities of Fannie Mae, Freddie Mac, and the FHLBank System. These 
enterprises have not only contributed to the affordability of housing 
credit, but also have taken the lead in expanding the menu of 
affordable housing programs and products.
GSE's and Housing Finance
    The housing-related GSE's are American success stories. As 
mentioned above, they have brought enormous benefits to homebuyers, 
renters, and the housing finance system. These include:

        Reduction of mortgage interest rates--The impact of the 
        housing-related GSE's on mortgage borrowing costs is well 
        documented. Homebuyers with conforming loans--mortgages 
        eligible for purchase by Fannie Mae and Freddie Mac, those up 
        to $333,700 for one-unit properties--pay mortgage rates that 
        are approximately 25 to 50 basis points lower than rates paid 
        by other conventional mortgage borrowers. The FHLBanks have 
        done their share by passing through their advantageous 
        borrowing rates for use in member loan programs. Further rate 
        reductions are provided through the subsidies of the FHLBank 
        System's Affordable Housing Program (AHP) and the Community 
        Investment Program (CIP).
        Reliable and stable flow of mortgage credit--The linkage that 
        the GSE's provide to the national and international capital 
        markets sustains the flow of capital to housing, even under 
        changing economic conditions. While the economy has undergone 
        major shocks over the past decade, homebuyers have experienced 
        no interruption in the availability of mortgage credit.
        Elimination of regional disparities in interest rates--The 
        GSE's provide a nationwide market for mortgage funds, a key 
        factor in the elimination of regional disparities in the 
        availability and cost of mortgage credit, which occurred 
        regularly before the housing-related GSE's came on the scene. 
        Today, interest rates in mortgage markets around the country 
        vary by no more than 10 basis points.
        Cushion against local economic downturns--When regional 
        economies begin to slow, some participants in the mortgage 
        industry have restricted credit or abandoned markets in search 
        of opportunities elsewhere. This is not the practice of the 
        GSE's. They maintain a presence in all markets under all 
        economic conditions, cushioning the impact of local or regional 
        declines in economic activity.
        Market standardization and innovation--The GSE's have brought 
        innovation to the mortgage markets to address a broad range of 
        borrower and 
        investor preferences. For example, Fannie Mae and Freddie Mac 
        have established reduced downpayment programs to help cash-
        strapped first-time homebuyers. Recently developed mortgage 
        products to assist borrowers with tarnished credit histories 
        further exemplify the extent to which Fannie Mae and Freddie 
        Mac employ novel approaches to respond to consumer credit 
        needs. The FHLBanks also stand out in this area by virtue of 
        the programs that are stimulated and supported by the AHP and 
        the CIP.
        Expansion of homeownership and rental housing opportunities--
        The housing GSE's have made very significant strides in 
        expanding homeownership opportunities and increasing the supply 
        of affordable rental housing in underserved areas. The housing 
        goals enacted by the 1992 GSE Act have successfully encouraged 
        both Fannie Mae and Freddie Mac to significantly 
        increase their service to the market sectors targeted by the 
        housing goals. The supply of affordable housing is further 
        augmented by the 12 FHLBanks; each contributes at least 10 
        percent of its annual net earnings to its statutorily 
        prescribed Affordable Housing Program to subsidize the cost of 
        housing for very low-income and low- or moderate-income 
        households.
Context for GSE Oversight Evaluation
    NAHB believes that debate and discussion on the future of GSE 
regulation should begin by reflecting on how and why these entities 
came to exist. The genesis of all three housing-related GSE's can be 
traced to Congress' recognition of the strong public policy benefits of 
housing and homeownership opportunities. Fannie Mae, Freddie Mac, and 
the FHLBank System were chartered to provide liquidity and stability 
for the Nation's housing finance system. The decision by Congress to 
confer the sponsorship of the U.S. Government on these entities was not 
a superficial one. Undoubtedly, Congress realized that no private 
corporation would assume the risks or expend the resources to undertake 
an objective of this magnitude. Moreover, it would be unlikely that any 
particular entity would have the credibility to attract the appropriate 
blend of borrowers and investors. Rather, Congress was keenly aware 
that in order for an enterprise to overcome such obstacles it would 
need the imprimatur of the U.S. Government. It is this well-forged 
public/private alliance that makes this Nation's housing finance system 
the model, if not the envy, of the world.
    As mentioned above, housing is a significant financial element in 
today's economy, not just in a macroeconomic sense, but also in terms 
of every homeowner's portfolio. The remarkable growth of Fannie Mae, 
Freddie Mac, and the FHLBank System has been raised by others as a 
point of discussion and concern. NAHB suggests that the performance of 
these entities should be evaluated within the context of the growth of 
the housing finance sector and its impact on consumers, investors, and 
the economy at large. From this perspective their growth can be viewed 
in a positive light.
    NAHB believes it would be a tremendous mistake to turn discussion 
on GSE regulation into a referendum of our highly successful housing 
finance system. Attempts to alter the Government's sponsorship of 
Fannie Mae, Freddie Mac, or the FHLBanks arguably contradicts Congress' 
intent, and most definitely would destroy the foundation upon which the 
system rests.
    The key to the GSEs' success is their steadfast focus on their 
mission. They are in one business, housing finance--a relatively low-
risk endeavor. This narrow focus should be recognized in the discussion 
of any future regulatory framework. The GSE's are not banks operating 
in far-flung and highly risky product lines and markets and should not 
be regulated as such.
    Even the staunchest advocates of GSE regulatory reform would agree 
that there is no imminent crisis in the GSE system. Therefore, NAHB 
urges a careful and thoughtful approach on GSE regulation. NAHB is 
certain that such a course will produce tremendous rewards to those 
with most at stake in the process--America's homeowners and renters.
Guiding Principles for GSE Oversight
    Since the GSE regulatory reform debate began in earnest last year, 
there has been no shortage of recommendations on a wide range of 
elements that many policymakers believe would enhance the stature of 
the regulatory system for Fannie Mae, Freddie Mac, and the FHLBank 
System. NAHB notes that most of the recommendations focus primarily on 
enhancing the power of the regulator to impose restrictions on the 
GSE's. Such proposals often make no reference to the responsibility of 
the regulator to ensure that the GSE's fulfill their Congressionally 
mandated purpose. Furthermore, others have recommended simply 
transferring the oversight from one agency to another without 
establishing a logical nexus between the expertise of the regulator and 
the mission of the entities to be regulated. NAHB urges this Committee 
to take a more rational approach by first establishing a foundation of 
core principles on which to build a solid regulatory framework. As 
direct participants in the production of housing and related 
activities, NAHB offers the committee the following set of core 
principles:

        1. The GSE status of these institutions must be maintained. 
        Efforts to privatize, withdraw any of the Federal privileges 
        and legal exemptions, or otherwise diminish the ability of the 
        GSE's to provide housing financing at the lowest possible cost 
        should be opposed.
        2. The GSE's should fulfill their public mission by conducting 
        activities authorized by their charters in a safe and sound 
        manner and by promoting access to mortgage credit to address 
        the needs of affordable housing throughout the Nation.
        3. The regulatory framework of the GSE's should be strong and 
        credible, possess adequate authority and resources and reflect 
        the differences inherent in the charters and operating 
        structures of the GSE's. Further, the regulatory framework 
        should foster competition among the GSE's to develop and 
        implement innovative, low-cost funding and other programs to 
        meet the nation's housing credit needs.
        4. The mission oversight of Fannie Mae and Freddie Mac 
        (including approval of new programs and enforcement of 
        affordable housing goals) should be conducted by the Department 
        of Housing and Urban Development or another entity with a 
        thorough understanding of and extensive involvement in housing-
        related issues.
        5. The safety and soundness oversight of Fannie Mae and Freddie 
        Mac should be conducted by an independent regulatory agency 
        through rigorous examinations, enforcement of regulations 
        (including capital standards) and transparency, without 
        unnecessarily impairing the ability of these GSE's to 
        accomplish their mission.
        6. The recently implemented risk-based capital standards for 
        Fannie Mae and Freddie Mac should be allowed to remain in place 
        for a period of time sufficient to evaluate the effectiveness 
        of the new standards.
        7. The regulation of the mission and safety and soundness of 
        the Federal Home Loan Bank System should reflect the uniqueness 
        of the System's mission, cooperative operating structure, 
        charter type, and other characteristics. This is best 
        accomplished by having a regulator dedicated solely to FHLBank 
        System oversight or by having a separate FHLBank System 
        oversight division if a single agency regulates all of the 
        housing GSE's.
Current GSE Regulatory Framework
Fannie Mae and Freddie Mac
    The 1992 GSE Act established a dual regulatory oversight structure 
for Fannie Mae and Freddie Mac. HUD is the programmatic (or mission) 
regulator and the Office of Federal Housing Enterprise Oversight 
(OFHEO) is the safety and soundness regulator.
    The 1992 GSE Act requires Fannie Mae and Freddie Mac to obtain 
prior approval by HUD of any new mortgage programs. The Act defines new 
programs as any programs that are significantly different from programs 
previously approved or engaged in prior to 1992. HUD is required to 
review new programs to ensure that they are consistent with the GSEs' 
charters and are in the public interest. In addition, Fannie Mae and 
Freddie Mac are required by law to meet annual housing goals 
established by HUD.
    Finally, the 1992 GSE Act established OFHEO as an independent 
office within HUD to oversee the safety and soundness of Fannie Mae and 
Freddie Mac. OFHEO's primary responsibilities are to establish and 
enforce capital standards for Fannie Mae and Freddie Mac and to conduct 
annual on-site examinations of the firms to ensure that they are 
operating in a safe and sound manner. Fannie Mae and Freddie Mac are 
required to meet two capital standards, a minimum leverage ratio and a 
risk-based capital (RBC) standard.
Federal Home Loan Bank System
    The FHLBank System was created by Congress in 1932 by the Federal 
Home Loan Bank Act. The Federal Housing Finance Board (Finance Board) 
is the FHLBank System's regulator. An independent agency, the Finance 
Board regulates both mission and financial safety and soundness. The 
FHLBanks are required to comply with both a leverage and a RBC capital 
requirement. The FHLBanks are also required by law to contribute a 
percentage of their net earnings each year to fund affordable housing 
programs.
Administration's Proposal
    The Bush Administration proposes to create a new Federal agency 
within the Department of the Treasury (Treasury) to regulate and 
supervise the financial activities of Fannie Mae, Freddie Mac, and the 
FHLBank System. The new agency would have general regulatory, 
supervisory, and enforcement powers for GSE oversight, including the 
authority to establish, enforce, and revise capital standards. 
Oversight of Fannie Mae's and Freddie Mac's existing activities and 
approval of new activities would be shifted from HUD to the new 
Treasury agency. HUD would be left with minimal regulatory authority, 
limited to oversight of the annual affordable housing goals and a 
consultative role in program oversight. The Administration's proposal 
makes no specific recommendations for how the new regulatory agency 
would accommodate the inherent differences between Fannie Mae, Freddie 
Mac, and the FHLBank System. The Secretary of the Treasury would 
enforce policy accountability through review of the new agency's 
regulations, budget, and policy statements to the Congress. 
Importantly, the Administration does not recommend any changes in the 
GSEs' agency status.
NAHB Position on Key Elements
    Several elements of the Administration's proposal are antithetical 
to the core principles of GSE oversight. At the very least, the 
Administration's proposal would raise the costs of housing and stifle 
innovation. At worst, the proposal has the potential to undermine the 
entire housing finance system.
    Much of the debate surrounding the GSE regulatory restructuring has 
focused on the treatment of Fannie Mae and Freddie Mac. Indeed, most of 
the key elements of the Administration's proposal relate exclusively to 
these two GSE's. Other reform proposals have proposed including the 
Federal Home Loan Banks under the new GSE regulatory framework, either 
within the Treasury safety and soundness regulator or through the 
establishment of an independent regulator for all the housing GSE's. 
NAHB's comments and recommendations on key elements of these various 
proposals are discussed below.
Proposed Fannie Mae and Freddie Mac Regulatory Framework
Location of Program Oversight
    Under the Administration's proposal, Treasury would assume not only 
safety and soundness duties but also most mission-related oversight 
duties. For example, HUD's current authority to approve new programs 
would be transferred to Treasury under the premise that new program 
approval is a safety and soundness issue rather than a mission-
oversight issue. HUD would have a consulting role.
    NAHB maintains that the program approval activities that are 
currently conducted by HUD should not be transferred to the Treasury 
Department. HUD is the preeminent regulatory authority on housing-
related issues. Treasury has virtually no experience or expertise in 
evaluating the effectiveness and appropriateness of housing policies, 
especially those pertaining to housing for working families. Treasury 
presently has oversight for two important housing tax programs, low-
income housing tax credits and mortgage revenue bonds. Operation of 
these programs is left to the States and HUD to set program specifics. 
Outside of these tax programs, Treasury has little experience or 
expertise in evaluating the effectiveness and appropriateness of 
housing policies.
    The ability of Fannie Mae and Freddie Mac to spur innovative 
solutions and to develop new products that increase homeownership and 
rental housing opportunities will be jeopardized if the mission of 
these corporations is regulated by Treasury. This stifling of 
innovation would reduce the capacity of Fannie Mae and Freddie Mac to 
provide the liquidity and stability needed to keep mortgage credit 
available at the lowest possible cost to homeowners and rental housing 
providers.
    NAHB believes that Fannie Mae's and Freddie Mac's ability to spur 
innovative solutions and to develop new products that increase 
homeownership will continue only if the mission of these corporations 
is regulated by an agency which also has a housing mission, that would, 
as a consequence, contain a thorough understanding of and extensive 
involvement in housing-related issues. The only Federal agency in 
existence now with sufficient housing mission orientation, experience, 
knowledge and focus is the Department of Housing and Urban Development. 
For this reason, NAHB recommends that HUD should retain its current 
status as the mission regulator for Fannie Mae and Freddie Mac, 
including approving new programs and establishing annual affordable 
housing goals.
    The legislative history of program oversight provisions clearly 
indicates that the objective and focus of program oversight is not 
safety and soundness, it is mission compliance. The 1968 Fannie Mae 
Charter Act, which reconstituted Fannie Mae as a Government sponsored 
private corporation, granted HUD general regulatory power to ensure 
Fannie Mae's compliance with its housing mission as specified in the 
charter. In 1970, HUD was vested with prior approval of all new Fannie 
Mae programs through the Emergency Home Finance Act, which also created 
Freddie Mac. HUD was granted regulatory oversight of Freddie Mac in 
1989 through the Financial Institutions Reform, Recovery, and 
Enforcement Act (FIRREA), which transferred this authority to HUD from 
the Federal Home Loan Bank Board. Finally, the Federal Housing 
Enterprises Financial Safety and Soundness Act of 1992 (the GSE Act) 
reaffirmed HUD as the program regulator of Fannie Mae and Freddie Mac 
and gave HUD the authority to establish, monitor and enforce affordable 
housing goals.
    The legislative history reflects the recognition by Congress that 
program oversight is a function of mission regulation that must be 
conducted by an agency with a thorough understanding of and extensive 
involvement in housing-related issues. Indeed, during consideration of 
the 1992 GSE Act, Senate Banking Committee Chairman Riegle stated that 
``in order to properly coordinate national housing policy . . . 
regulations relating to the housing missions of Fannie Mae and Freddie 
Mac should be issued only with the review of the HUD Secretary.''
    HUD has proven itself to possess the capacity to adequately 
evaluate the potential benefits to housing from the GSEs' innovation 
and advancement in products and to ensure that the GSE's do not stray 
from their statutory mission. However, NAHB believes that HUD's program 
oversight could be strengthened through the establishment of an 
independently funded office within HUD. Having an office within HUD 
dedicated to mission oversight of Fannie and Freddie would be 
preferable to the current situation where GSE oversight is conducted 
through the Office of Housing with few dedicated staff and staff from 
other HUD offices are detailed on an ad hoc basis for GSE oversight 
duties. NAHB would support assessing Fannie Mae and Freddie Mac to fund 
the new HUD office.
Process of Program Approval
    Under current law, Fannie Mae and Freddie Mac must submit a new 
program approval request to HUD if the initiative is ``significantly 
different'' from a program previously approved; is an activity in which 
the GSE had not engaged prior to passage of the 1992 GSE Act; or, 
represents an expansion in terms of dollar volume, number of mortgages 
or securities involved above limits expressly contained in any prior 
program approval. Further, if HUD believes an activity should be 
subject to prior approval, HUD may also request additional information 
or require a GSE to submit a program request. (Prior to 1 year after 
the effective date of the risk-based capital regulations, the GSE's 
were required to simultaneously submit new program requests to the 
Director of OFHEO. With the implementation of the RBC rule in September 
2002, OFHEO now has a consulting role, at HUD's discretion, in the 
evaluation of new programs.) HUD is required to approve any new program 
request unless it is not authorized by the GSEs' Charter Acts or is not 
in the public interest.
    The Administration proposes to significantly expand what would have 
to be 
approved, to include any activity or product that differs significantly 
from current activities. Fannie Mae and Freddie Mac introduce a myriad 
of new activities and products each year. Submitting each of these to 
the approval process envisioned by the Administration would severely 
inhibit or delay the development and implementation of valuable new 
mortgage products and technological innovations. The housing-related 
GSE's require a program approval process that provides adequate 
flexibility to respond promptly to market needs, while empowering their 
regulator to ensure ongoing charter compliance and to assess safety and 
soundness.
    The existing program approval requirements and process have served 
the housing market well by ensuring effective regulatory oversight and 
encouraging product innovation to fulfill the GSEs' housing mission. 
This is particularly true in the affordable housing area where both 
GSE's have introduced products and services to 
expand homeownership opportunities for low- and moderate- (low/mod) 
income borrowers, renters and residents of areas underserved by the 
broader housing finance system. Technological innovations by the GSE's, 
such as their automated underwriting systems (AUS), also have 
contributed to their efforts to expand homeownership opportunities. In 
the affordable multifamily market, both GSE's have established forward 
commitment programs that support much-needed production of new units. 
Further, each has developed partnerships and alliances at the national 
and local levels to expand affordable housing opportunities.
    While NAHB strongly supports the current process, we believe that 
the process could be improved in three areas: (1) the scope of review; 
(2) safety and soundness considerations, and (3) the mechanics of the 
review process.
    Scope of review should facilitate innovation. A delicate balance is 
required between a careful examination of whether a new GSE program 
serves its important public mission and the need to not over-burden 
these organizations' innovative efforts to provide new lending 
opportunities in the most difficult to serve communities. There may be 
a need to improve the current approval process, NAHB urges Congress to 
proceed cautiously, and resist efforts to over-encumber this process.
    The current process rightfully limits prior approval to new 
programs, which are defined as very broad undertakings unlike what is 
currently being done. The Administration proposes to significantly 
broaden what would have to be approved to include any new business 
activities. Submitting each new activity to the approval process 
envisioned by the Administration would result in such micromanagement 
of the GSEs' innovations that they would be unable to respond to 
changing market conditions in a timely fashion. The result would be to 
stifle or severely inhibit development and implementation of valuable 
new mortgage products and technological innovations that have helped to 
dramatically expand homeownership in the country.
    The Administration asserts that their proposed new activity review 
would be the same model under which banks operate. A review of activity 
approval for banks and their financial subsidiaries indicates that this 
is not the case. Banks are not subject to an activity by activity 
review as envisioned by the Administration. They have wide latitude to 
engage in any activity enumerated in the National Bank Act. Banks also 
are permitted to conduct activities that are incidental to those 
enumerated.
    There are no specific statutory or regulatory requirements for 
national banks to notify or seek OCC approval prior to engaging in a 
new business activity. However, banks often seek preliminary 
determinations from the OCC if an activity does not have a readily 
apparent nexus to an activity listed in the National Bank Act. Issues 
relating to new and ongoing activities are also addressed during the 
bank examination process.
    Similarly, financial subsidiaries of national banks also have 
expansive latitude to engage in a wide range of statutorily enumerated 
activities without prior approval. Under the Gramm-Leach-Bliley (GLB) 
Act financial subsidiaries may engage in activities that are 
``financial in nature''. The act provides a preliminary list of such 
activities and authorizes the list to be expanded by the Treasury 
Department in coordination with the Federal Reserve. If a bank wishes 
to engage in one of the enumerated new activities through a financial 
subsidiary, it must provide a notice to the OCC within 5 days before 
engaging in a new activity. The only prior approval notice added in the 
GLB Act is for activities not listed in the statute when the company is 
seeking the Treasury and Fed to authorize such activities.
    Safety and soundness considerations should accompany, not dominate 
program approval decisions. The present program approval structure 
strikes an appropriate balance between mission and safety and soundness 
oversight. Safety and soundness are not criteria for new program 
approval. Indeed, the Treasury Department reached the same conclusion 
in its 1990 study on the GSE's. Treasury stated,

        ``the regulatory authority which monitors a GSE's fulfillment 
        of its Congressional mandate should be different from the 
        entity implementing financial safety and soundness standards. 
        Separating these two regulatory functions will remove risks to 
        the taxpayers by removing a perceived conflict of interest 
        [emphasis added]. . . . The Treasury recommends that the 
        current program regulator continue to be responsible for 
        ensuring that the GSE meets its Congressional mandate by 
        effectively serving its intended beneficiaries.'' Report of the 
        Secretary of the Treasury on Government Sponsored Enterprises, 
        May 31, 1990.

    It is interesting that the Administration now views program 
approval as a function of safety and soundness oversight to be overseen 
by the Treasury. As discussed above, NAHB believes Treasury is the 
wrong place to put program approval. Treasury lacks experience in and 
knowledge of housing.
    This is not to say that safety and soundness should not be a 
consideration in new program review. NAHB believes that safety and 
soundness is one of the many elements that should be evaluated during 
the new program approval process, but maintains it should not be the 
paramount consideration as the administration has proposed.
    Reviewing new programs solely on the basis of safety and soundness 
would severely retard the development of programs needed by Fannie Mae 
and Freddie Mac to fulfill their housing mission. It will stifle 
innovation necessary to provide liquidity to the housing credit 
markets, particularly in areas that otherwise would not be adequately 
served. Such activities, by definition, involve higher risk and would 
be greatly constrained if program approval is solely a component and 
function of safety and soundness regulation.
    The safety and soundness regulator should have a consultative role 
in program review, not the final decision. Some criteria that the 
safety and soundness regulator should consider are:

 Risk assessment: Does the new program pose undue risks to the 
    Enterprise or the housing finance system generally?
 Risk management: Does the Enterprise have the expertise, 
    resources, and programs in place to effectively manage the interest 
    rate, credit, or other risks associated with the new program?
 Capital adequacy: Does the Enterprise have present or 
    reasonably anticipated reserves to compensate for the risks 
    involved?

    Further, we note that the risks of new activities are accounted for 
in the risk-based capital model, which ensures that the GSE's have 
adequate reserves to cover the risks of new programs.
    Program review process should be clarified with specific criteria. 
Presently, HUD has 45 days to review a new program request, with one 15 
day extension. As noted, HUD is required to approve a new program 
request unless it is not in compliance with the GSEs' Charter Acts or 
is not in the public interest. The present process is vague on the 
content of the application request and the criteria for approval. NAHB 
supports retention of the current timeframes for approval of new 
program requests and offers the following suggestions for application 
content and review criteria.
    New Program Request Application Content:

 Citation to the statutory, regulatory, or other legal 
    authority;
 Estimate of the anticipated dollar volume of the program 
    (short- and long-term);
 Full description of proposed program, including: Purpose and 
    operation; target market; delivery system; and effect of the 
    activity on the housing market, broadly, and/or ability to meet 
    affordable housing goals; and,
 Assessment of the risks associated with the activity, and a 
    demonstration of the Enterprise's ability to manage those risks.

    Review Criteria:

 Charter compliance: Is the program consistent with the 
    Enterprise's charter and other relevant statutory and regulatory 
    authority, and does the new program support the mission of the 
    Enterprise?
 Public interest: Is the new program in the public interest? 
    Does it support or help to fulfill an important housing-related 
    objective?
 Innovation: Does the new program foster innovation in the 
    availability or delivery of housing-related financial services?
 Risk Assessment: Must consult with and consider risk 
    assessment by safety and soundness regulator.

Extent and Control of Fannie Mae and Freddie Mac Affordable Housing 
        Goals
    The current statute contains three specific goals that are intended 
to push Fannie Mae and Freddie Mac further into housing finance 
products and markets than they may otherwise go. HUD sets the specific 
levels of business they must achieve. HUD has steadily increased the 
levels and the GSE's have achieved them.
    NAHB has always been a strong supporter of the affordable housing 
goals for Fannie Mae and Freddie Mac since HUD was granted this 
authority by the 1992 GSE Act. The housing goals establish percent of 
business purchase goals for three categories: Low- and moderate-income, 
underserved areas, and special affordable. The first set of goals was 
established by regulation in 1995, and was updated in 2000 to cover the 
years 2001-2003. Current goals levels, as a percent of annual 
purchases, are: 50 percent for low-mod; 31 percent for underserved 
areas; and, 20 percent for special affordable.
    Both GSE's have consistently exceeded all of the housing goals 
since the initial goals were established in 1995. The goals have 
encouraged Fannie Mae and Freddie Mac to reach deeper into the 
affordable housing market with tangible benefits. The GSE's financing 
of housing for low- and moderate-income families has increased from 
under 30 percent of their purchases in 1992 (prior to passage of the 
GSE Act) to over 51 percent in 2002.
    The Administration is proposing to strengthen HUD's housing goals 
authority over Fannie Mae and Freddie Mac. As the HUD Secretary 
outlined in his October 16, 2003 testimony before this Committee, this 
will include the creation of a new GSE office within HUD, independently 
funded by the GSE's, to establish, maintain, and enforce housing goals. 
HUD would be granted new administrative authority to enforce housing 
goals, enhanced civil penalties for failure to meet the goals, and 
expanded authority to set housing goals and sub-goals beyond the three 
currently established. The President's proposed budget for fiscal year 
2005 also calls for adding a new goal to promote affordable housing 
homeownership.
    For the same reason that NAHB supports HUD as Fannie Mae's and 
Freddie Mac's mission regulator, NAHB supports HUD as the regulator for 
the GSEs' housing goals. We agree with the HUD Secretary that ``HUD is 
the appropriate agency to develop and enforce housing goals. 
Institutionally, [HUD's] mission is devoted to furthering the goal of 
affordable housing and homeownership and HUD has the most expertise in 
this area.'' Indeed, NAHB believes housing goals authority is one of 
HUD's key functions as mission regulator for Fannie Mae and Freddie 
Mac.
    NAHB also agrees that more needs to be done to encourage the GSE's 
to increase their activities in some market segments. However, we do 
not believe that adding additional goals or sub-goals, as the 
Administration has proposed, is the best way this could be 
accomplished. Fannie Mae and Freddie Mac were created to serve a broad 
range of housing needs and we would not want overly stringent or 
complex goals to impede that mission. Continual increases in the 
percentage targets will have diminishing returns and run the risk of 
adversely impacting other housing programs, such as FHA's single family 
program.
    NAHB believes that a better way to encourage increased GSE activity 
in underserved markets is through bonus point incentives within the 
existing goals system. HUD's 2000 goals rule, which established goals 
for 2001-2003, also provided for bonus points during this period for 
units financed for GSE mortgage purchases in small (5-50 unit) 
multifamily properties and for units in 2- to 4-unit owner-occupied 
units. These units are key sources of affordable housing for large 
numbers of low- and moderate-income households, first-time homebuyers, 
and minorities. One-third of the rented homes are in buildings with 5 
to 50 units and minority renters are more likely to be the occupant 
than are white residents. The bonus point system ended on December 31, 
2003, when HUD chose not to extend it beyond the effective termination 
date.
    NAHB is a strong supporter of the bonus points system as a flexible 
means to provide incentives for the GSE's to increase activity in 
targeted markets and we adamantly oppose HUD's decision to terminate 
the bonus points. The bonus points were an integral component of the 
current goals structure and they served their intended purpose as both 
Fannie Mae and Freddie Mac increased their purchases of bonus-related 
mortgages. For example, Fannie Mae's purchases of small multifamily (5-
50) properties as a percentage of their total multifamily purchases 
more than doubled from 1.7 percent in 1997 to 4 percent in 2002. 
Similarly, Freddie Mac's purchases increased from 3 percent in 1997 to 
6.5 percent in 2002.
    NAHB is concerned that the elimination of the bonus points 
incentive will disrupt the progress that has been made in these markets 
as the GSE's focus on larger multifamily properties which are more 
``goals-rich'' in order to meet their overall housing goals. More work 
remains to be done in the small multifamily market, especially in rural 
areas and urban infill locations that are part of community 
revitalization efforts.
    As we have stated above, NAHB believes bonus points are a very 
effective tool for focusing GSE affordable housing efforts on areas of 
greatest need. NAHB urges this Committee to instruct HUD to reinstate 
the bonus points for small multifamily properties. We also recommend 
that bonus points for loans on small multifamily projects, rural homes 
and newly built homes be included in statutory provisions for 
affordable housing goals under any new GSE regulatory regime.
    Finally, NAHB suggests that consideration should be given to the 
statutory factors HUD must consider in setting the housing goals. The 
1992 GSE Act requires HUD to consider the following six factors in 
establishing the goals:

 national housing needs;
 economic, housing, and demographic conditions;
 performance and effort of the GSE's toward achieving the goal 
    in previous years;
 size of the conventional mortgage market serving the targeted 
    population or areas, relative to the size of the overall 
    conventional market;
 ability of the GSE's to lead the industry in making mortgage 
    credit available for the targeted population or areas; and,
 the need to maintain the sound financial condition of the 
    GSE's.

    Of particular concern, is the requirement that the GSE's ``lead the 
market'' in reaching underserved populations. In evaluating this 
criterion, HUD includes markets in which the GSE's are unable to fully 
participate, such as manufactured housing loans and subprime loans. 
While NAHB does not dispute that the GSE's should be held accountable 
for their performance in these areas, NAHB believes that some 
allowances should be made for the fact that these markets are not 
readily available to them.
Safety and Soundness Regulator
    NAHB supports strong and credible safety and soundness oversight 
for Fannie Mae and Freddie Mac. The purpose of safety and soundness 
regulation is to ensure that Fannie Mae and Freddie Mac are adequately 
capitalized for the mission-related programs they are operating, and 
appropriate governance structures and procedures are in place to 
operate those programs in a safe and sound manner. The safety and 
soundness of Fannie Mae and Freddie Mac should be ensured through 
rigorous examination, enforcement of capital standards and 
transparency, without unnecessarily impairing the ability of the GSE's 
to perform their housing mission. It is 
imperative that the safety and soundness functions be separate from 
mission regulation, specifically program oversight and housing goals. 
Safety and soundness regulation should not be a vehicle for 
disapproving programs so the enterprises undertake little or no risk.
    As stated earlier, NAHB strongly disagrees with the position that 
the GSE safety and soundness regulator must have the primary role in 
approving new programs in order to adequately perform safety and 
soundness oversight. This argument is based on the assumption that the 
mission regulator would increase the riskiness of Fannie Mae's and 
Freddie Mac's operations by allowing them to expand into activities 
beyond the scope of their charters. As outlined above, charter 
compliance is a prerequisite for new program approval. NAHB supports a 
requirement that the mission regulator consult with the safety and 
soundness regulator during new program reviews. We also feel that the 
safety and soundness regulator should be empowered to prevent the GSE's 
from undertaking any new activity representing a threat to their 
ongoing viable operation. However, the focus of safety and soundness 
regulation and supervision should be on ensuring that Fannie Mae and 
Freddie Mac hold adequate capital in relation to the risk of the 
activities they are undertaking and that these enterprises have the 
appropriate staff, systems, and management controls in place to operate 
the programs in a safe and sound manner.
    Safety and soundness oversight of Fannie Mae and Freddie Mac 
presently resides with OFHEO, an independent office within HUD. Recent 
events with respect to Freddie Mac's and Fannie Mae's accounting 
practices have led a number of observers to raise serious questions 
about OFHEO's ability to perform these regulatory functions. In light 
of these concerns, NAHB would support the transfer of safety and 
soundness oversight of Fannie Mae and Freddie Mac from OFHEO to another 
entity with greater capacity and resources, such as the Treasury 
Department. We recognize Treasury as the premier financial institution 
regulator because of its expertise and experience with financial 
issues. However, as explained above, the authority of the office must 
be limited primarily to safety and soundness functions only because 
Treasury is not equipped to handle mission oversight of the GSE's.
Capital
    NAHB has consistently supported the establishment and enforcement 
of appropriate capital standards for Fannie Mae and Freddie Mac. 
Pursuant to the 1992 GSE Act, Fannie Mae and Freddie Mac are required 
to meet two capital standards, a minimum leverage ratio and a risk-
based capital (RBC) standard. The minimum leverage ratio is 2.5 percent 
of assets plus 0.45 percent of adjusted off-balance sheet obligations. 
By law, the RBC standard, is based on a stress test which calculates 
the amount of capital that Fannie Mae and Freddie Mac must hold to 
maintain positive capital over a 10-year period of adverse credit and 
interest rate conditions, plus an additional 30 percent of this capital 
level to cover management and operations risk. The firms must meet both 
the RBC and minimum capital standards to be classified as adequately 
capitalized. Failure to meet the capital standards would trigger 
enforcement actions ranging from limits on growth and activities to 
conservatorship.
    Fannie Mae and Freddie Mac have consistently met their capital 
standards and thus have been classified as adequately capitalized. 
Prior to the implementation of the RBC standard, the firms were 
required to meet the minimum leverage ratio. The RBC standard became 
enforceable on September 13, 2002, after nearly 10 years of 
development. The RBC test is the first regulatory capital standard to 
be based on a stress test and has been hailed as the most dynamic and 
stringent capital standard for any financial institution.
    The Administration proposes to provide the Treasury regulator 
greater flexibility in establishing the leverage and RBC requirements. 
However, in testimony before this Committee last year, Treasury 
Secretary Snow mentioned the need for stability in capital standards 
and suggested that capital standards should not be subject to frequent 
change. NAHB agrees with this perspective and applauds Secretary Snow's 
decision not to recommend any changes in the statute dictating the 
GSEs' minimum and RBC requirements. Given that the current RBC 
standards took 10 years to develop and have been in effect for only 1 
year, we are pleased that the Treasury is willing to give the 
requirements a chance to work. NAHB recommends against any immediate 
changes in the GSEs' minimum capital standard as well. Longer-term, 
NAHB agrees the safety and soundness regulator should have the 
flexibility to adjust capital standards as necessary. However, NAHB 
cautions against significant changes in the GSE's RBC standard or any 
significant increase in the GSE's minimum capital standard. 
Overcapitalization of the GSE's, beyond the level of risk, is not 
economically efficient and could have unintended consequences for the 
housing markets, by reducing the level of capital for housing and 
increasing mortgage rates.
    NAHB would also oppose the imposition of bank-like capital 
standards for the GSE's as some have proposed. Congress rejected this 
notion and intentionally drafted a separate capital regime for Fannie 
Mae and Freddie Mac under the 1992 GSE Act. The present capital 
framework takes into account the unique nature of the GSE's business, 
that there are only two firms (as compared to thousands of banks) and 
they engage in a monoline business, focused on low-risk residential 
mortgages (unlike banks which engage in a wide range of activities). 
During the lengthy development process of the current RBC standard, 
OFHEO took great pains to ensure that the standard appropriately ties 
capital to risk. Bank regulators have recognized that bank capital 
standards do not tie capital to risk and are now engaged in a process 
to revise bank capital standards through the Basel II Accord.
Independence of Regulator
    OFHEO currently operates independently of the cabinet agency where 
it resides (HUD). Other banking regulators within Treasury also operate 
with independence. For example, regulations, agency guidance and 
testimony emanating from the Office of Thrift Supervision (OTS) or the 
Office of the Comptroller of the Currency (OCC) are not subject to a 
mandatory approval requirement by Treasury. The Federal Housing Finance 
Board is an independent, stand-alone regulatory agency.
    The Administration proposal requires Treasury approval of testimony 
and regulations from the regulator within Treasury. NAHB strongly 
believes that safety and soundness regulators should be objective, 
nonpartisan, and protected from political interference. This is 
especially critical at times when regulators must make difficult and 
sometimes politically unpopular decisions. The primary responsibility 
of the regulator is to implement policy made by the Congress, and to do 
so in a safe and sound manner. NAHB strongly believes that a regulator 
lacking true independence may eventually find itself pursuing other 
agendas, not the will of Congress, nor what is demanded to assure 
safety and soundness.
    Independent regulation also protects Congress' ability to receive 
the regulator's best judgment on regulatory matters unfiltered and 
without delay. With billions of dollars of potential taxpayer liability 
at stake, it is in everyone's interest that this important safeguard 
not be weakened. Therefore, NAHB believes if a new agency is created 
within Treasury, it should have autonomy in the following key areas:

 Testimony. Congress should be able to count on receiving the 
    agency's unadulterated views on all issues it faces.
 Rulemaking. The agency's policy justification for issuing 
    regulations should be devoid of interference from politically 
    appointed officials.
 Supervision and Examination. True safety and soundness cannot 
    be attained without a strict separation between political 
    appointees and supervisory and examination staff.
 Enforcement. The agency's enforcement actions must be 
    unblemished by any extraneous influence.
Inclusion of the FHLBank System
    The Administration has called for placing Fannie Mae, Freddie Mac, 
and the FHLBanks under a single regulator. In fact, the President's 
proposed budget for fiscal year 2005 includes provisions for 
transferring oversight of the Federal Home Loan Banks from the Federal 
Housing Finance Board to the same new office at Treasury that would 
regulate Fannie Mae and Freddie Mac. NAHB believes that it is Congress' 
responsibility to scrutinize the regulatory oversight of the housing 
GSE's, and to ensure that they provide the Nation's network of 
community-based financial institutions with the safest, soundest source 
of residential mortgage and community development credit possible. 
While all three GSE's have much in common, NAHB believes it is 
important to both recognize and preserve the unique nature of the 
FHLBanks. For example, unlike Fannie Mae and Freddie Mac, the FHLBank 
System is a cooperative owned by its member institutions. The FHLBanks' 
stock is not publicly traded and does not fluctuate in value. In 
addition, each of the FHLBanks is jointly and severally liable to all 
the others.
    Each of the three GSE business models has their strengths. Any 
revised regulatory system should continue to respect those differences, 
while advancing the common goal--to maintain their financial safety and 
soundness.
Funding of Regulator
    President Bush's fiscal year 2005 budget proposes to increase the 
amount of resources allocated to regulating the housing-related GSE's. 
The proposed budget 
earmarks $83 million to establish a new office within Treasury. The 
budget also anticipates that HUD will incur approximately $6.25 million 
in the establishment and enforcement of affordable housing goals, 
ensuring GSE compliance with fair housing laws, and providing 
consultation to the safety and soundness regulator on new activities. 
The activities of the safety and soundness regulator would be funded 
through mandatory assessments on all of the GSE's; the mission 
oversight costs at HUD would be assessed on Fannie Mae and Freddie Mac.
    NAHB believes that those who supervise and regulate the GSE's 
should possess adequate authority and resources. The housing-related 
GSE's are engaged in a myriad of complex financial transactions. It is 
crucial for the regulator to possess a high degree of experience, 
knowledge, and familiarity with current accounting, risk-management and 
housing-related issues so that they are credible, confident, and 
capable. Furthermore, NAHB believes that it is entirely reasonable for 
the GSE's to fund the responsibilities of their regulator.
Independent Regulatory Body
    The idea of a stand-alone independent regulator has been floated as 
a compromise to break the current impasse among policymakers on the key 
issues of program oversight and political independence of the 
regulator. It is argued that a stand-alone agency would resolve 
concerns about independence of the regulator from Treasury, as well as 
Treasury's oversight of new programs. It might also ease concerns about 
including the FHLBanks in the new system since a merged agency would 
avoid a perception that any of these Government Sponsored Enterprises 
are subject to more effective regulation than any of the others.
    While not our first preference, NAHB would be open to exploring the 
concept of a new independent regulator for all three housing GSE's 
outside the Treasury Department, depending on how key details are 
implemented. NAHB's primary concern in either regulatory scenario is 
that the mission regulator must have a housing focus and expertise and 
the safety and soundness regulator must have sufficient respect and 
authority to satisfy Congress and the capital markets.
    In addition to the funding and political independence issues 
addressed in other sections of this testimony, NAHB notes that other 
preliminary characteristics to consider are the corporate structure of 
the agency, and how its managers will be selected. Given the diversity 
and complexity of supervisory issues the agency will address, NAHB 
initially recommends the agency be structured as a board of directors 
rather than a single agency head. In this scenario, NAHB suggests that 
a HUD representative should serve on the board in order to ensure that 
it possesses a housing-oriented focus and experience. NAHB also 
suggests that the board comprise stakeholders from various industry 
sectors. As mentioned above, it is imperative to recognize the 
differences between Fannie Mae, Freddie Mac, and the FHLBanks. This 
could be effectuated by establishing two divisions and maintaining 
separate funding for the costs of regulation.
Conclusion
    NAHB appreciates the opportunity to share our views on the 
regulatory framework for Fannie Mae, Freddie Mac, and the Federal Home 
Loan Bank System. The critical supports provided by these housing 
Government Sponsored Enterprises (GSE's) were an essential component to 
the recent success of the housing market in sustaining the Nation's 
economy. NAHB appreciates the Committee's efforts to assess and seek 
improvements to the regulatory framework of these GSE's. We look 
forward to working with the Committee as you progress toward fashioning 
a narrow regulatory solution to the oversight of these important 
housing institutions.

         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED 
                      FROM ALAN L. BELLER

    At our October 23, 2003 hearing, Federal House Finance 
Board (FHFB) Chairman Korsmo testified that he recommended to 
Congress that all 12 Federal Home Loan Banks (FHLB's) comply 
with the Securities Exchange Act of 1934. However, some of the 
12 FHLB's have argued that, due to the unique nature of the 
System, disclosure registrations as required under the 
Securities Exchange Act of 1934 are difficult to implement, and 
would prevent the FHLB's from efficiently offering securities 
to the market. Only the Cincinnati FHLB has voted to implement 
the disclosure registrations of the Securities Exchange Act of 
1934.
Q.1.a. What is your reaction to that argument? Do you foresee 
any major impediments to Securities Exchange Act of 1934 
compliance for the FHLB's? Why or why not?

A.1.a. We do not foresee any major impediments. We have met 
with representatives of many of the Banks and with staff of the 
Federal Housing Finance Board to discuss a number of aspects of 
the requirements and timing of registration under the 
Securities Exchange Act of 1934. In particular, we have 
addressed what have been identified as four threshold 
accounting issues. As noted in my testimony, we have resolved 
those issues.
    In addition, Commission staff members have worked with 
representatives of a number of the Banks to discuss 
accommodations the staff will make to address concerns the 
Banks have raised. The Commission staff has clearly indicated 
that it will provide ``no-action,'' interpretive or other 
relief, to accommodate each Bank's preference to register a 
class of its capital stock rather than a class of debt. We 
believe that the investors in the publicly issued debt of the 
Banks are entitled to the same level of information as that 
provided to investors in debt securities of other public 
companies. However, if the Banks register a class of their 
capital stock with the SEC, they would be subject to certain 
disclosure and other requirements beyond those to which 
companies that have registered only their debt securities with 
us, and not their common stock or other equity securities, are 
subject. In our discussions with the representatives of the 
Banks and the Finance Board, the Commission staff has agreed to 
provide relief from provisions of the securities laws that 
would make the requirements to which they are subject 
consistent with those of companies who have registered only 
their debt securities with us.
    The Federal Home Loan Banks, although federally chartered 
entities, have many of the same disclosure issues faced by any 
financial institutions whose securities are issued to, and held 
by, the public. The Federal Home Loan Bank System is one of the 
largest issuers of debt securities in the world. The debt of 
the Banks does not carry the full faith and credit backing of 
the United States and investors in the Banks' debt must, 
therefore, look only to the Banks for repayment of the debt. 
Therefore, disclosures by the Banks should give the holders of 
their debt a materially complete and accurate picture of the 
Banks' financial and operational situation to provide investors 
in their debt with sufficient information on which to evaluate 
an investment. As noted above, we believe that the holders of 
debt issued by the Office of Finance, for which the 12 Banks 
are jointly and severally liable, are entitled to the same type 
of information that is provided to investors in other public 
debt securities. We believe that the Commission's detailed 
disclosure rules and filing requirements and the staff review 
and comment process provide the best framework for disclosing 
information to which investors are entitled. In addition, we 
have a long history of reviewing complex entities that comply 
with the disclosure requirements of the Exchange Act and other 
Federal securities laws.

Q.1.b. Would registration prevent the FHLB's from efficiently 
offering securities to the market?

A.1.b. No. Under the Securities Exchange Act of 1934, publicly 
reporting companies are required to file periodic and current 
reports. Registration under the Securities Exchange Act of 1934 
is not tied to the timing of offerings as it is under the 
Securities Act of 1933. There would, therefore, be no impact on 
a Bank's timing or other aspects of offering securities as a 
result of Exchange Act registration. Some Banks have expressed 
concern that staff review of a Bank's Exchange Act reports 
might require a Bank to cease selling its securities. However, 
the staff does not advise or instruct a publicly reporting 
company to stop selling securities based on its comments on the 
company's Exchange Act filings. As is the case now, if a Bank 
uncovers a disclosure issue the Bank itself must determine 
whether or not it should continue to sell securities in the 
public markets. While registration under the Exchange Act may 
cause the Commission staff to raise a comment which could alert 
a Bank to a particular issue, it would, as now, be up to the 
Bank to determine whether the issue was significant enough to 
temporarily curtail securities offerings until the appropriate 
disclosure was 
provided to the public. This would be the case whether the 
issue was identified by the Bank itself or by the Commission 
staff in a comment letter.

    Fannie and Freddie have argued that due to the nature of 
the mortgage-backed securities market structure, the fees 
associated with the Securities Act of 1933 disclosure would be 
onerous, seriously slowing the offering of mortgage-backed 
securities to the ``To Be Announced'' (TBA) market, as well as 
being unfairly costly. They also claim the volume of the 
securities they offer also makes such registrations difficult 
for the SEC to handle expeditiously.
Q.2.a. What is your reaction to that argument? In your opinion, 
can the SEC handle such registrations? Would it be too 
difficult to implement or too costly?

A.2.a. We have a long history of overseeing the disclosure and 
offerings of companies in many diverse industries including 
financial companies that perpetually offer securities to the 
market. The current registration fee is $126.70 for each 
$1,000,000 of securities offered. Since Fannie and Freddie 
issue a large volume of securities, the fees they would pay for 
registering the offer and sale of securities under the 
Securities Act of 1933 could be large. We have no reason to 
believe that subjecting Fannie and Freddie to the same fees, 
disclosure, and review as other companies that offer mortgage-
backed securities to the market would be unfairly costly to 
Fannie or Freddie or present any difficulties for the SEC. 
However, as noted below, we do not know whether or how 
requiring registration of the mortgage-backed securities would 
impact the mortgage market, and we have consistently stated 
that an evaluation of this 
impact should be part of any consideration of whether their 
mortgage-backed securities should be registered under the Act.

Q.2.b. What would be the effect of implementing SEC 
registration on the liquidity of the Nation's housing finance 
system and on the end mortgage interest rates available to the 
homebuyer?

A.2.b. It has been our priority that investors who purchase and 
sell stock or ``straight'' debt (that is, non-mortgage-backed 
debt) of the GSE's are entitled to the corporate information 
publicly registered companies must disclosure under the 
Securities Exchange Act of 1934. Fannie Mae has registered its 
common stock under the Exchange Act and is now fully subject to 
the Commission's disclosure rules and the requirements of the 
Sarbanes-Oxley Act. Freddie Mac has not yet completed the 
process of registering under the Exchange Act but has stated it 
intends to complete the registration process when it completes 
its restatement and audit of its financial statements. Both of 
the GSE's continue to be exempt from the requirements to 
register the offer and sale of securities under the Securities 
Act of 1933 and as such the timing of their offerings and 
therefore, as noted above, their liquidity will not be impacted 
by Exchange Act registration.
    Registration of offerings of the GSE's mortgage-backed and 
related securities under the Securities Act may raise issues 
regarding the impact on the mortgage market, especially the TBA 
market. A decision to require registration under the Securities 
Act of offers and sale of mortgage-backed securities should 
properly take into account consideration of whether, and if so, 
how such registration might impact the mortgage market and the 
operation of the TBA market. The staff of the Commission does 
not have expertise to determine whether or how this might 
impact the mortgage market. As noted above, we have 
consistently stated that an evaluation of this impact should be 
part of any consideration of whether Fannie's and Freddie's 
mortgage-backed securities should be registered under the 
Securities Act.

Q.3. It is my understanding that Freddie's compliance with the 
1934 Act is being delayed due to its ongoing revisions of its 
financial statements. Freddie is expected to release its 
revised earnings sometime this month. Has Freddie communicated 
with the SEC regarding when they expect to come into compliance 
with the 1934 Act? When specifically do you believe they will 
be able to do so?

A.3. Freddie Mac has indicated it intends to complete the 
Exchange Act registration process when it completes its 
restatement and audit of its financial statements and is 
current in its financial statements. Most recently, Freddie Mac 
has indicated it believes it will complete registration under 
the Exchange Act by mid-2005.






                       PROPOSALS FOR IMPROVING
                       THE REGULATION OF HOUSING
                    GOVERNMENT SPONSORED ENTERPRISES

                              ----------                              


                       TUESDAY, FEBRUARY 24, 2004

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:01 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The Committee will come to order.
    Today, the Committee continues its consideration of needed 
reforms to the regulatory regime for the housing GSE's. This is 
the fourth hearing on this matter. The time and the resources 
that the Committee have dedicated to this matter underscore its 
importance.
    Fannie Mae, Freddie Mac, and the Federal Home Loan Bank 
System provide liquidity to a vital sector of our national 
economy--the housing markets. Because of their crucial roles in 
our economy, the financial condition, and safe and sound 
operations of these institutions must be diligently monitored.
    Given their size, and their sophisticated risk management 
strategies, this monitoring is no simple task. It is one of my 
top priorities to report legislation from this Committee that 
will create a new housing GSE regulator that will have the 
stature, sophistication, and necessary regulatory tools to 
ensure that these institutions continue to carry out their 
public policy mission in a safe and sound manner.
    Today, the Committee will hear from Alan Greenspan, the 
Chairman of the Board of Governors of the Federal Reserve 
System. Chairman Greenspan will share his insights with this 
Committee on the role that the housing GSE's play in the 
housing sector, the impact of their operations on our financial 
markets, and the need to establish a strong, credible 
regulator.
    Senator Allard, do you have an opening statement?

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I do have just a very brief 
statement.
    First of all, I would like to thank you for your diligence 
in following this issue. It is very important, I think, and I 
would also like to thank Chairman Greenspan for taking time 
from his busy schedule to show up before this Committee to 
testify. I have always valued his testimony before this 
Committee. And as Chairman of the Housing Subcommittee, 
reforming the GSE's is a topic in which I am keenly interested.
    The housing market is no doubt a critical aspect of the 
U.S. economy. We have seen the housing market sustain itself 
during this last economic downturn that we had. It was actually 
a persistent bright spot that we had in our economy when 
everything else was not doing well. The financing of mortgages 
I think in recent years has helped to power the economy through 
the recent recession.
    Now, the GSE's have been an active part of helping the 
American Dream come true for millions of families. The GSE's, 
though, are large, complex financial institutions that merit 
the highest levels of scrutiny. I believe alternative 
regulatory proposals to ensure the protection of the U.S. 
housing markets are necessary. This regulatory authority needs 
to rest on a strong, financially sound foundation, and I look 
forward to discussing the necessary elements a regulator must 
have to do its job effectively.
    Though many items still need to be worked out as part of a 
new regulatory regime, I believe we are making progress, and I 
hope that we can all agree that we must have a strong 
regulator. We owe nothing less to the taxpayers and homeowners 
of the Nation.
    I look forward to hearing from Chairman Greenspan and his 
thoughts on how we can reform and improve the regulatory 
structure for GSE's.
    Chairman Shelby. Senator Dole.

              STATEMENT OF SENATOR ELIZABETH DOLE

    Senator Dole. Thank you, Mr. Chairman. I would like to 
express my appreciation for your continued leadership on this 
very important issue.
    Last summer, Senators Hagel, Sununu, and I introduced S. 
1508, the Federal Enterprise Regulatory Reform Act. I think my 
colleagues would agree that approximately 95 percent of this 
bill enjoys broad, bipartisan support. As for that remaining 5 
percent, I am confident you will find agreement, Chairman 
Shelby, as you are working this issue.
    The question of the proper powers and resources available 
to a regulator of the Government Sponsored Enterprises has 
proven to be a vexing issue. Chairman Shelby, you have been 
carefully crafting solutions to some of the more controversial 
proposals contained in the GSE reform package, and this 
Committee is very close, I believe, to achieving a consensus. 
After so much work, it is my hope that the consensus will earn 
all of our support.
    I understand, Chairman Greenspan, that you have devoted a 
considerable amount of your time, in addition to that of your 
staff, on the risks and benefits of our GSE bill. I appreciate 
your willingness to weigh in on these important issues.
    One issue of particular importance is the need to ensure 
that the regulator has the ability to control nonmortgage 
investments of the GSE's. In his testimony 2 weeks ago, the 
Comptroller General stated, ``We again recommend that Congress 
legislate nonmortgage investment criteria for HUD or any new 
GSE regulator that may be established through legislation.'' 
The General Accounting Office has warned us that the incentives 
to use the benefits of Government sponsorship to increase 
shareholder value could, over time, erode the public mission. I 
believe every Member of this Committee is committed to ensuring 
that the mission to create greater opportunities for 
homeownership, especially for minority populations, is the 
number one priority for the GSE's. We must make sure that our 
effort gives this mission the focus and attention it deserves 
by all GSE's, and that there is no chance of erosion over time.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thanks, Mr. Chairman.
    Chairman Greenspan, welcome. It seems like you were just 
here. In fact, I think you were. Welcome back.
    I read in some of the briefing material for today's hearing 
an explanation--I think it showed up in the American Banker--
about different kinds of capital from minimum to risk-based 
accords, or a whole lot of others. And so the question that I 
am going to be asking you, just to telegraph my pitch, is to 
explain all those capital standards in ways that even former 
Governors can understand. And if you could do that today, you 
will get an A-plus from me, and maybe make those relevant to 
our discussion.
    When I was Governor of Delaware, we used to have a slogan 
in our administration. You have all heard probably somewhere in 
your life the axiom, somebody who did a job, did not do it 
necessarily very well, you say, ``That is good enough for 
Government work.'' I never liked that.
    Later on, I used to hear people say often, ``If it ain't 
broke, do not fix it.'' And that applies, I guess, to things 
inside as well outside of Government. And I have never been 
real crazy about that one either.
    The slogan that we adopted for 8 years was, ``If it is not 
perfect, make it better.'' And I think when we look at the way 
that we regulate our GSE's, it is not perfect. We can make it 
better. But as we approach the job of doing that, I think it is 
important for us to keep in mind that today in this country, 
almost 70 percent of the people live in a home that they own. 
And it is a remarkable success story.
    In my little State, our homeownership rate is actually 
approaching 75 percent. And as we try to make what is not 
perfect more perfect, I think it is important that we do so in 
a way that does not undermine the remarkable success that we 
have had in fostering homeownership.
    Welcome back. We look forward to your testimony.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman.
    Just less than 2 weeks ago, Chairman Greenspan, you 
testified before this Committee about monetary policy, and at 
the time I criticized you for allowing yourself and the Fed to 
be drawn into things that have nothing to do with monetary 
policy. I do not think that studies on home interest rates and 
whether GSE's help or hurt homeownership have much to do with 
monetary policy. However, your monetary policy decisions, 
comments, and studies can have a great influence on home 
interest rates and whether or not someone can purchase a home.
    I was very surprised to hear about the recent Fed GSE 
study. I was surprised it stated that Fannie and Freddie are 
responsible for an average of 7-basis-point decrease on home 
mortgages.
    I have two Kentucky papers in front of me. Both have 
mortgage surveys. Both of them show a 25- to 50-basis-point 
difference between 30-year fixed-rate mortgages that GSE's can 
buy and 30-year jumbo mortgages which GSE's cannot buy. I would 
like to know your opinion on why there is such a difference 
between the rates of the jumbo and the fixed-rate loans and if 
these differences are consistent with the recent Fed study.
    I was also struck by a comment in your speech yesterday to 
the credit unions. You stated, ``Recent research within the 
Federal Reserve suggests that many homeowners might have saved 
tens of thousands of dollars had they held adjustable rate 
mortgages rather than fixed-rate mortgages during the past 
decade, though this would not have been the case, of course, 
had interest rates trended sharply upward.''
    Of course, if homeowners knew that rates would be lower, 
they would have used adjustable rate mortgages. But most 
homeowners do not know what rates are going to be for the next 
30 years. That is why they buy fixed-rate mortgages. Not very 
many homeowners have the resources that the Fed has in being 
able to predict long-term interest rates. So they buy fixed-
rates despite the fact that they are more expensive to hedge 
against risk.
    For the average American, losing your home is not worth the 
risk of possibly saving some money on a 30-year adjustable 
mortgage. Rates were low in the last decade, historically low. 
But most of us here remember the 1970's and early 1980's and 
how high rates were then. If rates started to rise to Carter-
level rates, I am fairly certain that no one would want an 
adjustable rate mortgage.
    You are always warning economic institutions, public and 
private, that they must hedge against risk. I agree with you 
and think it is very prudent advice. But I also think the 
average American should hedge against risk for their most 
important investment--their home.
    Once again, thank you for coming today. I look forward to 
your testimony.
    Chairman Shelby. Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman, for 
scheduling these hearings on this very important topic of 
Government Sponsored Enterprises, and thank you, Chairman 
Greenspan, for attending.
    There are a host of technical issues that we have to 
consider, things such as the merger of the various regulatory 
agencies, whether or not there should be a statutory standard 
for capital, the potential impact on all of these things. But 
what most concerns me is how we can harness these 
organizations, both Fannie Mae and Freddie Mac and the Federal 
Home Loan Banks, to provide affordable housing opportunities 
for our citizens. Because as I go about this country, that is 
one of the great sources of concern and difficulty for families 
all across this country. Housing prices are soaring. The 
housing markets are doing extremely well. As a result, rental 
markets are appreciating dramatically. It is impossible for 
anyone making a minimum wage job to afford even a decent rental 
unit in most places, probably every place in the country.
    We have to do something. And, to date, we have been unable 
to harness in a proactive way the Federal policy for a housing 
trust fund or anything that will stimulate production and try 
to generate more opportunities. And if not by design, then by 
default, we have to rely upon some of these private entities.
    I frankly think we have to challenge all of these entities 
to do more, not just rhetorically but practically, to provide 
opportunity for affordable housing, not simply to provide 
mortgage support for people who can afford to buy expensive 
homes or even mid-priced homes, but to look out and make sure 
that we have a place so that all of our families can find a 
place. I hope in the context of these discussions that you can 
give us your advice on that point also.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Greenspan, again, we thank you for sharing your wisdom 
and being with us here today.
    I think my focus today is going to be, as I think is 
indicated by Senator Carper, on the capital standards issue. 
Obviously, there are a lot of issues that we need to deal with 
as we address the relationship in the home mortgage industry 
between Fannie and Freddie, the Federal Home Loan Banks, and 
the private sector lending institutions.
    To me, one of the questions that is clearly in the 
forefront is the question of capital standards, the questions 
like: Should the statute, if we pass one, set a floor? Or 
should the statute establish any type of capital standard as 
opposed to letting it be set regulatorily by any new regulator 
that might be established? Questions like: Should the capital 
requirements be different for different types of institutions 
depending on the nature of risk which they incur? Should 
capital standards be imposed that extend beyond the level of 
risk? And is establishment of a capital standard that exceeds 
risk economically inefficient?
    It is questions like this which I believe we must address 
as we address the question of establishing a new regulator and 
setting the parameters and the scope of authority of such a new 
regulator.
    I know that you have looked at this very closely, and I 
look forward to your testimony today. And, Mr. Chairman, I also 
look forward to working with you as we put this together. Thank 
you.
    Chairman Shelby. Absolutely.
    Senator Enzi.

              STATEMENT OF SENATOR MICHAEL B. ENZI

    Senator Enzi. Thank you, Mr. Chairman. I appreciate your 
holding this hearing. I would ask that my full statement be a 
part of the record.
    Chairman Shelby. Without objection, it is so ordered.
    Senator Enzi. I would mention something a little more basic 
on getting homes, and that is having jobs. I passed the 
Workforce Investment Act, and I am going to be pressing both 
sides to come up with conferees for that so that people can 
upgrade their skills, make a little bit more money, and be able 
to afford houses.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Mr. Chairman, first of all, I want to 
express my appreciation to you once again for continuing the 
Committee's thorough and careful examination of the issue of 
the regulation of the housing GSE's. This is an important 
series of hearings, and obviously, I hope at the end of it we 
will be able to develop a consensus with respect to a world-
class regulator for Fannie Mae, Freddie Mac, and the Federal 
Home Loan Banks.
    I think it is always important, of course, to remind 
ourselves that the primary purpose of Fannie Mae and Freddie 
Mac is to maintain a strong, liquid, stable secondary market 
for residential mortgages, including multifamily mortgages. I 
think most people feel they have done this well over the years 
and it is reflected in the rates of homeownership that exist in 
this country when compared with what exists elsewhere in the 
world.
    The other primary purpose of these Enterprises is to expand 
access to affordable housing for low-income families and for 
those who live in underserved areas. We have sought to 
accomplish this by setting certain affordable housing goals, 
and while those targets have been met, there is some 
considerable sentiment that more could be done to expand 
housing opportunities.
    Housing has a special place in American society. A home of 
one's own is part of the American Dream. Both the current and 
previous Administrations have made expanded homeownership, 
particularly for minorities, an important goal. And, indeed, I 
think it should be. Homeownership is associated with a whole 
set of social and civic virtues, from better school performance 
to lower levels of juvenile delinquency, to higher levels of 
voting and civic participation. And I think we need to keep 
that in mind as we consider the framework within which these 
institutions will operate.
    The considerable question has been raised as to the 
adequacy of existing regulations, with considerable concern 
about the Federal Housing Finance Board, whose examination and 
supervisory capacity is being far short of what is required. 
OFHEO, which has been working quite hard recently to catch up 
on its responsibilities, seems not to have been aware of the 
depth of the problems at Freddie Mac. And because the housing 
GSE's are so important to our economy and our financial system, 
obviously we have an important responsibility to ensure that 
they are properly supervised and regulated.
    Mr. Chairman, I am pleased that we have Chairman Greenspan 
here with us today. I understand, I think, that tomorrow 
afternoon we will be hearing from the representatives of the--
--
    Chairman Shelby. That is right, the GSE's.
    Senator Sarbanes. The three GSE's, and I look forward to 
that hearing as well.
    Thank you very much.
    Chairman Shelby. Chairman Greenspan, welcome again to the 
Committee. You spend a lot of time with us, but we think that 
is quality time. You proceed as you wish.
    Senator Sarbanes. They tell us you look forward to it with 
unanticipated joy. Is that correct?
    [Laughter.]
    Chairman Greenspan. It is always a joy, Senator.
    Senator Sarbanes. Thank you.
    Chairman Shelby. The Chairman can handle his own, I am 
sure.

             STATEMENT OF ALAN GREENSPAN, CHAIRMAN

        BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Chairman Greenspan. Mr. Chairman, Senator Sarbanes, and 
Members of the Committee, thank you very much for inviting me 
to discuss the role of the housing-related Government Sponsored 
Enterprises in our economy this morning.
    As you know, Fannie Mae, Freddie Mac, and the Federal Home 
Loan Banks collectively dominate the financing of residential 
housing in the United States. Indeed, these entities have grown 
to be among the largest financial institutions in the United 
States.
    During the 1980's and 1990's, Fannie and Freddie 
contributed importantly to the development of the secondary 
mortgage markets for home loans and to the diversification of 
funding sources for depository institutions and other mortgage 
originators, as I explain in somewhat greater detail in my 
written remarks.
    Yet given their history of innovation in mortgage-based 
securities, why do Fannie and Freddie now generate such 
substantial concern? The unease relates mainly to the scale and 
growth of the mortgage-related asset portfolios held on their 
balance sheets. That growth has been facilitated, at least in 
part, by a perceived special advantage of these institutions 
that keeps normal market restraints from being fully effective.
    The GSEs' special advantage arises because, despite the 
explicit statement on the prospectus of GSE debentures that 
they are not backed by the full faith and credit of the U.S. 
Government, most investors have apparently concluded that 
during a crisis the Federal Government will prevent the GSE's 
from defaulting on their debt. An implicit guarantee is thus 
created not by the Congress but by the willingness of investors 
to accept a lower rate of interest on GSE debt than they would 
otherwise require in the absence of Federal sponsorship.
    Because Fannie and Freddie can borrow at a subsidized rate, 
they have been able to pay higher prices to originators for 
their mortgages than can potential competitors and to gradually 
but inexorably take over the market for conforming mortgages. 
This process has provided Fannie and Freddie with a powerful 
vehicle and incentive for achieving extremely rapid growth of 
their balance sheets. The resultant scale gives Fannie and 
Freddie additional advantages that potential private sector 
competitors cannot overcome. Importantly, the scale itself has 
reinforced investors' perceptions that, in the event of a 
crisis involving Fannie and Freddie, policymakers would have 
little alternative than to have the taxpayers explicitly stand 
behind GSE debt. This view is widespread in the marketplace 
despite the privatization of Fannie and Freddie and their 
control by private shareholders, because these institutions 
continue to have Government missions, a line of credit with the 
Treasury, and other Government benefits, which confer upon them 
a special status in the eyes of many investors.
    A recent study by a Federal Reserve economist, Wayne 
Passmore, attempts to quantify the value of that implicit 
subsidy to the private shareholders of Fannie and Freddie. His 
research indicates that it may account for more than half of 
the stock market capitalization of these institutions.
    Passmore's analysis suggests that Fannie and Freddie likely 
lower mortgage rates less than 16 basis points, with a best 
estimate centering on about 7 basis points. If the estimate of 
7 basis points is correct, the associated present value of 
homeowner savings is only about one-half the after-tax subsidy 
that shareholders of these GSE's are estimated to receive. 
Congressional Budget Office and other estimates differ, but 
they come to essentially the same conclusion. A substantial 
portion of these GSEs' implicit subsidy accrues to GSE 
shareholders in the form of increased dividends and stock 
market values.
    As noted by the General Accounting Office, the task of 
assessing the costs and benefits associated with the GSE's is 
difficult. One possible way to advance the technical discussion 
would be for the Congress to request disinterested parties to 
convene groups of technical experts in an effort to better 
understand and measure these costs and benefits.
    The Federal Reserve is concerned about the growth and the 
scale of the GSEs' mortgage-related portfolios, which 
concentrate interest rate and prepayment risks at these two 
institutions. Unlike many well-capitalized savings and loans 
and commercial banks, Fannie and Freddie have chosen not to 
manage that risk by holding greater capital. Instead, they have 
chosen heightened leverage, which raises interest rate risk but 
enables them to multiply the profitability of subsidized debt 
in direct proportion to their degree of leverage. Without the 
expectation of Government support in a crisis, such leverage 
would not be possible without a significantly higher cost of 
debt.
    In general, interest rate risk is readily handled by 
adjusting maturities of assets and liabilities. But hedging 
prepayment risk is more complex. To manage this risk with 
little capital requires a conceptually sophisticated hedging 
framework. In essence, the current system depends on the risk 
managers at Fannie and Freddie, as good as they are, to do 
everything just right, rather than depending on a market-based 
system supported by the risk assessments and management 
capabilities of many participants with 
different views and different strategies for hedging risks. Our 
financial system would be more robust if we relied on a market-
based system that spreads interest rate risks, rather than on 
the current system, which concentrates such risk with these two 
GSE's.
    As always, concerns about systemic risk are appropriately 
focused on large, highly leveraged financial institutions such 
as the GSE's that play substantial roles in the functioning of 
financial markets. I should emphasize that Fannie and Freddie, 
to date, appear to have managed these risks well and that we 
see nothing on the immediate horizon that is likely to create a 
systemic problem. But to fend off possible future system 
difficulties, which we assess as likely if GSE expansion 
continues unabated, preventive actions are required sooner 
rather than later.
    As a general matter, we rely in a market economy upon 
market discipline to constrain the leverage of firms, including 
financial institutions. However, the existence, or even the 
perception, of Government backing undermines the effectiveness 
of market discipline. A market system relies on the vigilance 
of lenders and investors in market transactions to assure 
themselves of their counterparties' strength. Many 
counterparties in GSE transactions, when assessing their risk, 
clearly rely instead on the GSEs' perceived special 
relationship to the Government. Thus, with housing-related 
GSE's, regulators cannot rely significantly on market 
discipline.
    Determining the suitable amount of capital for Fannie and 
Freddie is both a difficult and technical process, and in the 
Federal Reserve's judgment, a regulator should have a free hand 
in determining the minimum and risk-based capital standards for 
these institutions.
    The size of Fannie and Freddie and the complexity of their 
financial operations and the general indifference of many 
investors to the financial condition of the GSE's because of 
their perceived special relationship to the Government suggest 
that the GSE regulator must have authority similar to that of 
the banking regulators. In addressing the role of a new GSE 
regulator, the Congress needs to clarify the circumstances 
under which a GSE can become insolvent and, in particular, the 
resultant position--both during and after insolvency--of the 
investors that hold GSE debt. This process must be clear before 
it is needed; otherwise, should these institutions experience 
significant financial difficulty, the hands of any regulator, 
and of public authorities generally, would be constrained by 
uncertainties about the process. Left unresolved, such 
uncertainties would only heighten the prospect that a crisis 
would result in an explicit guaranteeing of GSE debt.
    World-class regulation, by itself, may not be sufficient 
and, indeed, as suggested by Treasury Secretary Snow, may even 
worsen the situation if market participants infer from such 
regulation that the Government is all the more likely to back 
GSE debt. This is the heart of a dilemma in designing 
regulation for the GSE's. On the one hand, if the regulation of 
the GSE's is strengthened, the market may view them even more 
as extensions of the Government and view their debt as 
Government debt. The result, short of a marked increase in 
capital, would be to expand the implicit subsidy and allow the 
GSE's to play an even larger unconstrained role in the 
financial markets. On the other hand, if we fail to strengthen 
GSE regulation, the possibility of an actual crisis or 
insolvency is increased.
    Most of the concerns associated with systemic risks flow 
from the size of the balance sheets that these GSE's maintain. 
One way the Congress could constrain the size of these balance 
sheets is to alter the composition of Fannie's and Freddie's 
mortgage financing by limiting the dollar amount of their debt 
relative to the dollar amount of mortgages securitized and held 
by other investors. Although it is difficult to know how best 
to set such a rule, this 
approach would continue to expand the depth and liquidity of 
mortgage markets through mortgage securitization but would 
remove most of the potential systemic risks associated with 
these GSE's. Ideally, such a ratio would focus the business 
operations of Fannie and Freddie on the enhancement of 
secondary markets and not on the capture of the implicit 
subsidy.
    Limiting the debt of Fannie and Freddie and expanding their 
role in mortgage securitization would be consistent with the 
original Congressional intent that these institutions provide 
stability in the market for residential mortgages and provide 
liquidity for mortgage investors. Deep and liquid markets for 
mortgages are made possible using mortgage-based securities 
that are held by non-GSE private investors. Fannie's and 
Freddie's purchases of their own or each other's securities 
with their debt do not appear needed to supply mortgage market 
liquidity or to enhance capital markets in the United States.
    The expansion of homeownership is a widely supported goal 
in this country. A sense of ownership and commitment to our 
communities imparts a degree of stability that is particularly 
valuable to society, as Senator Sarbanes pointed out. But there 
are many ways to enhance the attractiveness of homeownership at 
significantly less potential cost to taxpayers than through the 
opaque and circuitous GSE paradigm currently in place.
    In sum, Mr. Chairman, the Congress needs to create a GSE 
regulator with authority on a par with that of banking 
regulators, with a free hand to set appropriate capital 
standards, and with a clear process sanctioned by the Congress 
for placing a GSE into receivership. However, if the Congress 
takes only these actions, it runs the risk of solidifying 
investors' perceptions that the GSE's are instruments of the 
Government and that their debt is equivalent to Government 
debt. The GSE's will have increased incentives to continue to 
grow faster than the overall home mortgage market. Because they 
already purchase most conforming mortgages, they, like all 
effective profit-maximizing organizations, will be seeking new 
avenues to expand the scope of their operations, assisted by a 
subsidy that their existing or potential competitors do not 
enjoy.
    Thus, GSE's need to be limited in the issuance of GSE debt 
and in the purchase of assets, both mortgages and nonmortgages, 
that they hold. Fannie and Freddie should be encouraged to 
continue to expand mortgage securitization, keeping mortgage 
markets deep and liquid while limiting the size of their 
portfolios. This action will allow the mortgage markets to 
support homeownership and homebuilding in a manner consistent 
with preserving the safe and sound financial markets of the 
United States.
    Thank you very much, Mr. Chairman, and I would appreciate 
it if my complete remarks are included for the record, and I 
look forward to your questions.
    Chairman Shelby. Without objection, your written statement 
will be made a part of the record in its entirety.
    Mr. Chairman, to go back over this again, you state that 
possible future systemic difficulties are likely if GSE 
expansion continues unabated. Why do you feel that such 
systemic problems are likely--your word--and what can be done 
to prevent such problems? I think this is important here.
    Chairman Greenspan. Senator, this is the most crucial 
issue. As I have stated in my written remarks, Fannie Mae and 
Freddie Mac are extraordinarily effective institutions, and 
they have done a great deal for this country in developing the 
secondary mortgage market, which has been a very important 
issue in the whole structure of the developed asset-backed 
securities markets in which they originally took the lead.
    The problem that exists is that because of the fact that 
they have a subsidy, granted, as I indicated before, not by the 
Congress, but by the expectation that Government will bail them 
out in the event of a crisis, they have been able to take a 
highly competitive position and, indeed, essentially are 
elbowing out a number of competitors who did not have such a 
subsidy, and as a result, they have been growing at an 
exceptionally rapid rate, increasing their share of the market. 
And if you project into the future, you effectively get a 
system in which they will be increasingly pressing to move 
beyond the mortgage markets because they need a continuous 
growth rate in their profitability to maintain the level of 
their stock price.
    Chairman Shelby. What do you mean ``move beyond the 
mortgage''--into other products?
    Chairman Greenspan. Yes, into other products and into 
nonmortgage areas. And to the extent that they are a profit-
making organization, they are very properly concerned about the 
value of their stock, and the value of their stock has been 
largely a function of the extraordinarily stable gain in 
earnings, although I must admit that has come into question 
with respect to the accounting at Freddie Mac, but nonetheless 
they have been very effective increasing balance sheets, 
increasing earnings, and increasing stock prices.
    I must say to you these are very effectively run 
organizations, and I wish they would be running without their 
subsidy because I think they would still be doing very well.
    Chairman Shelby. Mr. Chairman, you stated that the GSE's 
receive a funding advantage from the market's perception that 
they are too big to fail. What about large banking institutions 
like Citigroup or Bank of America, does the market perceive 
them too big to fail in perhaps a different vein? Do they 
receive a similar funding advantage?
    Chairman Greenspan. I think they receive some, Senator.
    Chairman Shelby. Have you ever quantified that? Has anybody 
at the Federal Reserve?
    Chairman Greenspan. Yes, it is very substantially less than 
the types of numbers we are looking at. Remember that there are 
significant differences. Remember that these large banking 
organizations are fairly well-capitalized, far better, of 
course, than Fannie or Freddie, and they are supervised with 
respect to all of their actions and activities in a way which 
we are hopeful that the Congress will move on shortly on the 
GSE's.
    So the answer is, yes, there are similarities here, but the 
degree of difference is very large. And I would say one of the 
reasons why the issue of Fannie and Freddie did not arise 
earlier is they were not large enough, and they did not create 
a potential significant problem for the overall financial 
system--not that they do today, as I point out, but they will 
almost surely do in years ahead unless some changes are made in 
the structure of how these organizations function.
    Chairman Shelby. If these huge banking institutions, 
Citigroup, Bank of America and so forth, if they are perceived 
as too big to fail, do we need--
    Chairman Greenspan. Let me just say that I did not mean to 
imply that. I think there are some who do believe that. I do 
not think that is the general market.
    Chairman Shelby. There is a perception by some people that 
some of the largest banks are too big to fail.
    Chairman Greenspan. Yes, the reason I say ``not quite'' is 
that if you look at the prices of their securities in the 
marketplace, it is fairly evident that there is very 
considerable question as to whether in the event of failure 
they will in fact be bailed out. That is far less the case on 
the part of the securities of Fannie and Freddie, which very 
significantly indicate a generalized expectation of support by 
the Government in the event of crisis.
    Chairman Shelby. In that context, do we need to give the 
new proposed GSE regulator the same type of systemic risk 
powers that FDIC has?
    Chairman Greenspan. I would certainly think so, sir.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Chairman Greenspan, do you favor, as a goal, privatizing 
the GSE's?
    Chairman Greenspan. As a goal, I would, and, in fact, I 
have stated so on many occasions--but the main problem is to 
reduce the subsidy and to make these particular institutions 
far more balanced in the way they function in the market. I 
think privatizing them would do that, but I think, short of 
that, the types of recommendations that I have made will also 
do that.
    And since I fully recognize that my view about 
privatization is a highly minority point of view, I think it is 
sometimes important to go to the really important issue, which 
is eliminating the subsidy, and that could be substantially 
done and taken out of the marketplace as a crucial disturbing 
factor without privatization.
    Senator Sarbanes. Why do you think your view on 
privatization is a highly minority view?
    Chairman Greenspan. Because I have taken surveys amongst a 
lot of people.
    [Laughter.]
    Senator Sarbanes. Well, that explains the quantity of it, 
but it does not explain the quality of it. What is the 
rationale that prevents it or that keeps it as a highly 
minority point of view?
    Chairman Greenspan. I suspect it is an issue of experience 
and education. I believe my concern is that we do not get 
educated in a way which will make us all recognize that 
privatization is a potential goal.
    I do think that if Fannie and Freddie were to function 
mainly by securitizing mortgage-backed securities, which is a 
profitable business, I think that the extent of the subsidy 
which is involved in that is really quite small. And 
considering the advantages that would carry with it, I think it 
could be well within the realm of the types of subsidies which 
the Congress has created over the years, and certainly would 
not, in any way, from my point of view, induce concerns about 
systemic risk.
    The systemic risk issue is wholly related to the question 
of issuing debentures and investing the proceeds of those 
debentures in other assets, whether they be mortgages, 
mortgage-backed securities or, as a significant part of the 
portfolio of the GSE's indicate, nonmortgage assets.
    Senator Sarbanes. In a letter to Representative Baker back 
in 2000, you said that ``lower mortgage costs that may result 
from the implicit subsidy would result in housing expanding 
relative to nonhousing investment, including private-sector 
initiatives such as investment in productivity-enhancing plant 
and equipment.''
    Do you think, as a society, we channel too much capital 
into housing?
    Chairman Greenspan. I do not. I think that, from an 
economic point of view, there is no question that doing that, 
in a technical sense, is less efficient than moving capital 
into productivity-enhancing assets.
    I made a speech on Friday in which I indicated how 
important the issue of the sense of property rights and 
ownership is to the basis of a free market capitalist system in 
this country. And while I certainly recognize the 
inefficiencies that might technically be 
involved with respect to moving capital from so-called 
productivity-producing assets to homeownership, I think the 
value that homeownership has is far superior as an important 
value in maintaining our economic and social system than the 
question of efficiency.
    There is no doubt that it is, from a technical point of 
view, less efficient in the creation of wealth. But from the 
overall view of what is important for a market capitalist 
system, to have broad acceptance of property rights and a broad 
ownership of property in this country far exceeds, in my 
judgment, the values of the efficiency questions which I 
raised.
    Senator Sarbanes. Let me address this Passmore study. There 
are two CBO studies which find a greater reduction in mortgage 
rates for borrowers than the Fed study. You found a reduction 
of 7 basis points in the mortgage rates. The two CBO studies 
found 25 basis points in one, 35 basis points in the other.
    Now, in your testimony, you seem to dismiss this difference 
by saying that the Fed and CBO come essentially to the same 
conclusions, that shareholders were paying a portion of the 
subsidy. But the degree might be quite significant from a 
policy point of view. The CBO studies indicate the benefit to 
the public of the GSE's is considerably greater than one would 
conclude from the Fed study.
    Chairman Greenspan. But they are both very small in the 
sense that all of the analysis that we have done, and others, 
have indicated that 25 or 35 or 45 basis points has very little 
effect on the rate of homeownership or on housing starts. We 
have examined, over the years, the sensitivity of home 
construction and homeownership to interest rates.
    Senator Sarbanes. Let me be clear on this point. So you are 
shifting your argument now away from how much of the benefit 
goes to the borrower to the argument that even if all of the 
benefit went to the borrower, it would still not affect the 
rate of homeownership; is that correct?
    Chairman Greenspan. No. ``All of the benefits'' is a very 
large number.
    Senator Sarbanes. The CBO study has about two-thirds of the 
benefits going to the borrower.
    Chairman Greenspan. Let me put it this way, very 
specifically. There are two questions here. One is there is a 
gross subsidy and how much of it passes through directly to the 
homeowner, that number is a fraction of the total by everyone's 
calculation. And the question essentially is, is this an 
efficient way of creating homeownership, when we know, 
statistically, that the major contributors to homeownership are 
issues of downpayment and income? I am not saying that interest 
rates do not have an effect. What I am largely saying is that 
where the numbers are concentrated with respect to estimates, 
the notion that significantly enhances homeownership is 
something we find statistically difficult to sustain.
    One of the reasons why I am suggesting that this issue be 
examined in far greater detail is that we are dealing with a 
very major public policy question, and how one concludes on 
this issue and how one decides what to do I think requires the 
best analysis.
    Obviously, Wayne Passmore and his staff had full access to 
the previous studies, and I think it is a question of people 
sitting down who are technically expert in this field and 
making judgments of which sets of data are accurate. I will 
just say this: One, all of the estimates imply that a very 
significant amount of the subsidy goes to the profits of these 
institutions and, two, the major estimates indicate levels 
which do not historically suggest to us that they have a major 
impact on homeownership. I would suggest, finally, that issues 
of downpayment be looked at far more carefully. FHA, for 
example, does it quite efficiently in that regard.
    Senator Sarbanes. Mr. Chairman, I am still not getting an 
answer. If all of the benefits pass through, I take it, it 
would still be your position against because you do not think 
it affects homeownership rates; is that right?
    Chairman Greenspan. First of all, let us remember this is 
not a legal subsidy. This is a subsidy granted by the private 
sector. If all of the subsidies went through, and it was 
sanctioned by the Congress, I would say that was an appropriate 
procedure by which the Congress endeavored to lower mortgage 
interest rates, which have value.
    I am not saying it has no value. I am just saying its 
impact on homeownership and on housing starts is not great, but 
it is obviously a very important financial advantage to a 
homeowner to get a lower interest rate, and if the whole 
subsidy were passed through to homeowners, it would make a 
significant difference. I am saying that it is not a 
substantial proportion and that, in my judgment, is not the way 
a subsidy should function.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    I am going to base my question on what you think the impact 
of the debt that both of the GSE's have on our economy 
potentially. I have been looking at some of the figures too. 
The figures I have is on the CBO. I think they said about 50 
percent of the value of the subsidy goes to homeowners and 
about 50 percent goes to administration, which is mainly 
executive salaries and then also the shareholder profits.
    And then I also look at the total debt that you have in the 
GSE's. It is around $2.2 trillion I think in 2002, and the 
public debt for the Federal Government was at $3.2 trillion, 
and the trend, as expressed by Dr. Gregory Mankiw, who is 
Chairman of the President's Council of Economic Advisers, said 
if that trend continues, it could exceed the privately held 
debt of the Federal Government.
    So my question to you, Mr. Chairman, and I would appreciate 
hearing your thoughts on the future of the GSE's, as it relates 
to debt and systemic risk, and do you believe that this debt 
poses any threat to the U.S. economy?
    Chairman Greenspan. I believe the process, in the long-run, 
would, in the sense that we have now in place a very ambiguous 
structure which I do not think should be allowed to continue. 
Either the Congress should agree that, in the event of default, 
it will guarantee GSE debt or not. If the former is the case, 
then it should be stipulated explicitly, and the Congress 
obviously can do that, and that would clarify a good deal of 
the issue.
    The problem is that, unless that is done, we are confronted 
with a situation in which, on the one hand, there is a general 
belief in the marketplace that these securities are backed by 
the full faith and credit of the U.S. Government, even though 
they are explicitly not so stated, and the law says they are 
not, and the question is, the larger that debt becomes, the 
more this is an issue.
    What we have is an ambiguity which, in the event of a 
crisis migth require explicit guaranteeing of the debt, and a 
crisis could occur not because Fannie and Freddie are doing 
anything wrong, and indeed, as I said in my opening remarks, 
they are very skillful operators. I think they do risk 
management exceptionally well, and I think they are very well-
run organizations in general.
    The problem is that it is not in their control to really 
comprehend all of the type of crises that can arise, and 
because they have concentrated interest risk, what that 
basically means is that their ability to hedge that risk is 
limited; that is, it is theoretically possible to fully hedge 
interest rate risk. As a practical matter, it is extremely 
costly and never quite fully the case, for reasons I could get 
into, but I do not think it is really necessary at this point.
    My major concern is that if you just project this debt into 
the future without resolving either the subsidy question that 
is implicit there or what will happen in the event of a crisis, 
it may be many years hence before you can address the issue 
again. I find that an issue which can be addressed now or in 
the immediate future in a manner which would fend off that 
concern which I think will grow as the years go on.
    Senator Allard. Mr. Chairman, I even worry about the 
Federal Government. If the Federal Government guarantees this 
debt of $2.2 trillion, that would add into the public debt. 
That is going to have an impact, would it not?
    Chairman Greenspan. It becomes equivalent to public debt, 
certainly.
    Senator Allard. Yes, and then all of a sudden your public 
debt has really a marked increase, and I wonder what that would 
do, as far as instilling confidence in the economy when that 
figure would come out? It seems to me that even that would have 
an adverse impact on the economy.
    Chairman Greenspan. Well, I think the main issue here is to 
get this issue resolved sooner rather than later. I am not sure 
exactly what the impact would be now, but I would certainly 
agree with you if the issue were left to fester for a number of 
years, and we tried to address it at a later time.
    Senator Sarbanes. Is the Senator referring the U.S. 
Government debt?
    Senator Allard. Yes, I am referring to the debt that we 
have with the GSE's. He is assuming, in his response to me, he 
said, well, one way that we could assure that the debt would 
not be a problem, as far as the economy is concerned, is if 
there was a guarantee from the Federal Government.
    My point is, if there is a guarantee from the Federal 
Government, then that $2.2 trillion gets added into the $3.2 
trillion, and if people all of a sudden see that jump to $5.4 
trillion, that could have an impact on people's thinking, and 
consequently an impact on the economy.
    Senator Sarbanes. Oh, I see.
    Is the $3.2 trillion, that is the Government debt?
    Senator Allard. That is the public debt.
    Senator Sarbanes. And is that what we were told 3 years ago 
we were paying down too quickly?
    [Laughter.]
    Chairman Greenspan. I just want to point one thing out; 
that when the Government guarantees debt, it is handled in a 
somewhat different way. But from an economic point of view, 
there is no question that what you are stating is correct, 
Senator.
    Senator Allard. Mr. Chairman, may I proceed with a second 
question?
    Chairman Shelby. Go ahead. One more question.
    Senator Allard. I am interested in OFHEO. It has a lot of 
regulatory responsibilities, and the question I have is do you 
believe that funding for the regulator should be guaranteed in 
the President's budget or should it be subjected to the annual 
appropriations process? And also do you believe that the need 
for resources would differ greatly if the regulator resided 
independently rather than within the Treasury?
    Chairman Greenspan. With respect to the latter question, I 
am not sure, and I am not sure it should be an issue one way or 
the other.
    I do think that you want the funding of the resources of 
the new regulator to be outside the appropriations process, if 
that is at all feasible.
    Senator Allard. Mr. Chairman, my time has expired, and I 
appreciate your generosity on that.
    Thank you.
    Chairman Shelby. Senator Carper.
    Senator Carper. Thanks.
    Chairman Greenspan, I have a couple of questions I am going 
to ask, and I am going to ask you just to limit your responses. 
So just be as direct with me as you can, and I know you will.
    Let us just back up just for a moment, and just share, at 
least with me, and maybe with some of my colleagues, what is 
the wrong that we are trying to right here? What is the 
potential harm that we are trying to avert?
    Chairman Greenspan. I believe that is a very good question, 
Senator.
    What we are trying to avert is we have, in our financial 
system right now, two very large and growing financial 
institutions which are very effective and are essentially 
capable of gaining market shares in a very major market, to a 
large extent as a consequence of a subsidy that prevents the 
markets from adjusting appropriately. It prevents competition 
and the normal adjustment processes that we see on a day-by-day 
basis from functioning in a way that creates stability.
    It is basically creating an abnormality which the system 
cannot close around, and the potential of that is a systemic 
risk sometime in the future if they continue to increase at the 
rate at which they are.
    Senator Carper. You spoke of your own minority view as to 
the course that we should take with respect to privatizing the 
GSE's. You also shared with us a different approach, and I 
believe that it dealt with limiting GSE issuance of debt. Would 
you go back to that and just explain that again for us, please.
    Chairman Greenspan. Yes, Senator. There are two businesses 
here in the GSE's. First of all, the GSE's purchase mortgages 
from mortgage originators: Commercial banks, savings and loans, 
mortgage bankers, and the like.
    Part of their business is to securitize those mortgages, 
guarantee them, charge a fee for servicing and the guarantee 
and then selling the mortgage-backed security on to other 
investors like pension funds, commercial banks or a number of 
other institutions. That is a profitable business, and that is 
indeed the secondary mortgage market.
    There is another business which relates to the issue of 
taking part of the mortgages which are purchased and holding 
them on the balance sheets of the GSE's. These mortgages are 
selling at market interest rates. But if you have a subsidy in 
issuing debt, the GSE's are picking up an abnormal profit, 
which is the normal profit in the spreads plus the size of the 
subsidies, so that there is the incentive to put assets on the 
balance sheet, whether or not they are mortgages, corporate 
bonds, or other things which are on the GSE balance sheets, 
that, in effect, harvests the subsidy, which, remember, because 
it is not restricted by the Congress, can be expanded at will 
by the GSE's.
    And so what we have is a structure in which a very rapidly 
growing organization, holding assets and financing them by 
subsidized debt, is growing in a manner which really does not, 
in and of itself, contribute to either homeownership or 
necessarily liquidity or other aspects of the financial 
markets.
    There are disputes, I must tell you, and there are some 
people who do believe that has some effect on securities 
markets. I think the evidence here is very murky and clearly, 
in any event, more of a secondary issue than anything else.
    The crucial question there is these are two businesses. 
They are both subsidized. They both have a high rate of return 
on equity. Indeed, the rate of return on equity on the part of 
the GSE's is significantly above that of, say, large commercial 
banks, which is an indication that they have a special 
advantage. And I am saying that there is one part of this 
business which we should be endeavoring to get them to expand 
because that is the base in which the secondary mortgage market 
functions.
    The ownership of assets on the balance sheet is a very 
seriously lesser force. My own judgment is it has very little 
to do with either homeownership, home construction, or even 
having a very significant impact at all on interest rates. The 
real issue is the securitization, which is what Fannie and 
Freddie originated. They do an exceptionally good job of that 
technically.
    And my own view--and why I think privatization would be the 
thing for them to want to do--is I basically believe that if 
they were to fully privatize, they would be smaller 
organizations, their profit levels would be somewhat less, 
their price earnings ratios would be much higher, and in all 
likelihood they may even have greater market value largely 
because they do things so well.
    Senator Carper. My time has expired.
    Mr. Chairman, I had indicated earlier that I wanted to 
raise some questions relating to capital and different kinds of 
capital, but I am going to yield to Senator Crapo over there 
because my suspicion is he or Senator Enzi will probably get 
into that.
    Thank you.
    Chairman Shelby. Thank you.
    Senator Dole.
    Senator Dole. Chairman Greenspan, 2 weeks ago, the 
Comptroller General testified before this Committee and 
recommended that the legislation we consider contain clear 
criteria for nonmortgage investments.
    Your testimony clearly states that you support a limitation 
of nonmortgage investments. Would you elaborate on why this 
limitation is so important?
    Chairman Greenspan. Well, Senator, from the point of view 
of profitability of the GSE's, whether you hold mortgage 
assets, corporate bonds, or any form of securities not related 
to housing at all--indeed, any asset at all--will create a 
profit, because remember, since the issuance of debt, which has 
this implicit guarantee on it, is unrestrained--in fact, the 
initiation is wholly up to the GSE itself--it means that if you 
can find assets in which to invest the proceeds that are at 
market values, you will automatically generate a profit and in 
effect pick up an additional above-market profit to the extent 
that there is a lowered cost of your borrowed funds.
    I find very little in the way of this process which helps 
homebuilding--or, I should say, homeownership--and if the 
purpose of the structure of the GSE's is to enhance the 
secondary mortgage market, which was its original purpose, it 
is not clear to me that that does anything whatever except 
increase the profitability of the GSE's.
    Senator Dole. I appreciate how clear you are in your 
prepared testimony when you state that ``In the Federal 
Reserve's judgment, a regulator should have a free hand in 
determining the minimum and risk-based capital standards.''
    Should we have the regulator consider any factors other 
than safety and soundness when deciding what the proper level 
of minimal capital should be?
    Chairman Greenspan. Senator, I think it is very difficult 
to have mixed goals. It is tough enough as it is to have safety 
and soundness as your purpose in regulating an institution. And 
I would hope that to the extent that there are changes, 
enlargement, or anything with respect to the GSEs' mission that 
those things be kept separate from the issue of how capital is 
determined, because the purpose of capital in this particular 
context is to insulate the problems of a GSE from creating 
overall financial problems for the system as a whole.
    I would hope that the new regulator of the GSE's would have 
very much the same sorts of authority that the Federal Reserve, 
the Office of the Comptroller, and the FDIC have in order to 
manage the risks that we all are exposed to. To constrain that, 
I think, creates overall risks to the financial system which I 
do not think are desirable.
    Senator Dole. Now, it is my understanding that the GSE's 
consider families with incomes at or below 80 percent of area 
median income to be low income, while the Community 
Reinvestment Act defines families with incomes at or below 50 
percent of area median income to be low income.
    Chairman Greenspan, do you believe that we should create a 
uniform standard for what should be considered a low-income 
loan toward affordable housing goals?
    Chairman Greenspan. I think that is a determination for 
those who are directly related to housing policy in this 
country, because as I indicated before, homeownership is 
something which is strongly supported by this Nation and, as I 
said before, for good reason, and how one gets there is not 
necessarily through secondary mortgage market, which I 
certainly acknowledge does help, but there are lots of other 
things which relate to this policy, and I think that the 
integration of the homeownership goal and housing goal 
generally of the GSE's has to be consistent with the other 
goals of our policies in this area. But I could not give you 
any judgment as to how that should be reconciled.
    Senator Dole. When Fannie and Freddie established their 
automated underwriting standards, they established a standard 
in which no lender can compare its underwriting standards to 
those established by the GSE's. A loan is either accepted or 
rejected by the GSE's, with no idea as to how risk factors are 
weighted or why the borrower failed to qualify.
    How can this black-box underwriting be considered to 
support liquidity? Doesn't a liquid market need a significant 
degree of transparency?
    Chairman Greenspan. Senator, there is a problem here in the 
fact that these are private organizations, and that is private 
property, and they have developed it in a manner which they 
perceive to be of value, and I think one has to argue that it 
is clearly a significant value for these institutions.
    I think the issue that comes up is with respect to the 
question of transparency, largely because of this very 
ambiguous relationship with the GSE's, but in my judgment, so 
long as it is private property, it belongs to the GSE's and 
should not be made available except under extraordinary 
circumstances, and I think that is one of the issues which I 
think is on the table.
    Senator Dole. Thank you, Mr. Chairman. I think my time has 
expired.
    Chairman Shelby. Thank you, Senator Dole.
    Senator Reed.
    Senator Reed. Thank you very much.
    Thank you, Chairman Greenspan. Mr. Chairman, is there 
anything that we should do to make it clearer that the full 
faith and credit of the United States is not behind the 
operations of these GSE's, because much of our discussion this 
morning rests upon this subsidy of some kind, and yet--and I 
hope you can enlighten me--it appears that we have taken steps, 
at least legally, to try to make it clear that these agencies 
will not be supported by us. I mean, there is always the 
hypothetical, but what more can we do I guess is the question.
    Chairman Greenspan. I think that there are innumerable ways 
to do that. A basic problem that we all have is that when 
somebody--a Government official or even groups of people in the 
Congress--may stipulate that that will not happen, they do not 
believe you, because they believe that in the event of a 
crisis, in effect, the Federal Government will not allow the 
institution to go into receivership.
    I presume there are ways in which the Congress can pass a 
law that prohibits it or does something, but you have to be a 
little careful because what you do not want to do is inhibit 
any forms of activity which are required in the event of a 
crisis.
    For example, we are the lender of last resort. In the event 
of a crisis of a major institution which we think were it to 
liquidate very quickly could create systemic instability, we 
will endeavor to find a way to liquidate it gradually, unwind 
the whole operation, obviously eliminate all shareholders value 
and perhaps even create some haircuts to the debt itself. But 
that process is necessary in order to prevent a shock to the 
system and a destabilization.
    So it is not an easy issue to resolve, but I do think that 
in the wisdom of the Congress, you will find a way, if that is 
your desire, to make that clear and in effect, perhaps, in the 
way in which the receivership issue gets handled in the new 
regulator, convey that implicit in that are potential haircuts 
to debt.
    Senator Reed. As an aside, perhaps, but is your policy that 
you have just announced with respect to institutions that you 
govern reflected in their equity prices and their ability to go 
to the market and receive the more preferential rates?
    Chairman Greenspan. Do you mean is our general policy--
    Senator Reed. For a large money center bank, do you think 
it is reflect there as you suggest it is reflected in the 
ability of Freddie and Fannie to go to the equity markets and 
the debt markets?
    Chairman Greenspan. For Fannie and Freddie, it is very 
clear that it is reflected. If you look at the prices of debt 
of some major commercial banks, you see some of it, but far 
less. In other words, senior debt on the part of the major 
banks has higher yields than senior debt on the part of Fannie 
and Freddie. And the reason for that is largely there is a 
different view. While there is a Federal safety net for our 
depository institutions, the market does not view that debt as 
risk-free, essentially, and as a consequence requires a higher 
yield than the market requires of Fannie and Freddie.
    Senator Reed. Let me turn to a question that I raised in my 
opening statement. This goes to how we can support policies for 
better, more affordable housing--not just homeownership but 
multifamily housing that provides for citizens who cannot yet 
afford a house.
    What I think you have been saying is that there is an 
implicit subsidy because the market reads what we do or thinks 
that we will step in at the last minute. This implicit subsidy 
is not fully passed through to achieve the goals that we have 
outlined--homeownership, expansion of those opportunities. Do 
you think as a matter of policy it would be appropriate for us 
to somehow recapture some of that undistributed benefit for 
housing programs?
    Chairman Greenspan. I think that is an issue for Congress 
to make a judgment on. In other words, I am not against private 
institutions making a profit. I feel uncomfortable when their 
profit is made by subsidies. And I am not in a position to make 
a judgment as to where the Congress draws the line, but in this 
case, I will say, and I have said many times in the past, I do 
not think it is wise for this very odd situation to continue 
indefinitely, namely, that the markets believe that the 
Government will do one thing, the Government says it will not, 
and down the road eventually from that point of view is a very 
serious financial problem.
    So clarification of this question I think is very 
important. If the Congress decides that it is perfectly all 
right for a significant part of the subsidy to go to 
shareholders, that is a judgment for the Congress to make.
    Senator Reed. And on the contrary, some of that subsidy 
should be returned in some way into the marketplace for 
homeownership--is that a legitimate judgment also?
    Chairman Greenspan. Sure.
    Senator Reed. Thank you.
    Chairman Shelby. Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Chairman Greenspan, I have a number of issues I want to try 
to get into, so I will try to move as quickly as I can through 
them. But first, before I get into the capital requirement 
issue, I noted in your testimony that you have stated that the 
Federal Home Loan Banks are not the focus of your testimony 
today but that much of what you have to say today applies to 
them as well. In fact, you say that because the Federal Ho