<DOC>
[108 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:21980.wais]


                                                        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


      Available at: http: //www.access.gpo.gov /congress /senate/ 
                            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<SUP>'</SUP>.....   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:

<bullet> 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.
<bullet> 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.
<bullet> 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\
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    \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.
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    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:

<bullet> Tie capital levels to risk;
<bullet> Be based on an analysis of historical mortgage market data;
<bullet> Remain operationally workable and as transparent as possible; 
    and
<bullet> 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:

<bullet> 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.
<bullet> 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.
<bullet> 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.
<bullet> 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.
<bullet> 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:

<bullet> Provide cost-effective funding to members for use in housing 
    finance and community development.
<bullet> 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.
<bullet> Support housing finance through advances and mortgage 
    programs.
<bullet> 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:

<bullet> Preserve the role and function of the Office of Finance.
<bullet> 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.
<bullet> 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:

<bullet> Preserve the cooperative ownership of the Bank System and the 
    joint and several liability that is the underpinning of the Bank 
    System.
<bullet> 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:

<bullet> Our mission is somewhat broader than the other housing GSE's, 
    incorporating economic and community development.
<bullet> 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.

<bullet> 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.
<bullet> 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:

<bullet> 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.


<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>


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:

<GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT>


    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:

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


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     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.


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                        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<SUP>'</SUP>.
    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 e