Committee on Financial Services Thursday, September 25, 2003

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HR 2575, the Secondary Mortgage Market Enterprises Regulatory Improvement Act and the Administration's proposals on GSE regulation
by United States House of Representatives
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H.R. 2575—THE SECONDARY MORTGAGE MARKET ENTERPRISES REGULATORY IMPROVEMENT ACT

Thursday, September 25, 2003
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.

The committee met, pursuant to call, at 10:10 a.m., in Room 2128, Rayburn House Office Building, Hon. Michael Oxley [chairman of the committee] presiding.

Present: Representatives Oxley, Leach, Baker, Bachus, Castle, Royce, Lucas of Oklahoma, Ney, Kelly, Paul, Gillmor, Ryun, Ose, Green, Shays, Shadegg, Hart, Tiberi, Kennedy, Feeney, Hensarling, Garrett, Murphy, Brown-Waite, Barrett, Harris, Renzi, Frank, Kanjorski, Waters, Maloney, Carson, Sherman, Meeks, Lee, Inslee, Moore, Gonzalez, Lucas of Kentucky, Clay, Israel, Baca, Matheson, Miller of North Carolina, Scott, and Davis.

The CHAIRMAN. [Presiding.] The committee will come to order. Today the Financial Services Committee will hear from the regulators, the regulated, and outside parties interested in the oversight of the housing government-sponsored enterprises.

Two weeks ago, Secretaries Snow and Martinez came to the committee with the Administration's proposal to improve regulatory oversight for the GSEs. They proposed developing a world-class regulator with the tools to rigorously supervise the activities of these highly complex financial institutions. The Secretaries called for the regulator to be housed in the Department of the Treasury as an individual office, similar to that of the Office of the Comptroller of the Currency.

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Additionally the proposal called for the Department of Housing and Urban Development to retain its role as regulator of the GSEs' mission and to ensure that the agencies meet their affordable housing goals.

HUD's expertise in this area is critical. Under the Administration's proposal the Department would receive additional powers to enforce compliance with the housing goals.

There is a broad agreement that the current regulatory structure for the GSEs is not operating as effectively as it should. The Office of Federal Housing Enterprise Oversight is underfunded, understaffed and unable to fully oversee the operations of these sophisticated enterprises.

This was reflected in the surprise management reorganization by Freddie Mac and by Wall Street reports stating that GSE oversight is viewed with skepticism because OFHEO is largely seen as a weak regulator.

A strengthened regulator will send a signal to the markets that these entities have solid management and are engaging in safe and sound activities. Confidence will be restored in the GSEs and they will be able to get back to their important work of expanding home ownership opportunities without the distractions that have been plaguing them over the past several months.

Fannie Mae and Freddie Mac have done a good job of promoting home ownership and providing liquidity to the secondary mortgage market. These GSEs have quickly grown into large financial institutions that have a major impact on the housing market and the domestic economy. We must ensure that they have competent and thorough oversight, while making certain that any action we take does not have a negative impact on access to housing.

I am encouraged by the letters and statements of support the committee received following the last hearing on GSE regulatory reform and I hope today serves as an opportunity for members to learn more about the need for changes to the GSE regulatory structure and how that can be accomplished.

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I would like to thank our Capital Markets Subcommittee Chairman Richard Baker for his years of work to strengthen the regulatory structure of the GSEs. His expertise on this issue serves our committee well. His numerous hearings, studies and bills provide our committee with an informed background on which to move forward.

I welcome the witnesses and I look forward to their testimony.

And I now recognize the gentleman from Massachusetts, the ranking member, Mr. Frank.

[The prepared statement of Hon. Michael G. Oxley can be found on page 106 in the appendix.]

Mr. FRANK. I think this is a very important hearing. And I appreciate the Chairman's willingness to have it under the auspices of the full committee.

I joined this committee in 1981 because I am interested in housing. And I guess I wouldn't want to boast about my accomplishments, because the situation regarding housing, particularly people who are of moderate and low income, has gotten worse during my tenure. I won't accept the blame, but I clearly haven't done a great deal of good.

And it makes it all the more important that we use every tool that we do have to try improve the housing stock. And Fannie Mae and Freddie Mac are two of the very important tools that we have.

And there are people I know who are critical of the arrangements that we have. I, frankly, welcome the fact that we have in Fannie Mae and Freddie Mac a means of bringing down housing costs that doesn't put a hit on the federal budget.

Essentially, there are people in the country who are prepared to lend money to Fannie Mae and Freddie Mac at less interest rates than they might get elsewhere. I thank those people for doing that. I must tell them that I hope they are not doing that on the assumption that if things go bad, I or my colleagues will bail them out. We will not.

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On the other hand, I think it is clear that Fannie Mae and Freddie Mac are sufficiently secure so they are in no great danger. And I was glad to have Secretary Snow say when he testified that this is not something we are doing in response to a crisis. For once, Congress is getting out ahead of a problem. This is not the situation where, like the editorial writers, we come down from the hills after the battle is over and shoot the wounded. In this case, we are taking some anticipatory steps.

I don't think we face a crisis; I don't think that we have an impending disaster. We have a chance to improve regulation of two entities that I think are on the whole working well.

I have a particular concern. I know the ranking member of the Capital Markets Subcommittee has another concern about the independence and how well it will be able to function, and I share his views and will be working with him on that.

My primary interest—and I know I share this with others on this committee who care a lot about housing—is to make sure that nothing is done in this reorganization that weakens the ability, indeed the obligation of Fannie Mae and Freddie Mac to help us with our housing problem.

Now, housing is an interesting part of our economy. The argument that prosperity in general deals favorably with a lot of social problems has a lot of truth to it. By the end of the 1990s, the wages of low-income people had gone up. A number of things that we want to see happen happened from prosperity in general, but not in housing.

Paradoxically, because of the nature of the supply-demand relationship with housing, because of the kinks in the pipeline that negatively affect the supply of housing, the very prosperity of the 1990s that was so welcome for most of us exacerbated the housing problem for many people, in particular geographic areas and for people in particular economic situations.

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So it is all the more important that we muster the maximum resources to protect those people and to maximize the leverage.

So when you move the regulation to Treasury, if that is done, and you leave housing with HUD, I am skeptical that, absent anything else, that is going to sufficiently protect housing.

Now, of course there are differences, I would agree. In the current Administration it might make not much difference whether it is in HUD or Treasury or if it were at the Nuclear Regulatory Commission, for all the attention we have gotten to housing from HUD. But we are not legislating only for the next year and a half, we are legislating for the future.

So I intend to be pressing to make sure that if a transfer goes through—and there are other questions to be addressed, and the ranking member on Capital Markets will be addressing some of them—that the housing function is not only protected, but strengthened. I want to increase the leverage we have.

Fannie Mae and Freddie Mac do very good work, and they are not endangering the fiscal health of this country. But they do derive benefits from the current set of legal arrangements.

I am fully supportive of maintaining that set of legal arrangements as long as in return we get not just help for the housing market in general, which is important, and lowering housing costs in general, as they do, is a good thing, but also a particular use of the great resources that they have and the profits that they make to help us with affordable housing which the market in and of itself will not do.

So that is what we, many of us on our side, will be trying to do as we proceed, to make sure that whatever the final arrangements are, the housing function is not only protected, but enhanced, and that both the ability and the obligation of these two entities to help us with affordable housing is strengthened.

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Thank you, Mr. Chairman.

The CHAIRMAN. The gentleman's time has expired.

The gentleman from Louisiana, Mr. Baker.

Mr. BAKER. Thank you, Mr. Chairman. I want to again commend you for your continuing leadership role in addressing this issue, which is really very vital not only to taxpayers, but homeowners alike, and prospective homeowners.

This is not an issue which has really convenient answers, but it is essential for this committee, and I appreciate the full committee providing the leadership to get us to resolution.

Over the years the committee has made various inquiries in this effort, from probing the enterprises to determine the adequacy of their efforts in meeting important housing goals, as the ranking member has indicated his interest, to express concerns relative to their overall regulatory oversight.

The questions have not been limited just to a couple of obvious issues. Over the years, questions concerning mortgage-backed securities, leverage ratios, duration gap, bank investment concentration of GSE securities and a lot of other unique issues have been before the committee.

I am, frankly, quite ready, in fact anxious to turn over the examination of many of these questions to a fully funded, properly constructed, independent regulator, full of professionals able to give analytical examination and appropriate answers to these myriad questions.

It is, frankly, not business that members of Congress should routinely find themselves engaged, and I am sure many of my colleagues will enthusiastically agree with that perspective.

I also look forward to eliminating, frankly, the political risk that now exists with regard to threatening changes to the GSE charter, almost as much as I look forward to making absolutely sure that the taxpayers will never be called on to pick up the tab for the failure of the system.

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Others may suggest radical new capital regimes, perhaps unreasonable constraints on new product approval, or attacks on the basic structure of the charter. I do not intend and will not go there.

Responsible regulatory oversight is the goal, and the closure that results from this effort will be beneficial, in my judgment, to all concerned.

I do think it appropriate to make a clarifying statement today concerning my opinion of the work of Mr. Falcon and his regulatory agency.

I have certainly expressed frustration at times with the pace with which action has been taken, and on some occasions I have had disagreements with recommended actions.

But there is one clear observation I want to put on the record, on behalf of all those employees who have given their best effort over the years, and that is, you have made considerable effort, with limited resources and your constrained authority which you have been given to discharge your responsibilities in a professional manner.

In fact, Mr. Falcon, your testimony today is one of the best statements by anyone as to the direction that this Congress should take in providing adequacy of regulatory oversight. It is evidence of your leadership and your willingness to take a difficult stand and give professional counsel to the best of your ability. I commend you.

As to the current task, I am very pleased to have received excellent recommendations for the modification of H.R. 2575 from the Secretary of the Treasury. All of those recommendations are suggestions which we have previously considered, have previously agreed, and do now fully support.

In fact, there are few modifications required to H.R. 2575 to make the provisions wholly consistent with Treasury recommendations.

As the Secretary has stated, Fannie and Freddie are world class financial organizations, and they require a world class regulatory structure, which is independently funded, with all appropriate authority, and the ability to make professional decisions absent political interference.

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That has been, and remains, my legislative goal. It is also evident that protracted discussion of these concerns really has had no adverse effect on home ownership opportunities.

For those who continue to object to any structural change in regulatory oversight, I suggest just taking a deep breath. What we have enjoyed and continue to enjoy, the lowest mortgage interest rates in our country's history. I suggest that Alan Greenspan and his effect is more powerful than any action this Congress or this committee might consider.

In fact, this effort is only to ensure that the secondary mortgage market has stability, not to place constraints that will in any way adversely affect any individual's ability to achieve the dream of home ownership.

Further, it is certainly appropriate to afford opportunity to all stakeholders in this process to give their perspective on this important decision, but it should be clear to all concerned that if we are to construct an independent regulatory structure, the Congress should make the final policy decision in a manner which is independent from any single business perspective.

The enterprises, after all, are creations of the Congress, created to meet the needs of all who seek the opportunity of home ownership. We must balance that requirement with the responsibility of limiting risk to the taxpayer. That is, and should remain, the policy decision that only the Congress should make.

Regardless of the final determinations, Mr. Chairman, of the committee with regard to the construction of H.R. 2575, I will respect the consensus opinion reached on the myriad of issues and fully support the Chairman's effort to achieve this reform.

But is it now time for decisions. We don't need more inquiries, any more hearings. We have asked all the questions, and frankly heard all the various answers. It is now simply time for decisions.

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I look forward to the completion of this work, and, Mr. Chairman, with your continuing strong leadership, consideration by the full House of this measure before the year is concluded.

I thank the chair.

The CHAIRMAN. The gentleman's time is expired.

The gentleman from Pennsylvania, Mr. Kanjorski?

Mr. KANJORSKI. Mr. Chairman, we will hear today from numerous witnesses about their views on the need to alter the current regulatory system for government-sponsored enterprises. I believe it is once again very important to highlight some of my current thoughts on these matters.

As my colleagues already know, I support strong and independent GSE regulation. A strong regulator, in my view, will protect the continued viability of our capital markets and promote confidence in Fannie Mae and Freddie Mac. It will also ensure taxpayers against systemic risk and expand housing opportunities for all Americans.

We must, however, tread carefully in developing any legislation to modify the GSE regulatory system. The housing marketplace is one of the most vibrant sectors in our struggling economy and we must ensure that our actions in Washington will not lead to unintended consequences in places like Scranton, Baton Rouge, Findlay or Fall River.

In our last hearing on GSE issues, senior officials within the Bush Administration indicated that there was no crisis that demanded immediate attention of the Congress. Consequently, instead of rushing to judgment, we ought to move judiciously and objectively in these matters to make sure that we properly construct an appropriate regulatory system.

In other words, the obligation to create an effective regulatory system should guide the timing of our deliberations instead of meeting some arbitrary deadline for taking action.

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In developing any enhanced GSE regulatory system, I further believe that we should perform deliberate surgery. We should therefore abstain from considering radical proposals that would fundamentally change the ways in which the GSEs operate and the charters of the GSEs.

We must also ensure that the GSEs continue to achieve their statutory obligation of advancing affordable housing opportunities for low-and middle-income families.

As you know, Mr. Chairman, at the start of our two most recent hearings on GSEs, I have outlined five principles to guide our consideration of GSE regulatory reform legislation. Today I feel it is very important to expand my previous comments on one of these principles, regulatory autonomy.

In recent weeks, I have participated in numerous meetings with many experts on GSE matters.

The majority of these individuals have counseled me that in order to maintain credibility and be effective, a strong GSE regulator must have genuine independence from the political system.

In their prepared statements, many of today's witnesses also recognize the importance of and need for regulatory autonomy. Accordingly, they will call upon us to adopt a system in which the GSE regulatory reform bill can proceed in a proper and orderly manner.

Additionally, several others who will not testify at this hearing have noted the importance of statutorily protecting any new GSE regulator from improper political influence.

For example, the Independent Community Bankers Association has strongly urged us to construct legislation containing appropriate firewalls and independence between any new safety and soundness regulator for Fannie Mae and Freddie Mac and the Treasury Department's politically appointed policymakers. We should heed their sensible advice.

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The National Association of Realtors has also recommended that any GSE regulator within the Treasury Department should have necessary and sufficient firewalls to ensure its political and operating independence, comparable to those that presently exist for the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

I wholeheartedly agree. The OCC and the OTS models provide us with an effective framework for constructing a new GSE safety and soundness regulator.

Specifically, this new agency should have the authority to submit testimony, recommendations and reports to the Congress without the prior review or approval of the Treasury Secretary.

It should further have the ability to issue rules and regulations without the review and approval of the Secretary.

Additionally, it should have the power to initiate and complete supervisory and enforcement actions without intervention by the Secretary. It should also have independent litigation authority.

Finally, we should prohibit the Secretary from merging the responsibilities of this office with any other regulator.

In closing, Mr. Chairman, I commend you for your leadership in these matters. I look forward to continuing to work with you to develop a balanced and bipartisan plan of action for reforming GSE safety and soundness regulation, ensuring the independence of the new regulator and preserving the affordable housing mission of Fannie Mae and Freddie Mac.

I yield back.

[The prepared statement of Hon. Paul E. Kanjorski can be found on page 117 in the appendix.]

The CHAIRMAN. The gentleman yields back.

The gentleman from California, Mr. Royce?

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Mr. ROYCE. Thank you, Mr. Chairman, and thank you for holding this hearing. And I want to commend you, I want to commend Chairman Baker certainly, as well, for your leadership.

And I look forward to hearing the testimony of our witnesses today. Especially I look forward to welcoming a fellow Californian, Mr. Dean Schultz, who is with us, and he is the President of the Home Loan Bank of San Francisco.

This committee, in my view, must include the Federal Home Loan Bank system in any legislation that would create a new regulatory body for housing government-sponsored enterprises.

I think that today I would like to once again raise my own concerns with the Office of Federal Housing Enterprise Oversight and with the Federal Housing Finance Board.

The arguments to include the Federal Home Loan Banks in a better, stronger regulatory framework are consistent with the same arguments to include Fannie Mae and Freddie Mac. The Federal Home Loan Banks have debt outstanding and a derivatives portfolio comparable in size to both that of Fannie Mae and Freddie Mac.

Additionally, the Federal Home Loan Banks are changing the risk profile of the system through their rapidly growing mortgage assets.

The Finance Board has neither the depth nor the experience to oversee this risk. All three GSEs need to hedge their portfolios against movement of interest rates. And for this reason, Chairman Greenspan and Secretary Snow both make a compelling public-policy case to create one regulator for all three GSEs.

I believe that there is a political consensus building to act on the Federal Home Loan Banks. However, at the end of the day, if this committee must choose between sound public policy on one hand and a unanimous political consensus on the other, the committee here should pick good public policy.

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In my view, the benefits of better regulation would accrue not only to the taxpayer and to the financial system at large, but it is also going to accrue to Fannie Mae and Freddie Mac and to the Federal Home Loan Banks. And the reason that is the case is because, not only is there going to be better regulation, but there is going to be a lower cost of capital for those institutions.

The regulator must see the whole scope of risks in GSE housing finance to perform its duties well, including, if we go forward and we include the Federal Home Loan Banks, this is going to allow Congress to construct the proper foundation for this oversight.

So I look forward to working with my colleagues from both sides of the aisle to create legislation that includes all three GSEs. And that legislation should adhere to a few basic principles.

The regulator should be independent, like the OCC and the OTS. The regulator should be independently funded, outside of the congressional appropriations process. The regulator should recognize distinctions in the business models between Fannie Mae and Freddie Mac and the Federal Home Loan Banks. And with the exception of affordable housing goals, with that exception, mission regulation should move to the new regulator.

And I thank you again for your leadership, Mr. Chairman.

[The prepared statement of Hon. Edward R. Royce can be found on page 122 in the appendix.]

The CHAIRMAN. Gentleman yields back.

Are there further opening statements?

Gentlelady from California?

Ms. WATERS. Thank you very much, Mr. Chairman. I am pleased that we are here today. And I do think this is a very important meeting.

The last time I heard testimony from Fannie Mae and Freddie Mac was May 16, 2000. As you know, I was a member of this distinguished committee when we enhanced the structure of these GSEs in 1992 to assure safety and soundness in particularly their housing mission.

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However, I have sat through nearly a dozen hearings where, frankly, we were trying to fix something that wasn't broke. Housing is the economic engine of our economy, and in no community does this engine need to work more than in mine. With last week's hurricane and the drain on the economy from the war in Iraq, we should do no harm to these GSEs. We should be enhancing regulation, not making fundamental change.

Mr. Chairman, we do not have a crisis at Freddie Mac, and in particular at Fannie Mae, under the outstanding leadership of Mr. Frank Raines. Everything in the 1992 act has worked just fine. In fact, the GSEs have exceeded their housing goals.

What we need to do today is to focus on the regulator, and this must be done in a manner so as not to impede their affordable housing mission, a mission that has seen innovation flourish from desktop underwriting to 100 percent loans.

We must be mindful that capital allows these GSEs to perform their mission. Nothing in the concerns at Freddie Mae had to do with their capital.

In this regard, I am pleased that Secretary Snow has communicated that Treasury has no intent to change the GSE's minimum capital or risk-based capital. Their risk-based capital requirements are subject to a decade-long, and I quote, ‘‘nuclear winter or deeply adverse credit and interest rate environment.’’

These GSEs have more than adequate capital for the business they are in: providing affordable housing. As I mentioned, we should not be making radical or fundamental change.

I also have several concerns, which I raised at last week's hearing, and I need to further set the record straight.

First, these GSEs lead, not lag the primary market in funding mortgage loans for low-income and minority home buyers. The goals we put in place in 1992 work.

In 2002 alone, Fannie Mae provided $279 billion in credit serving low-and moderate-income households.

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Fannie Mae's $136.2 billion investment in mortgages to minority families exceed that of any private financial services institution—and may I say particularly Wells Fargo and their other competitors, who thrive in subprime and predatory lending—and even greatly exceeded the FHA's $46.4 billion in minority loan originations.

Moreover, since the inception of goals from 1993 to 2002, loans to African-Americans increased 219 percent and loans to Hispanics increased 244 percent, while loans to non-minorities increased 62 percent.

Additionally, in 2001, 43.1 percent of Fannie Mae's single-family business served low-and moderate-income borrowers compared to 42 percent for the conventional conforming market as described by the HMDA data. A total of 23 percent of Fannie Mae's business served minority home buyers, compared to 21.3 percent for the conventional conforming market.

Mr. Chairman and members, the GSEs are working. That is why I oppose the transfer of program approval to Treasury and expansions into new activities by either Treasury or HUD. I am opposed to a new bureaucracy at HUD to track sub-goals. We should focus on those banks, many of them competitors of these GSEs, who avoid CRA and practice predatory lending.

In addition, less than 17 percent of OPO's budget was used for examinations. Reallocations of funds, not a new and expensive bureaucracy, is what is needed.

I also oppose the tinkering with the GSEs' status and indicia of GSEs' status. Leave the Presidential appointment of directors alone. Don't rattle the domestic and international markets with this tinkering.

Mr. Chairman, let me just close by saying, it is almost unfair to the regulatory agency at this point to simply criticize them for not exercising the kind of oversight that is now being concluded that they should be exercising without a real examination of their resources and their power and all that should go along with any regulatory agency.

If there is anything to fix or improve, it is the regulatory agency.

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And again, I suppose I take a position that is somewhat different from some of my colleagues. I am absolutely, unequivocally opposed to the transfer to Treasury and the expansion into new activities by either Treasury or HUD.

I yield back the balance of my time.

The CHAIRMAN. Gentlelady yields back.

Are there further opening statements?

The gentleman from Ohio, Mr. Ney?

Mr. NEY. Thank you, Mr. Chairman. I think we all can say that we appreciate your holding this hearing. It is important we proceed cautiously, but expeditiously and carefully on the issues of providing a new regulator for GSEs, and you have done that.

I want to thank our many witnesses who will be here today, the current panel and also upcoming panel. David Hehman, who is President and CEO of the Cincinnati Federal Home Loan Bank will be here today.

As I mentioned, the hearing we held a couple weeks ago, as Chairman of the Housing Opportunities Subcommittee, I have a keen interest in the strength of our nation's housing market.

GSE regulation is an incredibly important issue for all Americans. One of the only things that held this economy together as we all know in the last two years was housing and automobiles. Right now, it is housing as an important part of the recovery.

The United States mortgage and credit markets are the envy of the world. The mortgage market has singlehandedly kept the economy afloat during the recent difficult economic times, and housing has proven to be the greatest single generator of wealth in our nation.

As our last hearing demonstrated, a consensus has begun to emerge that it is time to create a new safety and soundness regulator for Fannie Mae and Freddie Mac at the Treasury Department. With the important role the GSEs play in the capital markets and the possible risks they could pose to the financial system, reconstituting their safety and soundness regulator at Treasury is a prudent step at this time.

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Such a move would send an important signal that we understand the importance of the GSEs and the secondary mortgage markets in maintaining a stable economy and providing affordable housing for all Americans.

While there is a consensus regarding the safety and soundness regulator, I am anxious to hear from our many witnesses today on what they believe should be done with the HUD's oversight responsibility for the housing missions and enterprises, including approval authority for any new program and enforcement compliance with affordable housing goals.

These issues have received a significant amount of attention since the hearing a few weeks ago, and I look forward to asking some specific questions about them.

I would also like to make one personal observation on the regulation of GSEs. I believe it is important in any legislation we may consider to allow the housing GSEs to have sufficient flexibility to adapt to a changing mortgage market.

The liquidity that Fannie and Freddie provide to the market should not be compromised by unnecessary government regulation.

As I said before, I believe there are several important components that have been integral to providing enhanced regulation for GSEs while not impeding their ability to support affordable housing in America.

For example, I think it is imperative for HUD to continue to have an important role as it relates to the mission, charter and affordable housing goals of Fannie Mae and Freddie Mac. I have no doubt that the Treasury Department is unparalleled in its ability to manage safety and soundness for these corporations. However, Congress has charged HUD with the job of supervising affordable and minority housing in our country.

I am interested to hear what our witnesses think should be done regarding the capital requirements for Freddie Mac and Fannie Mae, if anything at all. Personally, I believe that the requirements Congress had mandated for GSEs have done a good job of setting a strong safety and soundness standard.

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Likewise, I believe that while we must give the regulators the authority they need to keep the risk-based capital regulation relevant to the changing marketplace, we have to also allow the newly required risk-based capital requirements to take hold before we begin questioning it.

I know that there are critics of OFHEO risk-based capital regulation. However, it has been in place for less than a year, and we should allow a decent amount of time to evaluate its effects before we begin to dismantle it.

Finally, I want to make it clear that I believe the Department of Housing and Urban Development must maintain its role in leadership in promoting housing. This agency has an important role in ensuring our nation is focused on providing decent and affordable housing for all Americans. We have to respect that mission.

I also want to say hello and welcome to Mr. Falcon today for the job he has been undertaking here.

Again, Mr. Chairman, I thank you for holding this hearing and our witnesses for taking the time to be here. I look forward to the hearing. Thank you.

The CHAIRMAN. The gentleman yields back.

Are there further opening statements?

The gentleman from California, Mr. Baca seeks recognition?

Mr. BACA. Thank you very much, Mr. Chairman.

First of all, I would like to commend you for having this important hearing this morning.

Mr. Chairman, as we move forward on deliberation actions on the issues of GSE regulations I want to underscore what I heard many of my colleagues say that at the last hearing that is that we would oppose any changes in mission, charter or status of governmental-sponsored enterprises.

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As our ranking member said at the last hearing, there is no crisis regarding the GSEs. We have two companies that are remarkably effective in the mission of providing affordable mortgage financing, to move more low-income families into home owning.

Fannie Mae plays an essential role in helping to finance affordable housing throughout the United States. One reason Fannie Mae has been successful is because the current status encourages them to be innovative, I state, be innovative, to introduce new products and to partner with other institutions to be proactive in reaching out to low-income families, I state, low-income families unembedded with corporate culture.

When you change this mission, the status or charter, you risk losing the focus, intensity and drive that bring on the challenge of providing, and I state, on providing the challenge of home ownership opportunities to low-income families.

Regarding the GSEs, safety and soundness is important, but whatever this committee does, we should not interfere with GSEs ability to innovate, to meet the needs of low-income families in underserved areas, and I state, underserved areas throughout the United States, such as my area, where the majority of the growth is in the Inland Empire.

GSE must have the flexibility and the products to develop and fulfill the responsibility of their congressional charter and housing mission.

Thank you again, Mr. Chairman, for having this hearing. I look forward to hearing the witnesses.

The CHAIRMAN. The gentleman yields back.

Are there further opening statements?

Having none, we now turn to our first distinguished panel, the Honorable Armando Falcon, Jr., Director of Federal Housing Enterprise Oversight; the Honorable John T. Korsmo, Chairman, Federal Housing Finance Board.

Gentlemen, welcome to the committee.

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And, Mr. Falcon, we will begin with you.STATEMENT OF ARMANDO FALCON JR., DIRECTOR, OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

Mr. FALCON. Thank you, Mr. Chairman.

Chairman Oxley, Ranking Member Frank 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.

I would like to begin by stating up front that I support legislation to strengthen the supervision of Fannie Mae and Freddie Mac. Upon taking office as Director of OFHEO in October of 1999, I quickly realized that the agency's long-term success was jeopardized by inadequate resources, a constraining funding mechanism and the lack of powers equal to those of other regulators.

Over the past four 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 and your efforts, Mr. Chairman, to move forward.

While I am in general agreement with the well-considered proposal that Secretaries Snow and Martinez have presented to the committee, 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, one, the regulator should remain independent; two, 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.

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Adherence to each of these principles would strengthen supervision and the safe and sound operation of the enterprises. Our ultimate goal and benchmark should be to establish a regulator that is on an equal plane with the Office of the Comptroller of the Currency and the Office of Thrift Supervision, 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 regulator 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 the Congress' experience with the savings and loan crisis.

I had the privilege, Mr. Chairman, of serving as counsel to this committee for eight years, this committee's predecessor, 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 regulators' best judgment on regulatory matters unfiltered and without delay.

With billions of dollars of potential taxpayer liability at stake, it is in everyone's interest that this important safeguard not be weakened.

Like OFHEO, the Office of Thrift Supervision is another useful example of how a new independent regulator should be established as part of a departmental organization.

In 1989, Congress transferred responsibility for thrift regulation from the Federal Home Loan Bank Board to the newly created Office of Thrift Supervision within the Treasury Department. The Office of Thrift Supervision was established as a fully independent regulator. It has the same powers and unfettered ability to use those powers as the OCC.

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So I believe Congress should ensure that the new regulator has full independence.

Second, the regulator should be permanently funded outside the appropriations process. Currently, OFHEO is funded annually through the federal budget and appropriations process, even though the agency does not utilize any taxpayer funds. OFHEO is funded through assessments on the enterprises, but those assessments cannot occur until approved by an appropriations bill and at a level set by the bill.

OFHEO is the only safety and soundness regulator funded in this limited manner. At a minimum, this serious anomaly should be fixed.

Permanent funding will enable the regulator to fulfill its budgetary needs on a more reasonable basis, without the timing constraints associated with the annual appropriations process.

There should be clear authority for the agency to levy special assessments or establish a reserve fund as needed to meet emergencies. Currently, any additional funds required to meet urgent, unexpected needs can be attained only after a supplemental appropriation is enacted. This can delay action by the agency to resolve problems early, before they threaten the safety and soundness of an enterprise.

At this point let me state, Mr. Chairman, that I appreciate that the Administration has sent up a supplemental budget request for the agency of $7.5 million, and I ask for the committee's support in getting that supplemental appropriation enacted.

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 receivership authority, independent litigation authority, enhanced hiring authority and the full range of enforcement powers provided to financial regulators.

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Also, the law should be revised to provide clearly that the regulator is empowered to address misconduct by institution-affiliated parties and to exercise general supervisory powers.

I would be happy to provide the committee with a more comprehensive package if you so desire.

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 available information through the examinations process and otherwise to determine if capital adjustments are necessary. 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 the enterprises business, the market environment in which they operate and the changing nature of risk measurements themselves.

As Secretary Snow said in his testimony before this committee, broad authority over capital standards and the ability to change them as appropriate are of vital importance to a credible, world class regulator. I agree.

Fifth, legislation should build on the progress we have made over the last 10 years. Regulating Fannie Mae and Freddie Mac requires a specialized skill set. The capacity to model the cash flows of all the mortgages, debt and other financial instruments of the enterprises, a necessity for the stress test, is unique among financial institution regulators.

Expertise in how these two secondary mortgage market companies manage mortgage risk, including the broad use of sophisticated derivative and callable debt, is vital for effective regulation.

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In addition, an understanding of how the enterprises are affected by the markets in which they operate is extremely important.

Over the past 10 years, OFHEO has developed the specialized expertise, from our examiners and financial analysts to our researchers and capital analysts, that is necessary to supervise these two unique companies.

The cost in terms of lost regulatory capacity spent while trying to rebuild that infrastructure would be substantial.

That is why I recommend that if a new regulator is established in the Treasury Department, OFHEO's personnel, regulations and administrative infrastructure should be transferred intact to the new agency. It would be highly counterproductive to do otherwise.

There are a couple of other matters I would like to briefly discuss.

First, I agree with Secretary Snow that the Presidentially appointed board positions should be discontinued. This is not a reflection of current or former Presidentially appointed directors. Rather, I think corporate governance would be enhanced if the shareholders were allowed to select all members of the board.

Also, I support granting authority to the safety and soundness regulator to determine whether activities of an enterprise are consistent with its charter. This would mean that a single regulator would have the ability to review all of the enterprises' activities, new and existing.

This would consolidate the supervision of the enterprises in a manner consistent with the authorities of other regulators once again.

I appreciate the concern expressed about the primacy of the enterprises' housing mission, if and when charter compliance responsibility is shifted. The goal, in fact, of enforcing charter compliance is to ensure that the enterprises remain properly focused on their housing mission and not stray into extraneous ventures.

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Consistent with that goal, I think mechanisms could be instituted to ensure that the new regulator actively solicits and considers all views, including housing advocates, when exercising this authority.

The importance of their housing mission is actually why the enterprises exist. Strengthening their safety and soundness regulations supports that mission by ensuring that they are strong enough to provide the financial services that make that mission a reality.

Mr. Chairman, that concludes my testimony. I look forward to working with the committee as this important legislation moves forward. I look forward to answering any questions that you may have.

[The prepared statement of Hon. Armando Falcon Jr. can be found on page 145 in the appendix.]

The CHAIRMAN. Thank you, Mr. Falcon,

Mr. Korsmo?STATEMENT OF JOHN T. KORSMO, CHAIRMAN, FEDERAL HOUSING FINANCE BOARD

Mr. KORSMO. Thank you, Mr. Chairman.

Chairman Oxley, Ranking Member Frank and distinguished members of the committee, thank you for inviting me to be part of this discussion today.

I have submitted more extensive written testimony to the committee and ask that it be included in the record.

The CHAIRMAN. Without objection, all of the statements will be made part of the record, including the members'.

Mr. KORSMO. Thank you, Mr. Chairman,.

Over the past year and a half, my colleagues and I at the Federal Housing Finance Board have undertaken a disciplined, continuing and I believe successful effort to improve the Finance Board's supervision and regulation of the Federal Home Loan Banks.

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A 1998 GAO study found that nine years after its creation, the Federal Housing Finance Board remained inadequately focused on safety and soundness and too closely involved in operating the Federal Home Loan Banks.

When I became chairman in December 2001, my colleagues and I determined these problems persisted and required correction for the Finance Board to effectively oversee the banks for safety and soundness and achievement of their housing finance mission.

I think one quick example demonstrates my point. At the time of my appointment, the Finance Board had only eight bank examiners on staff to supervise a dozen financial institutions with at the time more than $700 billion in assets, more than $30 billion in capital and some $650 billion in outstanding debt.

At the same time, the agency also had eight people in its Office of Public Affairs.

The relative allocation of resources simply did not meet the agency's statutory mandates.

Addressing these problems began with the recruitment of new leadership for the agency's Office of Supervision. After a national search, a new Director and a new Deputy Director of Supervision were hired who between them have 40 years of Federal Bank regulatory experience.

My Finance Board colleagues and I increased the resources available for supervision, expanding the examination staff to 17 full-time examiners today. Our goal is to have 24 in place by the end of this calendar year and 30 by October 2004.

We are now conducting more thorough examination, focusing on the bank's risk assessment processes, internal control systems and systems of corporate governance, and we are communicating the results of those examinations more effectively to the banks.

Our examinations now recognize that banking, including AAA-rated GSE banking, is a business of managing risks. And the responsibility of bank supervisors is to ensure the institutions they regulate understand those risks and monitor and control them through prudent risk-management practices and effective board governance.

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Board governance was recently the subject of the first of a series of system-wide supervisory reviews. This increased emphasis on bank board governance emerges from the Gramm-Leach-Bliley mandate that the Finance Board's appropriate role is not to operate the Federal Home Loan Banks, not to cheerlead for them, but rather to function as a true, arms-length regulator.

These staffing and policy improvements, as well as an ongoing initiative to enhance the bank's quarterly and annual financial disclosures and a renewed emphasis on building the retained earnings of the banks, have been guided by core principles of effective supervision.

Fortunately, the prerogatives and authority afforded the Finance Board by the Federal Home Loan Bank Act have permitted us to put these principles into practice.

They include, first, a GSE safety and soundness and mission regulator should have adequate resources, beginning with financial resources, to carry out its responsibilities.

Second, a GSE regulator should have the flexibility to allocate resources appropriately and efficiently to ensure the regulated entities operate in a financially safe and sound manner.

Third, a regulator must be able to attract experienced and knowledgeable staff, with specialized knowledge of the enterprises they supervise who are capable of keeping pace with changes in the mortgage, finance and capital markets.

Fourth, a regulator's authority to carry out its responsibilities should be clearly articulated in law and regulation. And, finally, a GSE regulator should be clearly independent of both undue political influence and the entities it regulates.

Finance Board adherence to these principles has produced stronger, more comprehensive oversight of the Federal Home Loan Banks. I believe the fast progress my Finance Board colleagues and I have made in increasing the capacity and sophistication of the agency's supervision staff demonstrates the effectiveness of the Finance Board's regulatory model.

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Before I close, let me briefly comment on questions raised recently concerning cost of funds. I feel obliged to put this concern in some context.

Despite different charters, different ownership and capital structures, different business models and different regulators, all three housing GSEs raise funds in the agency debt market and benefit from the shared advantage of what the market perceives is an implied taxpayer guarantee.

The pricing of agency debt reflects a variety of factors that may affect the relative desirability of particular issuers at any given moment.

One factor that will never vary, however, is the Federal Housing Finance Board's commitment to the strongest possible safety and soundness supervision of the 12 Federal Home Loan Banks. On that commitment, the capital markets and this committee can rely.

Mr. Chairman, distinguished members of the committee, thank you for allowing me to discuss with you today the Federal Housing Finance Board and its efforts to strengthen oversight of the Federal Home Loan Banks. I believe the success of these efforts demonstrates that the Finance Board is achieving the goal of providing effective, efficient and independent regulation of the banks.

I hope our experience can be of value to you as you consider H.R. 2575. I am pleased to respond to any questions.

Thank you, Mr. Chairman.

[The prepared statement of Hon. John T. Korsmo can be found on page 182 in the appendix.]

The CHAIRMAN. Thank you, Mr. Korsmo, for your appearance today.

And let me begin some questions.

The Administration has argued that the Treasury Department should have the final say on regulations issued in testimony presented by the new regulator. And some claim that this will subject the regulator to the political process and possibly suppress statements or regulations that could be embarrassing to the Treasury.

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On the other hand, others argue that without input from Treasury, the new regulator will not be able to utilize the depth and breadth of the Department's expertise.

I would like to hear both of you as regulators, your take on both sides of that issue.

Mr. Falcon?

Mr. FALCON. Thank you, Mr. Chairman.

I do believe it is important that the agency, with all the expertise that it has, the examination program and all of our analysts, be able to promulgate regulations based on what we believe is the best public policy for the agency.

I am not saying necessarily that there would be political interference guaranteed with every regulation that we try to promulgate, but just the additional delay and the possibility for the political interference, I think, makes it better public policy that we be allowed to promulgate the regulations without the reviewing approval of the Department.

We do that currently. Our regulations do go through OMB review. There is an opportunity of OMB review for any department, including the Treasury Department, to have some input into the regulations that we do promulgate, and I think that provides an adequate means for other input.

The CHAIRMAN. Mr. Korsmo?

Mr. KORSMO. Mr. Chairman, obviously my experience is a little different and limited to what experience I have had at the Finance Board. Our statute makes clear that the Finance Board acts as a body, and so as chairman I have to be very careful to make clear that my comments are only my own.

But I do have to feel that the independence our statute affords us in making comments is significant. Obviously, our regulatory process anticipates public comment when we make new regulations. The departments of the Administration have not been shy, as neither have others in commenting on our activities, but I think there is a significant strength to any regulator in the independence that we appreciate at the Finance Board.

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The CHAIRMAN. Let me ask both of you, is there a difference between what you mentioned, Mr. Falcon, in terms of promulgating regulations, and the Treasury having to sign off, for example, on testimony given here on Capitol Hill?

Mr. FALCON. Let me use today's testimony as an example, Mr. Chairman. I disagree with the Secretary of the Treasury's testimony that he gave you recently.

Whether or not I would be able to say that in the choice of words that I wanted to use might not be guaranteed if I had to get my testimony cleared by the Treasury Department. But I am able to come here today and give you my best judgment about what should be done and the status of anything with regards to companies that we regulate. That wouldn't be absolutely guaranteed if it had to be reviewed and approved by the Secretary of the Treasury.

The CHAIRMAN. Mr. Korsmo?

Mr. KORSMO. Again, Mr. Chairman, my experience is limited to that at the Finance Board, and I would say again that independence is a paramount feature of our experience, and I think the latitude, the flexibility it affords can't be overstated.

The CHAIRMAN. Mr. Falcon, as you know, Freddie Mac announced this morning that they will be unable to meet the deadline on their restatement. Could you share with us the OFHEO's involvement with the restatement process and what impact do you expect that this delay will have on Freddie's ability to comply with this voluntary agreement to register with the SEC?

Mr. FALCON. Yes, Mr. Chairman. We have been very involved in the restatement process ever since it began when they hired the new accountant. That is when Arthur Andersen was relieved of their duties by the company.

The recent development is that there has been a very recently uncovered glitch with one of the computer systems that produces data pursuant to FAS 140. The company has been keeping us informed. We are watching it very closely. It is going to result, though, in a delay until November of this year.

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With regards to the registration with the SEC, that will not begin to happen until the company is able to produce timely quarterly financial statements. The restatement, when it comes out in November, will be for quarters leading up to the end of 2002. They still have work to do to produce financial statements for quarters for 2003. We hope that will be done by the end of this calendar year.

Then it will take maybe a quarter or two, into 2004, before the quarterly statements for each quarter can be produced in a timely manner. It is slowly getting all on track. But until they are able to produce a quarter's financial statements in a timely manner, they will not be able to register with the SEC. So it probably looks like maybe summer or fall of 2004 before that can actually take place, Mr. Chairman.

The CHAIRMAN. The chair's time has expired. The gentleman from Pennsylvania?

Mr. KANJORSKI. Thank you, Mr. Chairman.

I appreciate both of your initial testimony. I think you were frank, and I want to be very clear, particularly you, Mr. Falcon, and Mr. Korsmo, any vetting of testimony by an independent regulator by Treasury would have an effect on what you would initially suggest that you would want to say in testimony or potentially could be subject to correction.

And as I take your testimony, you are indicating you think that would be counterproductive. Is that correct?

Mr. FALCON. Yes, sir.

Mr. KORSMO. Yes, sir.

Mr. KANJORSKI. And when we use terms, the Secretary used them, ‘‘strong,’’ ‘‘independent,’’ ‘‘world class,’’ clearly vetting testimony would interfere with the adjective ‘‘independent.’’ Is that correct? I mean, can you be independent and have your testimony affected or vetted by a department such as Treasury?

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Mr. FALCON. I think ‘‘independence,’’ by definition, means you have the individual ability to take action and make statements without the necessity for review and approval by another individual or entity. And for the new regulator to be established as a world class regulator that would mean it will need all of those powers and independence that are comparable to the other financial safety and soundness regulators. This is just a vitally important part of it.

Mr. KANJORSKI. Is there anything that you see peculiar with the entities that you regulate that are significantly different than the banks or the thrifts that are regulated by the two other independent regulators that we have evidence of how they operate? Is there something unique with Freddie and Fannie that you really need the special resources of Treasury before you are capable of making judgments as a regulator?

Mr. FALCON. I think the agency has more expertise than exist in any other agency or department in the Federal Government with respect to the knowledge of these two companies and how they operate, the risks they face and how they manage those risks.

I think having the independence in exercising our best judgment with all of that expertise is very important.

Now, the independence plays another vitally important role because another unique aspect of what we do is we regulate only two companies, and they are two companies that are of course very politically active and very politically savvy. So it is important that the regulator be able to take its actions based on what it sees as using its best judgment without the potential for the companies to exercise their political acumen in a way that could undermine safety and soundness regulation.

Mr. KANJORSKI. Mr. Korsmo, do you have the same situation, some uniqueness or a lack of uniqueness on what you regulate that you need the support and depthful knowledge of Treasury before you are capable of performing your functions as a regulator?

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Mr. KORSMO. Well, Congressman, as with the instance with Mr. Falcon's response, I think the expertise that resides at the Finance Board is unparalleled. I think the increased capacity and sophistication that we have brought over the last two years to our Office of Supervision leaves no doubt that we are more capable than any other institution in taking a look at and providing oversight to the Federal Home Loan Banks.

Mr. KANJORSKI. Is there any reason, and either of you, that over this last several years that you have a need for support in creating policy decisions at your respective agencies that again you need a grandfather symbol out there or position of Treasury to help you out with these very difficult policy considerations you are called upon to make?

Mr. FALCON. I think we have in house all of the expertise necessary to make judgments on regulations we might promulgate. It is very helpful to have comments through the notice and comment process, and we appreciate that and take them under consideration. But the expertise necessary to take supervisory actions and promulgate regulations, I think does reside within the agency.

The CHAIRMAN. Gentleman's time has expired.

The Chair would indicate to the members that there is a vote on the floor, but it would be the Chair's intention to keep going. And Ms. Kelly is dutifully going over to vote and to come back and Chair while the Chair has a chance to vote. So we will continue to go through the questioning.

And the Chair now recognizes the gentleman from Louisiana, Mr. Baker.

Mr. BAKER. Thank the Chairman.

Mr. Falcon, in your itemization of those issues that are important to the new regulatory capacity, number four is full discretion of the regulator in setting capital standards. There has been some controversy surrounding the provisions in H.R. 2575, specifically section 114, which gives the regulator discretionary authority with regard to minimum capital standards.

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The Secretary of the Treasury indicted in his testimony that he did not foresee the necessity for nor immediate action to increase either the risk-based, nor the minimum capital standards.

Is that a view with which you would concur, based on your information today?

Mr. FALCON. Yes. We have no plans currently and see no need currently to raise the capital standards.

Mr. BAKER. And that is a view with which I concur. But that is a distinctly different matter from whether the regulator should have the authority to adjust capital standards based on your review of risk and capital adequacy.

Have you had an opportunity or are you familiar with 2575 and that provision of 114 which gives the discretion to the new regulatory structure to adjust capital? Have you see that provision?

Mr. FALCON. Yes, I have.

Mr. BAKER. In your view, does that provision require an upward adjustment of the minimum capital standard?

Mr. FALCON. As I read it, I think it simply gives the agency the discretion to set capital as it thinks is appropriate.

Mr. BAKER. And I concur with that view. I just wanted to have your perspective as the regulator with regard to the effect of that provision. And I have no intent to pursue a provision which would arbitrarily require the upward adjustment of capital, but do fully intend to give the regulatory structure the authority to adjust minimum and risk-based capital as the regulator may deem appropriate, exercising your independent authority.

Secondly, I corresponded with you some time ago relative to the severance packages of former officials of Freddie Mac, only with regard to the question of the appropriateness of having those compensation packages finalized prior to a final determination of fact and a finding of accountability with regard to the conduct of those officials, making no comment as to what should or should not be done, only as to the agency's ability to intercede in the finalization of those compensation packages.

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I have subsequently received correspondence from one of the employee's counsel indicating that the agency did not have the authority over the enterprise to either approve or disapprove those severance packages.

As I understand it, you have now corresponded with the board of Freddie Mac and indicated that you would like to see those employees terminated for cause, which the consequence of it would be to effectively terminate those packages.

Is that a correct summation of where we are?

Mr. FALCON. Yes.

Mr. BAKER. Is there, therefore, no actual authority for your agency today to review compensation packages or severance packages prior to their finalization with an employee?

Mr. FALCON. Well, I think we do have the authority to take appropriate action and determine what is the appropriate severance package or compensation for the individuals. I thought it was important as a matter of good corporate governance to set a clear principle that if you engage in wrongdoing you will be terminated and won't be allowed to resign and keep a large, substantial amount of money.

With respect to the letter you may have received from one individual's counsel, I understand they are representing their client's interests, but I am trying to protect the public's interest. I believe I have the authority and we will take action as we see is necessary.

Mr. BAKER. I only wanted to clarify for the record going forward, is there any need in your view while this committee is constructing the regulatory authority to make clear that the regulator that will be created has clear statutory authority and further a responsibility to review these matters.

And I say it in light of not only the Freddie Mac issue, but the unfortunate developments with the New York Exchange in the broad context of corporate governance. Particularly where it is an enterprise created by the Congress, we have a full responsibility, I believe, to assure the taxpayer that we are looking at the appropriateness of and have reviewed via the regulator the compensation arrangements.

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Am I understanding that you do not believe we need to take any further action in regard to that matter to have this assurance?

Mr. FALCON. We do have the authority. However, if you think it advisable, it might be appropriate to remove any doubt, so you don't have to receive letters such as you did. You may want to say something specific in the statute.

Mr. BAKER. Let me suggest, if I may, and I would be happy to receive any recommendations you choose to forward, but specifically with regard to that item, should you have language you would suggest that we might consider I would be appreciative to receive it.

And, Mr. Korsmo, I am sorry to move so quickly, but the time on the vote on the floor is moving quickly and I will need to step out.

Not to do this quite so inappropriately, but is there a position, affirmatively or negatively, with regard to the bank system's participation in the new regulatory structure? I know there is division among individual bank districts as to the advisability. Has the board or have you reached some determination as to what this committee should do?

Mr. KORSMO. The board has not taken a formal position. I think it is safe to say, however, after consultation with my colleagues that we are unanimous in our feeling that given the progress we have made, and particularly the very different charters that exist between Fannie Mae and Freddie Mac and the Federal Home Loan Banks, the different ownership structures, the different business models, that we believe the progress we have made demonstrates that the Finance Board's independence should be preserved.

Mr. BAKER. So that is an independently arrived at ‘‘not sure, but probably not’’?

Mr. KORSMO. Correct.

Mr. BAKER. I understand.

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Mr. Falcon, there is one other question that has also been raised in press reports relative to new product approval processes. To my knowledge, in the history of HUD, who has to act after the product is in the marketplace, there has not been, to my knowledge, a product offering which has been revoked by HUD in its capacity as a new products regulator.

In your testimony, I believe I understood you to say that new product authority ought to be more appropriately housed in the regulatory structure that also reviews safety and soundness. Just to confirm, that is your recommendation to the committee?

Mr. FALCON. I think it would be appropriate to consolidate charter compliance authority with the safety and soundness regulator. All other safety and soundness regulators have the authority to interpret the charters of the entities that they regulate.

Now, as I see it, it is a matter of, as I put it, charter compliance. It is not a matter of, for us, new product approval authority. Charter compliance would go to every activity of the company.

Because OFHEO as a safety and soundness regulator has examiners in the companies every day, because we learn of new activities in order to incorporate them into our stress test, we could exercise that charter compliance authority without the necessity for any formal new product approval process. But I think it would be appropriate to consolidate and follow the model of the OCC and the OTS.

Mr. BAKER. I really regret my time has expired. After all these years, I have got to run. Thank you.

Mrs. KELLY. I guess it is my turn to ask a few questions.

So, two weeks ago, the Administration proposal called for the increased powers, and we have heard a lot of testimony from the Administration about the need for a powerful regulator over at Treasury.

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And at our hearing Secretary Martinez testified before the committee, and I am quoting him, ‘‘As the President's budget noted in February, numerous HUD studies and independent analyses have shown that the GSEs have historically lagged the primary market instead of leading it with respect to funding mortgage loans for low-income and minority home buyers.’’

This question, Mr. Falcon, is for you, because as a regulator for Fannie Mae and Freddie Mac, do you believe that they could increase their efforts to fund loans for low-income and minority home buyers if HUD was given greater authority to set the goals and the powers to enforce them?

Mr. FALCON. Let me say, Congresswoman, that I am fully supportive of the enterprise's affordable housing goals and their housing mission. I don't have the ability to comment as to whether those goals could be higher or not. I will leave that to HUD.

However, I do think, if you support goals, probably you would also support some teeth behind those goals. So I think the committee should consider whether or not some enforcement powers for HUD are appropriate to make sure that, if there was any need for some type of action to make sure the goals are met, that the authority is there.

Mrs. KELLY. So tell me how we would do that.

Mr. FALCON. If you use something comparable to a safety and soundness regulator's authority, you might require some type of corrective action plan where they would outline exactly how they would go about meeting the goals and addressing the shortcomings if the goals weren't met.

Mrs. KELLY. And where would that corrective action be, at Treasury or——

Mr. FALCON. With the housing goals being at HUD, I think it would be at HUD.

Mrs. KELLY. Do you think that this would harm the safety and soundness of Fannie Mae and Freddie Mac?

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Mr. FALCON. We do communicate with HUD frequently about the housing goals when they go through the process of promulgating new goals, and we do offer them input as to whether or not we think there would be any safety and soundness concerns raised by any increased affordable housing goals. So we do provide input to the Department on the safety and soundness implications of new goals.

Mrs. KELLY. I want to go back to the low-income and minority home buyers statement by Secretary Martinez. I think there is a certain amount of concern on the part of a number of members of this committee, including myself, that this mission that is a part of what we are trying to do with housing, with Freddie Mac and Fannie Mae, I think there is a certain amount of concern that there be that mission continued. And I want you to address that, if you would.

Mr. FALCON. Thank you. I absolutely share that view that we don't want to do any harm to their ability to fulfill their housing mission. I am confident that if the committee decided to give the new regulatory agency the authorities that it seeks that that wouldn't be inconsistent with their housing mission.

In fact, a stronger and healthier government-sponsored enterprise is more likely to be able to get deeper into affordable housing.

And so I think, rather than it being inconsistent or at odds with the housing mission, a strong and fully empowered safety and soundness regulator actually helps them further their housing goals.

Mrs. KELLY. I would like both of you to answer what your thoughts are on the relationship between balancing strong regulation and oversight and encouraging housing goals. Will you both answer that?

Mr. KORSMO. Representative Kelly, obviously the Congress has created a quite different model for the Federal Home Loan Bank System and how it meets its obligations to promoting affordable housing. The banks, of course, set aside 10 percent of their net—the greater of 10 percent of their net revenue or each bank's pro rata share of $100 million annually for funds that go into grants and subsidies for affordable housing projects.

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Since 1994, every year that dollar figure has exceeded the $100 million minimum. In fact, last year it was in the neighborhood of $199 million.

And I think over the course, since the set-aside program was established, the banks have provided something like $1.7 billion in grants and subsidies for affordable housing projects.

I think that is a reasonable method, frankly, and I can't really speak to the housing goals, I am not as familiar with how they have been constructed and how they operate. But I think the banks should—well, frankly, the banks represent the largest single source of affordable housing dollars in the country, and I think that all too often that fact isn't recognized and the banks should be applauded for the great contribution they make to affordable housing.

Mrs. KELLY. Mr. Falcon, what I am getting at is that there are two different entities that are responsible for the tasks, and I am trying to figure out how we should appropriately coordinate the job that has to be done here to ensure that people have the necessary safety and soundness regulations in place, but also the mission of HUD is not lost. And if you have, either one of you have any suggestion for how you think we should do that, I would like to hear that.

Mr. FALCON. I think what I have suggested in terms of consolidating what you call mission, I think more of as charter compliance. Someone needs to be responsible for assuring that the enterprises always operate within the boundaries of their charters.

Congress gave them a charter with specific responsibilities, with specific powers. It is the same for any other federally chartered institution. Every other safety and soundness regulator has the responsibility of ensuring that the entities they regulate operate within the boundaries of the power Congress has granted to them.

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And what I am suggesting is more of an issue of charter compliance, not prior approval, nothing else.

If a company wanted to invest in electronic commerce, that raises an entirely different issue, I think, than whether or not there is an impact on their housing mission. In fact, I think the responsibility of charter compliance is to make sure that there is no deviation from the housing mission of the companies.

Mrs. KELLY. I want to ask another question. You requested $7 million to investigate the management reorganization at Freddie Mac. Is this just a question of a lack of funds or are there other tools that the OFHEO really needs to fully investigate and oversee the GSEs, and what percentage of your current budget is actually set aside right now for your examination staff?

Mr. FALCON. On average the percentage of dollars that we spend on supervision, examination and supervision, is comparable to that of every other regulator.

We do spend money that is comparable to every other regulator when it comes to allocation of dollars to the examination program versus the other responsibilities of the agency.

I have heard another comment about a misallocation, that we are not spending the right amount of money on exams. I don't think that data is accurate. We have looked at this question. When we compare the allocation of our agency budget to supervision, the examination program, it is comparable to the other regulatory agencies.

So I would want to assure you that we do allocate our budget in the proper manner.

Mrs. KELLY. Thank you very much.

Mr. Davis?

Mr. DAVIS. Thank you, Madam Chairman. One of the few times when someone on this row gets to go this early in the proceedings.

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Let me try to focus my questions, if I can, on two particular areas. The first one relates to the nature of prior approval for new activities, which is one of the major parts of Mr. Baker's bill, as both of you know.

Let me ask you—and let me broadly associate myself with the comments of the Ranking Member and then Ms. Waters earlier to some extent, that in our desire for reform we don't want to necessarily over reform; we don't want to necessarily generate new problems in the effort to fix problems that we are already well aware of.

Can either of you comment, but particularly, you, Mr. Falcon, on whether or not there has been any historical or even any anecdotal evidence for that matter that either one of the GSEs has ever abused the current scope of activities? Is there any historical or anecdotal evidence that under the current structure that either Freddie Mac or Fannie have been engaged in doing anything that doesn't fit within their charter? How are we doing right now under the new activity section?

Mr. FALCON. I can give you one instance, involving one of the companies, several years ago. The companies when they purchase high LTV mortgages are required to use one of three forms of credit enhancements: one of them is mortgage insurance; another is participation insurance; and another I believe is repurchase arrangements.

One of the companies wanted to use a fourth that was inconsistent with what the law required, so we stopped the company from doing that.

But on this more general matter, to your question, OFHEO as a safety and soundness regulator is in the enterprises day in and day out through our examination program.

Through the examination program and through the need to incorporate new activities on a real-time basis into our stress test, we learn about new activities in a timely manner. And I think if charter compliance was given to the new agency, we could exercise that responsibility without the need for any formal prior approval, so that there wouldn't be any impact on their ability to innovate.

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So it is different from HUD, which doesn't have an examination team in the enterprises and doesn't have a risk-based capital standard. But it is something that the safety and soundness regulator could do without the need for a formal prior approval mechanism.

Mr. DAVIS. Let me raise a question that a number of people on this side of the aisle and perhaps on the other side have raised, that if we give HUD under this new regime that Mr. Baker contemplates, if we give HUD a greater authority to oversee or to examine new activities, what is the level of transparency behind the decision-making at HUD?

One of the criticisms is that HUD could potentially, depending on a change in regime or a change in the whim of the people running the Department, could make the decision that a particular kind of program, for whatever reason, was not one that HUD wanted to embrace.

But obviously, given the fact that there are no public hearings required around that kind of analysis, given the fact that HUD could potentially do what it wanted for whatever reason, why would we want to expand their authority to regulate new programs unless we at the same time create more transparency around the decision-making process.

Mr. FALCON. I think transparency would be important. I am not sure what level of transparency is required right now. But the decisions it makes and the basis for those decisions, I am not sure that there is a requirement that they be disclosed right now.

But I would encourage transparency. We try to operate as fully transparent as possible.

Mr. DAVIS. Would you contemplate that there would be any circumstance when HUD could reject a new activity, provided the activity fit within the charter? The previous example you gave me was something that strikes me doesn't fit within the charter.

Let us say that HUD were to make an analysis that an activity fits within the GSE charter. Just as a public policymaker can you think of any circumstance when they should be able to nix an activity at that point or should the charter essentially be the standard?

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Mr. FALCON. Well, I think the current standard that HUD applies under the statute is not just compliance with the charter, but there is also a public interest carve out as well. If HUD found that it wasn't in the public interest, even if it was permitted by the charter, I think the statute allows them to disallow the activity.

Mr. DAVIS. So your position would be that if Mr. Baker's bill were to be successful and we were to give HUD greater authority to regulate new activities, number one there should be a high-level of transparency, that would certainly be ideal. And number two, that you think that the public interest standard should also be incorporated into whatever rationale would guide the decision-making process.

Mr. FALCON. It is another basis by which the regulator could disallow a new activity. I am not sure whether or not it is advisable to keep it or do away with it, but I am simply stating as a matter of fact it is there. It is a question that you would need to decide as to whether it is appropriate to keep it or not.

Mr. DAVIS. Okay. I think that my time has expired, Madam Chairman.

Mrs. KELLY. Thank you, Mr. Davis.

Mr. Leach?

Mr. LEACH. I want to talk about independence for a second from a little different perspective. I am one that strongly favors moving regulation to the Treasury. I also believe that it should include the Federal Home Loan Banks and that it should be independent from the politics of the Executive Branch, but it also should be independent from the politics of the United States Congress.

And let me explain what is current law and what is following current law and what I believe should be changed. But I do not give high hopes that that will occur.

In current law the regulation of Fannie Mae and Freddie Mac are the only institutions in the history of the United States of America where Congress says there will be a maximum capital ratio. This is a statute written by the regulated and pressed through the Congress.

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Now, you indicated in earlier questions, Mr. Falcon, that you didn't have any current intent to raise capital standards. But do you believe that there should be a maximum capital ratio or do you think that that should be an independent judgment of the regulator, independent of the executive—that is, of Treasury—and of the Congress?

Mr. FALCON. I absolutely believe that that question should be left to the best judgment of the regulators to exercise, based on their knowledge of the companies. Yes.

Mr. LEACH. And that we should not have a maximum capital ratio statutorily imposed?

Mr. FALCON. That is right.

Mr. LEACH. Well, I think this is a fundamental issue and something that this committee is going to have to think through. We want independence from the Treasury; I think we should also want independence from legislative directives.

And I think it should be understood that I mean in a bizarre circumstance, but not a trivial one, the International Monetary Fund has called for an increase in capital ratios for Freddie and Fannie, based on scenarios that are conceivable, having conceivable difficulties in the world economy. And I hope that Congress does not hamstring any new independent regulator.

Now, Mr. Falcon, and also the distinguished head of the Cincinnati bank, do you think the Federal Home Loan Bank System ought to be within Treasury? What do you think, Armando?

Mr. FALCON. I think if Congress decided that it was appropriate, we could make it work. However, if you would allow me, I would defer to Chairman Korsmo to find out what he thinks, maybe in the best interest of his regulated entities.

Mr. LEACH. Well, I appreciate that, but I want to make it clear, Mr. Chairman, the issue isn't the best interest of the regulated entities, the issue is the public interest.

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Mr. FALCON. Yes, I agree. I misspoke there.

Mr. LEACH. What is your judgment on this, sir?

Mr. Korsmo?

Mr. KORSMO. Oh, excuse me. Pardon me, sir.

I think, frankly, that the job we are doing at the Housing Finance Board meets the goals of providing effective and efficient and independent regulation.

I think the progress we have made, particularly in the last two years, coupled with the very different charters under which the Federal Home Loan Banks and Fannie and Freddie operate, the very different ownership structure, the very different capital structure, the very different business models, it makes sense to preserve some degree of separation to ensure that the level of expertise that exists for the oversight of the Federal Home Loan Banks is distinct from that of Fannie and Freddie.

I would leave it to the Congress to make the judgment as to how that would be organized, but my belief is that we are demonstrating that the Federal Housing Finance Board is an appropriate regulator for the Federal Home Loan Banks.

Mr. LEACH. Well, let me just tell you the irony that is appearing. I am told Fannie and Freddie desperately do not want the Federal Home Loan Bank System under the same regulator, because the Federal Home Loan Bank System has a 4 percent capital requirement; they have a maximum 2.

I am also told that the Federal Home Loan Bank System, despite having a higher regulatory capital leverage ratio, the capital isn't particularly permanent and the regulation is not particularly firm.

We have an episode today in Pittsburgh where we have a bank that has been allowed to give dividends, dipping into capital not based upon income, which no bank regulator would likely have allowed for a commercial bank. And this does not strike one as a particularly prudential circumstance. Can you tell us a little bit about the Pittsburgh problem?

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Mr. KORSMO. First of all, let me correct. The Pittsburgh bank has not dipped into capital; it has dipped into retained earnings.

Obviously, like any safety and soundness bank regulator, I have to be very careful about the information that I make public that comes from examination and supervisory activity.

That having been said, I think we appreciate the very real concern that you express about the level of retained earnings at the Federal Home Loan Banks. In fact, our Office of Supervision recently issued an advisory to the banks to review their retained earnings policies with a view toward increasing retained earnings in the bank system. And I can assure you that part of our ongoing examination and supervision function is to review not only the retained earnings policy, but also the dividend policies of the various boards of the 12 banks.

Mr. LEACH. Well, I appreciate it. But all I can tell you is there has been an exponential growth in assets of these banks. This exponential growth has some analogies to the savings and loan issue of the 1970s.

Now, on the boards there are some smart people, but I am very concerned with the supervision of these banks.

And I would stress you have joint and several liability. And one bank gets in difficulty, all of you are accountable, and that implies, one has to be concerned for the capital of all the banks. And I just hope as a regulator currently you are on top of the capital issue.

And I also believe the case for putting both of you under Treasury is just profound, absolutely profound today. And the case for giving independence to an independent regulator is extraordinary. And I just have a sense that we have too much captive in a regulator, and I say that with great concern.

And I am very concerned you are going to see things happen that are going to stretch your treasuries and stretch the treasuries of potentially the public. And so I think this is a great opportunity for the committee to make a very responsible step, and I hope we do in a comprehensive way.

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Thank you.

The CHAIRMAN. The gentleman's time has expired.

The gentlelady from California, Ms. Waters?

Ms. WATERS. Thank you very much.

Mr. Chairman and members, I have been sitting here pondering the different requirements for the Federal Home Loan Bank and Fannie and Freddie. And I guess I am going to raise the question, why shouldn't the Federal Home Loan Banks be under the same requirements and restrictions as Fannie and Freddie?

Mr. KORSMO. In what regard, Representative Waters? You mean——

Ms. WATERS. Well, maybe we should start—we should back up, and let me ask, because I guess I don't really understand, what is the fundamental mission of the bank system? Is it cooperative lender or secondary market participant?

Mr. KORSMO. It is to provide liquidity to its member institutions, presumably for the purpose of making housing finance.

Ms. WATERS. And do you have housing goals?

Mr. KORSMO. There is a very different—Congress has constructed a very different methodology by which the Federal Home Loan Banks, as opposed to Fannie Mae and Freddie Mac, meet their responsibility to provide—to supplement affordable housing. In the case of the Federal Home Loan Banks, the greater of 10 percent of their net revenues, or each bank's pro rata share of $100 million a year, is set aside to be used for grants and subsidies to affordable housing projects.

What that has meant is every year since 1994, the banks have exceeded that $100 million target. In fact, last year it was something like $199 million was their 10 percent share. I think the year before it was approximately $246 million.

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Since 1990, when the Congress established this process, the banks have made available and distributed approximately $1.7 billion in grants and subsidies to affordable housing and low-income housing projects.

I am familiar, of course, with the program that the Federal Home Loan Banks have and that we oversee at the Federal Housing Finance Board. I am less familiar, of course, with the housing goal scenario that is appropriate to Fannie and Freddie. But it is certainly an issue that I think Congress should look at, whether or not a separate model is still appropriate. But again——

Ms. WATERS. What do you think?

Mr. KORSMO.——in my role as regulator, it is difficult for me to make an assessment because I am not that familiar with how the housing goals operate.

Ms. WATERS. So you would not have compared the $100 million so-called set-aside with the Fannie and Freddie goals?

Mr. KORSMO. Again, Representative, it is a very different model that Congress has established for the banks as opposed to Fannie and Freddie. I have not compared them. I think it is probably appropriate that somebody take a good look at it.

Ms. WATERS. All right. Thank you very much.

I yield back the balance of my time.

The CHAIRMAN. The gentlelady yields back.

The gentleman from California, Mr. Royce?

Mr. ROYCE. Thank you, Mr. Chairman.

Mr. Korsmo, you told Mr. Leach that retained earnings weren't part of capital. Well, it is capital.

Mr. KORSMO. No, no, no. I am sorry. I thought he was making reference to dipping into the capital. Obviously——

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Mr. ROYCE. Right.

Mr. KORSMO.——retained earnings is part of the minimum capital requirement.

Mr. ROYCE. Well, I just want to associate myself with the points that he made.

In your testimony, you told us that the Finance Board basically has improved over the last couple of years. But this morning in The Wall Street Journal and in the Financial Times, as you know, and in The New York Times, we have stories about some of the issues with the Federal Home Loan Bank of New York. And this follows other news about disappointing results that Congressman Leach pointed out about the Pittsburgh bank.

Now, I believe that the New York Bank has taken positive steps to manage through its troubles, but I am concerned that the Finance Board did not perform well here. I am concerned that the Finance Board again failed to protect against systemic risk.

Home Loan Banks do not usually either suspend their dividend or dip into retained earnings to pay their dividend. And, Mr. Korsmo, you have seen this happen twice in this quarter.

I guess my question is, should Congress be concerned about this? And should Congress be concerned that our Treasury Secretary Snow and our Federal Chairman Greenspan and our GAO have called for combining regulation of all three GSEs at this time?

Mr. KORSMO. Congressman, let me preface my response again with the statement I made to, I believe it was Representative Leach, that I have to be very careful as a financial regulator, and I know you would expect nothing different from the head of any bank regulatory agency, to discuss in a public forum examination and supervisory actions that we may have taken with respect to any individual member.

I can say in the case of the New York bank that the deterioration of the credit quality of certain of their asset-backed securities is a concern. I will tell you that we have monitored the situation very carefully.

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Our examiner in charge is in constant contact with the New York Bank. As a regulator, it is our role to ensure that the steps taken by the bank are consistent with Finance Board regulations and prudent operations, including appropriate accounting for any actions taken by the bank.

Beyond that, it is perhaps not appropriate for me to comment.

I can say that I did talk to our examiner in charge only this morning about the articles you cited in The Wall Street Journal. I should probably mention that he pointed out to me two very significant factual errors in the article, and let me quote The Wall Street Journal article.

It said, quote, the bank said it would suspend its dividend payments to the customer banks for the third quarter to conserve cash, unquote.

That is absolutely wrong. The bank has plenty of cash and plenty of access to cash. What it did was suspend the dividend to protect retained earnings, and I think that was a prudent action.

As I mentioned, the Finance Board's Office of Supervision recently issued an advisory to the banks about our concerns about the level of retained earnings, not just at the New York bank, which frankly has fairly substantial retained earnings, but at all the banks. And we are looking at whether or not we need to take further regulatory action to deal with the current level of retained earnings.

Mr. ROYCE. Let me ask you another question. Isn't it fair to say that the existing bank regulatory agencies under Treasury, the OTS and the OCC, benefit from their affiliation, benefit from their association with Treasury? Don't they attract numerous well-qualified people to work for them? Wouldn't you say that?

In 1989, Congress replaced the Bank Board, the regulator of thrifts at the time, with the OTS under Treasury. That was done to enhance regulatory capability and to, frankly, enhance the reputation of the regulator.

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Why, when we have this unusual chance to do the same for the regulation of these banks, should we not do this?

Mr. KORSMO. Well I think the two points I have made on that issue are significant. One, I think we have made significant progress. This is not your father's Finance Board, to coin a phrase. And, frankly, I am concerned that some of the significant enhancements that are now under way might be lost or deferred in a transition process.

We have made significant institutional changes at the Federal Housing Finance Board. We have created a new management infrastructure that I think the banks have come to recognize the primacy of safety and soundness that this Finance Board has placed.

The team we have built, the enhancements we have made, I think are significant.

I won't tell you that we are where we want to be yet. Frankly, we will never be done. But the movement is in the right direction and what exists today is a decided improvement over what existed two years ago. I would hate to see that progress lost.

Mr. ROYCE. Let me ask you this question: The GAO has three times done an objective analysis where they have come to the same conclusion as Treasury, the same conclusion as our Federal Reserve Chairman. So assuming that the inclusion of the banks could be accomplished to recognize their structure and operations, to recognize their difference in mission, such as creating a separate division within the new agency for supervision of the banks, would you oppose such a creation?

Mr. KORSMO. As a regulator, I suppose it would probably be inappropriate for me to make a judgment one way or another. I will leave the decisions in that regard, setting policy, to the policymakers.

Again, my concern is that there be appropriate recognition of the very different charters that exist, the very different ownership structures that exist between the Federal Home Loan Banks and Fannie and Freddie.

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And I would ask also that acknowledgement be made of the very real progress that the Finance Board has made. The last GAO study that you cited was made I think six months into my tenure. We were in the process of making improvements that now I think virtually every impartial observer recognizes. And I would just caution that the Congress move very carefully in dealing with the oversight of these——

Mr. ROYCE. I understand that, but to go back to the point that Congressman Leach made, you do have the question of what happened on your watch at Pittsburgh and what happened with the New York Bank. And they are certainly credited with taking the right corrective steps now, but the question is, in terms of the regulators, I mean, I think our concern is should we expect any more negative news stories soon?

And I think that what brings us here today is whether we are willing to take a look at the arguments advanced by the Federal Reserve Board Chairman, by our own GAO, by Chairman Greenspan and Secretary Snow of the Treasury, to look if we can't come up with a better model in which we can better anticipate and regulate for the GSEs.

The CHAIRMAN. The gentleman's time has expired.

Mr. ROYCE. I thank you, Mr. Chairman.

The CHAIRMAN. The gentleman from Texas, Mr. Gonzalez.

Mr. GONZALEZ. Thank you very much, Mr. Chairman.

The question will go to Director Falcon. I guess kind of as a threshold question, but for whatever reason, we believe this action is necessary, and we are moving forward regardless.

But up to this point, based on the recent situation arising out of the practices by Freddie Mac, is there any evidence that you are aware of that those actions and practices in any way jeopardized the safety and soundness of Freddie Mac?

Mr. FALCON. No, Congressman, this has not been a safety and soundness issue for the company. We have concerns, it is a serious matter, about accounting practices and management practices as well, but the results here were that earnings were not in fact manufactured, but there was an attempt to move earnings over a period.

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So it wasn't a matter that caused us concern about the financial liability or the safety and soundness of the company.

Mr. GONZALEZ. And there is no evidence out there right now that Fannie Mae has engaged in any similar type practice or action, is that right?

Mr. FALCON. That's right.

Mr. GONZALEZ. So regardless of the situation with the two big GSEs on safety and soundness, which usually is a predicate for anything that we do around here, we still will move forward with some new regulatory scheme.

And I think there are members on this side of the aisle that question that, for good reason, because we are not real sure. We are like a team of doctors and we decide that the patient, regardless of symptoms, is going to require a heart transplant. And we are going to do it, because we know if it is successful we will come out with a stronger patient.

The problem with a heart transplant is that the patient can die. And that is our concern, is that the patient, in this case the two big GSEs that accomplish such great goals in our communities, anyway, would be in danger.

I know you have had a chance to review Secretary Snow's testimony. It was not clear to me that what he was describing really adheres to your recommendations. On independence, for instance, I did not hear that. It was so incredibly general and nebulous that I am left with no real idea that Treasury had some thought what it would look like, what shape it would take.

Surely on clearance of testimony, there is disagreement. And I will tell you right now that members of this committee know that the least responsive witnesses are always from the departments. I think they must have classes or something when they come in there on how not to answer questions. Really, they just need to view all the testimony by Chairman Greenspan, and that would be sufficient to get a Ph.D. But nevertheless, that is what happens.

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I don't see where we really benefit by that.

When it comes to appropriations, again, that wasn't part of his recommendation.

Do you understand what the Treasury contemplates? I know what some members may have out there for consideration, but at this point do you have any firm understanding?

OFHEO is not going to be subsumed like in OTS or whatever, because I didn't hear that coming from Secretary Snow. As a matter of fact, I heard pretty much the opposite. That was my interpretation of his testimony.

So based on his testimony and your understanding of it, because I know you have been following it, do you have any idea of the structure contemplated by Treasury?

Mr. FALCON. We have the general construct, but much of this will decided in the details. I am not familiar with the details about how this gets fleshed out and how the construct was elaborated on in the testimony actually would take place.

I think how that is done will depend to a large extent whether or not. The principles that I have tried to lay out are met and whether or not we are actually moving safety and soundness forward or actually taking a step backward.

So, yes, we absolutely need to look at the details about how this is actually done.

Mr. GONZALEZ. Well, we share your concerns and appreciate your recommendations and suggestions. And I am hoping that legislatively we can build something out there that will assure that, that we give people latitude but not the ability to refashion the GSEs, to de facto change the charter and definitely its mission.

Again, thank you very much for your all's testimony.

The CHAIRMAN. The gentleman yields back.

The gentleman from Florida, Mr. Feeney?

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Mr. FEENEY. Thank you, Mr. Chairman.

Mr. Falcon, I was taking a look at some of your comments and comparing them to Secretary Snow's recommendations, and on at least one issue it seems like you have stepped well out in front of anything that the Administration has recommended—that would be with respect to setting minimum standards.

As I understand Secretary Snow's testimony, the Administration while, it suggests for some flexibility in the future toward capital requirements, it is suggesting there should be no statutory change at this point. But on page 5 of your testimony, you say that the agency needs to have the authority to modify both minimum and risk-based standards. That seems to contradict what Secretary Snow suggests we ought to be doing.

And additionally, I have some concerns that if we have an agency out there that is able to unilaterally raise minimum risk standards, what we are ultimately going to be doing is to raise the cost of credit, especially in the affordable housing area.

And I would like you to, number one, tell us why it took your agencies the better part of a decade to put together some of the standards for both the risk-based and the minimum capital standards, but also explain the differences as you see them between your position and the Administration's?

Mr. FALCON. You are right, Congressman, I do disagree with the Secretary on that point, if his point was that there should be no modification made to minimum capital. And the authority that I am seeking is no different from that of the other safety and soundness regulators.

So if there is a concern about constraints on credit, I think that concern would be placed with all of the regulatory agencies.

But, in fact, I think we all exercise a very reasonable judgment when we use that authority. Setting capital is a very important part of how a safety and soundness regulator accomplishes its mission, and it has to balance the capital requirements against the ability of the companies to operate.

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I think we try to balance those considerations very reasonably, and we wouldn't on some unsound basis just decide to increase the capital requirements. We don't have any current plan to increase the capital requirements right now, but it is important for us to have the authority to do so if we thought it was appropriate.

The last thing I want to do is come before this committee and explain why the capital was insufficient. So if the regulator ever needed to increase capital, I think we should have that authority.

On the risk-based capital standard, it did take more time than it should have. When I got to the agency, we all rolled up our sleeves and we just got it done. Now it is done and it has been functioning for about a year now. It is a state-of-the-art, vital stress test that makes sure that the companies can withstand severe economic shocks.

I am proud of the work the agency has done, and while it took longer than it should have, we did get it done.

Mr. FEENEY. Well, going back to the minimum capital for a second, the inference I draw from what you just said is that current minimum capital requirements, in your opinion, are not insufficient. In other words, that they are sufficient, to take out the double negative.

And yet you are asking Congress to give you the unilateral authority to raise those standards, which personally I believe would have the impact of at least marginally, and maybe substantially driving up the cost of capital, which would seriously affect especially the affordable housing market.

What would be wrong with, when the time comes that you believe that minimum capital standards are insufficient, coming to Congress and saying that, A, they are insufficient, and, B, you would like the power, if Congress doesn't raise the standards, you would like at that point to have the power to do so? Why should we give it to you now when there is no problem?

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Mr. FALCON. So that I can be sure that a problem never develops. I think by the time I came to Congress and asked for the authority to raise capital, that is too late.

It is my job to ensure that we are able to prevent problems before they develop and to ensure that the enterprises remain safe and sound. And I am asking for the authority that every other regulator has.

We exercise it in our best judgment, and while we have no plans currently to raise capital, if we consider that the condition of the companies, based on our knowledge of their activities through our examination process, ever required us proposing an increase in capital, we wouldn't just do it willy-nilly. We would do it through a notice and comment period and through full administrative procedures and follow a process whereby we take full comment, including comments from this committee, absolutely, as well as general public comments. So we would do it with all due process and exercising our best judgment.

Mr. FEENEY. I yield back, Mr. Chairman.

The CHAIRMAN. The gentleman yields back.

The gentleman, Mr. Scott, from Georgia?

Mr. SCOTT. Yes, thank you very much, Mr. Chairman.

I want to ask a two-part question. I want to preface it with a couple of what I think are facts here.

I think that given the tremendous growth of the size of Fannie Mae and Freddie Mac over the past decade, and their importance to the housing market, we all agree that they must have strong, independent regulation.

A couple of weeks ago, this committee heard testimony from the Secretaries of Treasury and HUD about the Administration's plans to improve the oversight of Fannie Mae and Freddie Mac, safety and soundness, as well as their housing mission. And I believe that we have got to keep oversight focused foremost on what is in the best interests of the consumer and the market.

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And given that, Freddie Mac and Fannie Mae have brought stability to the housing market. When they focus on their congressional-mandated mission, they provide a very vital tool for bringing home ownership to more Americans.

Right now, we are at a very critical point and juncture. Is it best to keep oversight in HUD or do we move it to Treasury?

I want to ask two questions, or a two-part question to each of you. First of all, have you talked with the folks at Fannie Mae? Have you gleaned the benefit of getting their inputs, since they have the congressional mandate, in terms of what would best help them to pursue their mission on this issue?

Especially in light of the second part of my question, which is that affordable housing goals for both Freddie Mac and Fannie Mae require that 50 percent of units should be built for low-and moderate-income home buyers, and 20 percent for very low-income families.

Yet, from 1998 to 2002, African-American home ownership rates only rose from 45.6 percent to 47.3 percent, less than 2 percent compared with the white average increase from 72 percent to 74.5 percent, huge gap remains.

Clearly, the mission of Freddie Mac, and especially Fannie Mae, is to close that gap.

Do you believe that the current housing goals are adequate enough to help bring African-American home ownership rates to 50 percent, just 50 percent, in the near future?

And the bottom line to this is this: Would moving the affordable housing mission to the Treasury Department weaken the focus from increasing home ownership and assisting Freddie Mac and Fannie Mae in achieving their mission?

Mr. FALCON. I think under the proposal that is before the committee, it doesn't propose moving the affordable housing goals to the new safety and soundness regulator. Those would remain with HUD.

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As far as, are the goals adequate, I share your concern, Congressman, about closing that gap. I am from San Antonio, Texas, and I see that whenever I go back home.

So I think definitely companies should do all they can to try to ensure that that gap, using innovative means, is closed. We work to make sure that the means they use are safe and sound. And we have found that they do meet the safety and soundness requirement when they use aggressive means of trying to meet higher affordable housing goals.

As far as whether or not and how much they can go up, I am afraid I don't quite have the expertise to answer that question. It is better put with the office at HUD.

Mr. SCOTT. The other part of my question: Have you had conversations with the folks at Fannie Mae, and specifically Mr. Raines?

Mr. FALCON. Yes. We discuss frequently any pending regulatory matters. We haven't spoken about the housing goals, but we do speak about regulatory matters frequently as needed. They are not shy about communicating their views to the agency.

The CHAIRMAN. The gentleman's time expired.

Mr. SCOTT. One point. May I have a little follow-up.

I just wanted to know, if I could, what was the disposition in that conversation with Mr. Raines concerning the movement to the Treasury Department?

Mr. FALCON. In our conversation we did not discuss each other's views on that point.

The CHAIRMAN. The gentleman's time has expired.

Gentleman, Mr. Raines will be on the next panel, I would say to my friend from Georgia.

The gentleman from Alabama?

Mr. BACHUS. I thank the chairman.

And I want to follow up, Director Falcon, with what Mr. Scott asked you about, and that is moving authority from HUD to the newly approved safety and soundness regulator, Treasury's proposal, as it relates to new product approval.

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Now, what is your current roll, OFHEO's current role, as it deals with new product approval?

Mr. FALCON. Our role with the bifurcated system is that we are the enforcement arm of the government in respect to Fannie Mae and Freddie Mac. Even in the mission area, if HUD thought there was a need to promulgate or take some enforcement action because of a mission issue, they would come to OFHEO to promulgate the cease and desist order.

Mr. BACHUS. But what I am talking about, if they want to offer new products, if Fannie or Freddie wants to offer a new product and HUD approves that, do you have any role in that? Do they consult with you? Do you consult with them?

Mr. FALCON. Oh, yes, they do consult with us on the safety and soundness implications. The risk management of the new management, we do consult with them on that.

Our other role is, because we are the enforcement arm, if there is a clear violation of the charter, we will step in and make sure that there is no violation.

Mr. BACHUS. But I am just saying, you know, on a run of the mill, they ask to do a new product. Do you get that proposal, too?

Mr. FALCON. No, HUD will receive the proposal. We will receive information about the activity or product because we have to——

Mr. BACHUS. Okay, let us say a new product—do you consult when you see that new product proposed? Do you consult with HUD on it?

Mr. FALCON. Yes.

Mr. BACHUS. Have you ever told HUD—have you ever had objections to any new products?

Mr. FALCON. Have we? No.

Mr. BACHUS. No? So you have never objected to any new product——

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Mr. FALCON. We don't see every——

Mr. BACHUS. What?

Mr. FALCON. I think we have seen every one, but I am not certain.

Mr. BACHUS. You may not have even seen some of them?

Mr. FALCON. Right. Well, I think we have seen every one.

Mr. BACHUS. Okay. But you never objected to any of them.

Mr. FALCON. No. We have raised concerns about——

Mr. BACHUS. Okay, you have raised concerns about certain new products.

Mr. FALCON. Yes.

Mr. BACHUS. As a result of you raising those concerns, was it given appropriate weight by HUD?

Mr. FALCON. I believe so.

Mr. BACHUS. Do you know?

Mr. FALCON. An example is one of the companies' investments, or an extension of the credit really, LendingTree. We consulted extensively with HUD on that activity and the implications of it.

Mr. BACHUS. Chairman Korsmo, in Treasury Secretary Snow's testimony two weeks ago before this panel, he expressed the view that leaving the Federal Home Loan Bank out of the new regulatory regime that would apply to Fannie and Freddie would place the banks, and I quote, ‘‘at a terrible competitive disadvantage.’’

Are you aware of his remarks? And do you disagree with the Secretary's views?

Mr. KORSMO. As I mentioned in my opening statement, I think there are so many factors at work that go into contributing to the pricing for various products that government-sponsored enterprises bring to the debt market that it is difficult to single out any particular aspect.

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Just as at the Finance Board, we don't go to the Secretary for his approval on our testimony, he didn't come to me for approval on his.

But I would suggest that——

Mr. BACHUS. Well, do you believe there is any basis for him to make that statement?

Mr. KORSMO. I think it is limited at best. I think there are very few players in the agency market who make their decision as to pricing relationships on agency debt based on who the supervisor—who the supervising institution is.

That having been said——

Mr. BACHUS. You mean pricing isn't based on who the supervisor is or the level of supervision?

Mr. KORSMO. I was just going to say, I think that having been said, I think it is certainly important, and the market probably recognizes the importance of having a strong, independent regulator overseeing the function and operations——

Mr. BACHUS. So the more——

Mr. KORSMO.——but I don't think that's the key element.

Mr. BACHUS. So the more resources that the regulatory agency has, the better supervision.

Mr. KORSMO. I think that's a fair statement.

Mr. BACHUS. I think you are asking for additional resources, and presently, I think you state in your testimony that you have—your present complement is 17 full-time examiners?

The CHAIRMAN. The gentleman's time has expired.

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Mr. BACHUS. Is that right?

Mr. KORSMO. Yes, sir.

The CHAIRMAN. The gentleman's time has expired.

The gentleman from Massachusetts.

Mr. FRANK. Mr. Chairman, we have got a vote. I will pass on my questions and go to my other members there and maybe we can finish up.

The CHAIRMAN. The chair would indicate—I talked to a couple of the members on this side of the aisle—we would like to dismiss this panel and then come back with the next panel.

What I would suggest is that the members recognize the gentlelady from New York. If the other members—if we run out of time, we recognize those members first when the second panel appears, if that is okay.

The gentlelady from New York.

Mrs. MALONEY. I will be very brief so my other colleagues can ask questions.

But going back to Mr. Bachus's question on competitiveness, I would like you to address one issue, the question of cost of funds, and are you concerned that if Congress creates a new regulator for Fannie and Freddie that is independent and viewed in the same league as the OCC and OCS, that it would undermine the competitiveness in regards to the cost of funds of the Federal Home Loan Bank?

And would you address, you said that you feel that everything is being regulated well, Mr. Korsmo, but the possibility that market perceptions may give an advantage to the other GSEs if they have a new sort of world-class regulator.

And very briefly, Mr. Falcon, I want to follow up on some of the questions of Mr. Baker on capital. In your testimony, you endorse allowing a new regulator to have discretion over the level of minimum and risk-based capital that the GSEs may hold.

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And do you believe this because you think that it is an important tool for the regulator or because you believe the GSEs are undercapitalized and therefore are a risk in the near future?

Mr. FALCON. I will give a quick answer. I believe it is just an important tool.

Mrs. MALONEY. Okay. And, Mr. Korsmo——

Mr. KORSMO. Quick answer as well. I certainly appreciate the concern that some have expressed about the implications for Fannie and Freddie having different regulators in the Federal Home Loan Banks and the agency market.

I think any contention that it will have a significant impact, particularly given the fact that both entities will be regulated by world class regulators, I think is highly speculative.

Mrs. MALONEY. Thank you.

And I want to work with Mr. Royce on this and place in the record a synopsis of various GAO reports.

And I yield to my colleagues, Mr. Meeks and Mr. Sherman.

Mr. SHERMAN. I will take the chairman up on his offer to be among the first on the next panel.

The CHAIRMAN. I thank the gentleman.

The gentleman from New York?

Mr. MEEKS. And since I have to go to another hearing, I will try to be just real quick. As well as the fact that I am just pissed off at OFHEO because if it wasn't for you I don't think that we would be here in the first place.

And Freddie Mac, who on its own, you know, came out front and indicated it is wrong, and now the problem that we have and that we are faced with is maybe some individuals who wanted to do away with GSEs in the first place, you have given them an excuse to try to have this forum so that we can talk about it and maybe change the direction and the mission of what the GSEs had, which they have done a tremendous job.

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There has been nothing that was indicated is wrong, you know, with Fannie Mae. Freddie Mac has come up on its own.

The question that then presents is the competence that your agency has with reference to deciding and regulating these GSEs.

And so I wish I could sit here and say that I am not upset with you, but I am very upset because what you do is give, you know, maybe giving a reason to, as Mr. Gonzalez said, to give someone heart surgery when they really don't need it, they need something else.

So the question, I guess, if there is a question that I have—and we don't have the time, because I want to know, really, what completely went wrong. You may have testified, but what really what was wrong and what would be needed by you. You know, you said, I think I heard you, you were talking about that if he had the same kind of powers or supervisory control as some of the big guys that maybe you can change it. But you didn't come voluntarily and say that at any point prior to the Freddie Mac incident.

So why and what can you say now so that we don't destroy the mission of these GSEs that are creating home ownership? Why should I have confidence, why should anyone have confidence in you as a regulator at this point?

Mr. FALCON. Congressman, OFHEO did not improperly apply accounting rules; Freddie Mac did. OFHEO did not try to manage earnings improperly; Freddie Mac did. So this isn't about the agency's engagement in improper conduct, it is about Freddie Mac. Let me just correct the record on that.

We don't review the accounting practices of the two companies. That is the role of the independent outside auditor. But we are going to begin to look at that going forward.

Mr. MEEKS. And you are saying—and I will stop you, because I know we have got to go vote—and you believe that just that one, by looking at the accountants—I mean, because we just had this huge corporate fraud dealing with accounting scandals, et cetera.

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You are saying that then we'll give you the ability to catch any problems that may be in accounting—or otherwise. I mean, we have got to look for—and any other kind regulatory or record-keeping at any GSEs so that the American people can have confidence that there is stability and soundness—and safety and soundness in the principles, in the practices of the GSEs.

You are saying that is the sole piece that you need?

Mr. FALCON. I have been asking for these additional authorities for four years now. I have been asking for additional resources, involving independent appropriations assessment powers.

This is not a matter of the agency engaging in any misconduct.

And, yes, I think it would be better if the agency had additional resources, so that we could hire the types of people that we need, given the different activities we are going to be doing now. It is not the role of the safety and soundness regulator to look at the application of GAAP with the GSEs books. That is the role of the auditor.

And as we have more resources, we are going to hire the type of people so that we begin to do that. Hopefully, we will try to catch these types of activities. These activities, by their nature, are concealed.

It is not easy for anyone to try to catch them. But with the resources, we are going to try.

The CHAIRMAN. The gentleman's time has expired.

The Chair thanks both of the gentlemen for your testimony, and the committee now stands in recess until 1 p.m.

[Recess.]

The CHAIRMAN. The committee will reconvene. And the Chair would like to introduce our second distinguished panel: Mr. George D. Gould, the Director of Freddie Mac; Mr. Franklin D. Raines, Chairman and Chief Executive Officer of Fannie Mae; Mr. Dean Schultz, President and CEO of Federal Home Loan Bank of San Francisco; and Mr. David H. Hehman, President and CEO of Federal Home Loan Bank of Cincinnati.

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Gentlemen, thank you, particularly for your patience on the length of the first panel. The only good news is you are not the third panel.

[Laughter.]

And so you take them where you can find them.

And so again welcome.

And Mr. Gould, we will begin with you.STATEMENT OF GEORGE D. GOULD, DIRECTOR, FREDDIE MAC

Mr. GOULD. All right, sir.

Well, thank you, Chairman Oxley, Ranking Member Frank, and members of the committee.

Good afternoon. My name is George Gould. I have served on the Freddie Mac board since 1990 and am currently the Presiding Director and Chairman of the Governance and Finance Committee. From 1985 through 1988, I served as Under Secretary for Finance at the Department of the Treasury.

I welcome the opportunity to discuss GSE regulatory oversight. Freddie Mac plays a central role in financing home ownership and rental housing for the nation's families, and given the importance of housing to the economy it is critical that our regulatory structure provide world class supervision.

But before expressing our views about regulatory restructuring, I would like to say a few words about the resolution of Freddie Mac's accounting issues and our continued safety and soundness.

In January 2003 we announced the need to restate earnings for 2000, 2001 and 2002. In stark contrast to other recent corporate restatements, we expect Freddie Mac's restatements to show a large cumulative increase in earnings for the prior years.

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Timing is an issue, however, and I am disappointed to report to the committee today that our restatement will not be completed during the third quarter, as we had previously stated.

We were nearing completion of the restatement and were in the process of verifying results when we discovered a systems error. We have isolated the underlying problem and will fix it as expeditiously as possible.

As the company stated in our June 25 press release, getting our financials right is job number one.

We are targeting to have this setback addressed during October; we plan to restate earnings in November. Whether it takes two more days or two more months, Freddie Mac is focused on getting our restatement right and regaining the trust of the Congress and the public in our financial statements.

As frustrating as these accounting issues are, let me say a few encouraging words about safety and soundness.

Freddie Mac's franchise is rock solid. Our exposure to both credit risk and interest rate risk remains extremely low.

Just today we announced that our key measure of interest rate risk, duration gap, was zero for the month of August in spite of it being a turbulent period in the bond markets. This is an outstanding example of Freddie Mac's highly disciplined approach to risk management.

Now I would like to comment briefly on the various regulatory proposals.

Over the past few years, Chairman Baker, Congressman Kanjorski and the entire committee have worked diligently to study ways to enhance our regulatory structure. I want to thank you for your hard work and I hope you will find that we have much in common.

To begin with, we support giving our regulator the authority to ensure we continue to carry out the public commitments we made in conjunction with this committee in October of 2000.

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In addition, we support codifying the commitment we made last summer to register our common stock with the SEC under the Securities Exchange Act of 1934.

Freddie Mac also would support the creation of a new regulatory office within Treasury. To ensure regulatory independence, we support applying the same operational controls as apply to the relationship between Treasury and the OCC and the OTS.

We also support providing both the regulator and HUD authority to assess the GSEs outside of the annual appropriation process.

Capital adequacy is key to our ability to attract low-cost funds to finance home ownership in America. Our capital standards were developed in keeping with our charter, which restricts us to lower risk assets than banks.

Given our lower risk exposure, we agree with Secretary Snow that the GSE minimum capital requirement is adequate and need not be changed.

With regard to risk-based capital, we agree that the regulator should have adequate discretion, such as provided to federal banking agencies, but discretion should be balanced with continuity.

The risk-based capital standard, which took some 10 years to develop with our present regulator, has been in effect less than one year, and it should not be changed unnecessarily or capriciously. Until an overhaul appears warranted, the regulator should continue to apply the existing rule.

We also support continuity in our mission oversight. We believe the HUD Secretary should retain all existing GSE mission-related authority. HUD should retain its authority to approve new programs under the same standard as in current law. HUD alone has the experience and the history to determine whether new programs are consistent with our charter and our statutory purposes.

The existing structure also works well with regard to our affordable housing goals. As mission regulator, HUD has significant discretion to establish and adjust the goals and to require the submission of a housing plan if we ever fail to meet one of them.

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These are strong incentives for the GSEs to meet the goals year after year, to say nothing of the reputational penalties of failing to meet a goal.

Considering that we have consistently met the permanent affordable housing goals, additional enforcement authority seems unnecessary. Therefore, we would respectfully suggest that no additional authority is needed.

In closing, thank you again for the opportunity to appear today. Freddie Mac is safe, sound and strong.

We are prepared to support many of the provisions put forth by this committee and the Administration. A strong, credible regulator is essential to maintaining the confidence of the Congress and the public.

We look forward to working with Chairman Oxley, Ranking Member Frank, Chairman Baker and Ranking Member Kanjorski and other members of this committee as you move forward to enhance our regulatory oversight structure.

I look forward to answering any questions the committee may have.

[The prepared statement of George D. Gould can be found on page 163 in the appendix.]

The CHAIRMAN. Thank you, Mr. Gould.

And, Mr. Raines?STATEMENT OF FRANKLIN RAINES, CEO, FANNIE MAE

Mr. RAINES. Thank you, Mr. Chairman, and thank you for this opportunity to appear before the committee. And let me as well thank the members.

Mr. Chairman, I have submitted a longer statement for the record, and I would ask that that could be included, and I can just summarize it.

The CHAIRMAN. Without objection, all the statements will be made part of the record.

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Mr. RAINES. Thank you.

I want to thank you for the crucial role that the United States Congress has played and is playing today in building and sustaining and constantly improving the best housing finance system in the world.

Fannie Mae is proud to be at the core of this remarkable system. And I am here today to ask Congress to take action to make this remarkable system even better by supporting the Administration's proposal to move our financial regulator to become a bureau within the U.S. Department of the Treasury.

The Administration's proposal would help ensure that Fannie Mae and Freddie Mac have a strong, well-funded, highly credible financial regulator.

We support the Administration's proposal for three reasons.

First, we support having a strong, well-funded, highly credible financial regulator. Having a strong regulator is in the best interest of housing and housing finance, the best interest of investors and the markets that supply private capital to housing through Fannie Mae, and in the best interests of Fannie Mae and our stakeholders.

Second, the Administration's proposal supports our charter, mission and status, including our freedom to continue to innovate with our lender customers and housing partners to expand affordable housing to new people and places.

And, third, the Administration's proposal supports the advanced capital structure Congress provided in 1992, which ensures that we remain safe and sound through even the worse economic conditions, while allowing us to direct the maximum amount of low-cost financing to home buyers.

Fannie Mae looks forward to working with Congress and the Administration to see the proposal enacted into law this year.

I believe that strengthening our financial regulator is the next natural step in a sequence of congressional actions to advance the success of Fannie Mae, a sequence that began 65 years ago.

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In 1938, with the blessing of Congress, the Federal Government created Fannie Mae. The purpose was to ensure a nationwide flow of low-cost mortgage capital to all communities, at all times, under all economic conditions and to make the long-term fixed-rate refinanceable mortgage available nationwide.

At the time, local housing lending was limited primarily to local bank deposits and the long-term, fixed-rate mortgage was a novel idea.

Today Fannie Mae is one of only two companies in America to guarantee the nationwide flow of low-cost mortgage capital at all times, even when other suppliers of mortgage capital cannot or choose not to provide such capital.

And the long-term fixed-rate mortgage is the standard home loan in America, the financing choice for 80 percent of homeowners and the most consumer friendly loan available.

With this financing, home buyers can lock in a low mortgage rate for the life of the loan. And if rates go down, they can refinance their mortgage and lower their monthly payments.

Three decades after creating Fannie Mae to ensure this nationwide flow of consumer friendly mortgages, Congress took a bold step to vastly enhance Fannie Mae's worth.

In 1968, Congress privatized Fannie Mae, creating a private, shareholder-owned corporation with a charter and a public mission of expanding home ownership by raising private capital.

Privatizing government functions was a novel idea at the time, but privatizing Fannie Mae has proven to be a resounding success and a model of marshalling private capital to achieve a public purpose, in this case the goal of expanding home ownership.

In its 30 years as a government agency, Fannie Mae had built $185 million of retained earnings, and in 1968, financed $6.8 billion in mortgages.

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But after 35 years as a shareholder-owned company, Fannie Mae has amassed over $30 billion of private equity capital to finance $2 trillion of mortgages today.

In the process, Fannie Mae has helped over 50 million American families become homeowners, saved homeowners an estimated $5 billion in mortgage costs annually, and helped to make a low down payment mortgage the industry standard.

In 1992, following the thrift crisis, Congress revisited our charter, reaffirmed its commitment to our mission and updated our regulatory structure.

This framework set specific affordable housing goals, created an independent financial regulator with constant on-site supervision and established a rigorous two-part capital framework that a decade later is still more advanced than that of other financial institutions.

Since then, Fannie Mae has met or exceeded every requirement of our updated regulatory framework. Every year, we have met or exceeded our affordable housing goals, even as they have increased. Last year, 62 percent of our total business served low-or moderate-income families or underserved communities or both.

In 1994, we launched our trillion-dollar commitment, a pledge to provide $1 trillion in financing for 10 million underserved families before the decade was over.

In 2000, after we met this pledge, we launched a redoubled new pledge, our American Dream Commitment, to provide $2 trillion for 18 million underserved families before this decade is over.

We also set a voluntary goal: to lead the market in serving minority families. We pledged to provide $420 billion to help serve 3 million minority families. And when President Bush challenged the private sector to help create 5.5 million new minority homeowners by the end of the decade, Fannie Mae boosted our pledge to $700 billion as part of a 10-point plan to support the Administration's initiative.

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As we expanded home ownership and our service to the market, Fannie Mae also met or exceeded the safety and soundness requirements of the 1992 act. In 2000, we adopted six voluntary initiatives to enhance our liquidity, transparency and market discipline.

In March of this year, we became a permanent SEC registrant and are now subject to the same corporate disclosure requirements of other SEC registrants.

Today we meet every requirement of the Sarbanes-Oxley legislation. Both Standard & Poor's and the Corporate Library have named Fannie Mae among the best companies in the nation and the world for corporate governance.

And since 1992, Fannie Mae has met or exceeded our capital requirements in every year. Indeed, we are one of the best capitalized financial institutions in the world, when compared to the risk of our business.

Our senior debt of course is rated AAA. Standard & Poor's risk-to-the-government rating is AA minus. Moody's rates us A minus on a scale where A is the highest rating in their ratings of the financial strength of international financial institutions.

These letter ratings rate our stand-alone financial strength in the absence of government support. These ratings make us one of the highest rated financial companies in the world. We are financially strong, because for every $2 in debt and liabilities, we have $3 in capital, collateral and mortgage insurance to back it.

Finally, if you look at Fannie Mae's capital under extreme conditions, we compare even more favorably with other financial institutions of our size.

Thanks to the periodic improvements Congress has made to our regulatory mechanism, Fannie Mae serves to reduce systemic risk. If we don't hold mortgages, some other investor, one with greater credit losses, a weaker hedging strategy, a lower credit rating and perhaps taxpayer-backed deposits at risk will have to hold them.

Now Congress is reviewing our regulatory framework a little more than a decade after the 1992 act, and I am heartened to see that there is a general consensus that everything Congress did to advance our charter, mission and status in 1992 has worked very well, and in many ways better than anyone could have imagined.

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Indeed, what has emerged is a consensus not to change our charter, mission or status, but to ensure that these world class companies have a world class financial regulator and to do no harm to the best housing finance system in the world.

The Administration's proposal would modernize our financial regulator while protecting the housing finance system. Thus it would continue to advance the success of Fannie Mae well into the new century.

We estimate there will be 30 million more people and 13 to 15 million new households in this country by 2010. Demand for housing credit will grow by $6 to $7 trillion by that time. We need to have in place a regulatory structure that helps us meet that demand.

Fannie Mae urges Congress to adopt this proposal.

Thank you very much, Mr. Chairman.

[The prepared statement of Franklin D. Raines can be found on page 197 in the appendix.]

The CHAIRMAN. Thank you, Mr. Raines.

Mr. Schultz?STATEMENT OF DEAN SCHULTZ, PRESIDENT AND CEO, FEDERAL HOME LOAN BANK OF SAN FRANCISCO

Mr. SCHULTZ. Thank you, Mr. Chairman, members of the committee.

I appreciate very much the opportunity to speak to you today on what I consider to be a very important issue.

I would like to start by making the simple point that I truly believe in the function of the GSEs. Using private capital, achieving a public purpose through this structure has benefited millions of Americans in home ownership.

I refer you to David Hehman's testimony on the size, strength and characteristics of the system and its ever-increasing role in American housing finance. The contribution is simply too large to put at risk.

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I am here to testify before you on a bill to move regulation of Fannie Mae and Freddie Mac and the other housing GSEs to a new regulator, an independent regulator, organized in the Treasury.

The idea of that legislation is to enhance and improve regulation; it is not to change GSE charters, but to enhance and improve regulation. I view this as an opportunity for you and for us to include the Federal Home Loan Banks.

If the banks are not included and the bill goes forward, I believe the banks are potentially put at risk and will have missed an opportunity to enhance our regulatory structure. The risk will come about because the market may—not will, but may perceive a difference, a lessening of our GSE status, and reflect that in our cost of funds.

That would place our mission accomplishment at risk.

The ability to raise agency funds is critical to our ability to re-lend those funds to our members.

I know there are arguments—people want to wait until there is a better market, a better set of market conditions, or there is less contention in the system about moving forward. There has always been contention in the system, and legislation has passed in the past notwithstanding that contention. And waiting for markets to change to an appropriate condition is nothing I have ever been successful at, but perhaps you have.

Thank you very much for your giving me this opportunity to make these brief remarks, and I look forward to your questions.

[The prepared statement of Dean Schultz can be found on page 229 in the appendix.

The CHAIRMAN. Thank you, Mr. Schultz.

Mr. Hehman?STATEMENT OF DAVID HEHMAN, PRESIDENT AND CEO, FEDERAL HOME LOAN BANK OF CINCINNATI

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Mr. HEHMAN. Mr. Chairman, Ranking Member Frank and members of the committee, I truly appreciate the opportunity to testify before you today.

My name is David Hehman. I am President and CEO of the Federal Home Bank of Cincinnati.

The Federal Home Bank System consists of 12 regional banks and over 8,000 member financial institutions that play a vital role in the nation's housing finance and community lending system.

The bank system is a unique GSE. While the system shares a congressional charter and housing mission with Fannie Mae and Freddie Mac, the Federal Home Banks are fundamentally different in both structure and perspective.

The 12 regional banks and their members form a cooperative that is driven by customer credit demand, not profit maximization.

And while the 12 banks are independently owned and operated, they share joint and several liability for the system's debts. This leads to low-risk, not risk-free operations that have been well supervised under the current independent regulatory regime designed by the Congress.

Two critical pieces of legislation shape today's home loan banks. The Financial Institutions Reform, Recovery and Enforcement Act of 1989, FIRREA, expanded membership to include commercial banks and credit unions with a demonstrated commitment to housing finance. FIRREA also created the system's Res. Corp. payment and mandated the affordable housing program through which each bank sets aside 10 percent of net earnings annually for the creation of affordable housing throughout the nation.

That commitment has resulted in $1.7 billion of private capital flowing into the housing market to create 380,000 units of affordable housing.

Title VI of the Gramm-Leach-Bliley Act of 1999, sponsored by Congressmen Baker and Kanjorski, established universal voluntary membership, provided for a more permanent capital structure, expanded the types of collateral the community institution can pledge to secure advances, and increased the independent corporate governance of each bank.

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Six banks, including Cincinnati, have implemented newly required capital stock plans. This task has occurred well within the legislative time frame and is due in no part to the strength of the system's independent regulator and the commitment of the board of directors of each Federal Home Loan Bank.

A financial snapshot of the Cincinnati bank I hope would be instructive to understanding how and why the cooperative structure is successful.

The Cincinnati bank is comprised of 750 members, serving Ohio, Kentucky and Tennessee. As of June 30, 2003, Cincinnati reported $47 billion in advances outstanding to its members, $7 billion in acquired mortgage assets, and $144 million in affordable housing program grants invested in the creation of 25,000 units of housing.

These are not just numbers; these are telecommunications jobs in central Ohio, the thousandth Habitat for Humanity house in Kentucky, which we dedicated last weekend, a small home improvement loan in Memphis that combats predatory lending, and 25 community-based financial institutions that are now able to sell mortgages into the secondary market.

My job as President of the Cincinnati bank and the job of my board are to ensure the success of this cooperative partnership. Our role at linking Main Street to Wall Street demands the flexibility to access the capital markets we now enjoy.

Bank advances are a critical component of the asset liability management of our community-based financial institutions, as evidenced by the fact that approximately three of every four members have borrowings outstanding at any given time.

The combination of our congressionally determined financial requirement, an independent regulator, engaged boards of directors and extensive risk management tools have proven to be a successful model.

However, adherence to this model does not mean we are adverse to change. The Cincinnati bank wants to do what is best for the financial quality of our institution and by extension the public it serves.

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At its regularly scheduled meeting last month, the Cincinnati board of directors concluded that it was in the best interest of shareholders and the public served to retain the present independent regulatory structure for the bank. The structure and performance of the Finance Board has resulted in 12 healthy, AAA rated regional Home Loan Banks that currently support $500 billion in credit activity serving virtually every neighborhood in America.

At the same time the Cincinnati board affirmed its support of our independent regulator, it also directed management to begin immediately the process of registering its stock under the Securities Exchange Act of 1934. And that process has indeed begun.

The Cincinnati bank strongly believes that registration of its stock with the SEC is the best method to provide both bond and stock investors the necessary financial information they require to assess the condition of the Federal Home Loan Banks.

My board and I believe that these two decisions are consistent and complementary of one another. We are confident the financial markets will continue to recognize that the Federal Home Loan Bank System consists of financially sound, conservatively managed, well-capitalized institutions.

In conclusion, the Federal Home Loan Banks are strong, conservatively run enterprises who have never experienced a loss on a loan to their member institutions.

The bank system's current independent regulator is best positioned to provide safety and soundness, as well as mission oversight for our cooperative enterprise.

Mr. Chairman, thank you for the opportunity to address the committee on this matter and I would be happy to answer any questions when so desired.

[The prepared statement of David H. Hehman can be found on page 173 in the appendix.]

The CHAIRMAN. Thank you, Mr. Hehman, and thanks to all of the witnesses.

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Let me begin with Mr. Raines.

There have been a lot of discussions prior to this hearing about new program approval. I wonder if you could take the committee through that process for us and explain how that works with the regulators working with Fannie?

Mr. RAINES. Well, thank you, Mr. Chairman, for the opportunity to do that, because I think there has been some confusion about how the process in fact worked.

This committee—and the chairman of this committee—and then the Congress defined very clearly in the 1992 Act what the standard was. And that was, we were expected to innovate.

However, if we had a new program, something that was substantially different from what we had done before, we had to get prior approval from the Secretary of HUD before we could do that.

But we were told specifically in the legislative history that that the approval process did not apply to products, it did not apply to new processes, and it didn't apply to new products under already approved programs.

And what has happened since then under multiple Secretaries of HUD is that we have in fact had interactions with HUD as to new things that we are doing and keeping them informed.

And on some occasions, they have indicated they thought something we might be doing was a program. In other cases we brought to them something we thought might be a new program.

An example would be energy efficient loans. Congress asked Fannie Mae to do energy efficient loans back in the early 1980s. It wasn't until the 1990s that we figured out how to do it. And we took that to HUD ourselves and said we think this is a new program, even though Congress has specifically authorized us to do it, and we believe that it requires your approval.

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The CHAIRMAN. Was that in the energy bill in the 1980s?

Mr. RAINES. It was in the energy bill in the 1980s. One of the things that the Congress did was look to Fannie Mae to help produce energy efficiency in the residential housing sector.

And so what happens in that process is that when HUD either determines on their own that it is a program or we suggest it is a program, they then have to make a determination, based on the legislative history which is to encourage innovation, to see if it meets our charter and if it is in the public interest.

And over that time, HUD has made decisions in a number of cases either that something wasn't a program or that if it was a program, that they would approve it.

And so this has actually been a dynamic process. Some had defined this as somehow that HUD was not carrying out their role.

If anything, our concern is that the process has been more restrictive on innovation than we think it should be or that we think Congress thought it should be, and that from time to time HUD has used their role to limit the development of new products in ways that we think are not helpful to the expansion of affordable housing.

But certainly this has been a dynamic process and not one that is by any means an inactive provision of the charter.

The CHAIRMAN. So it has not been a rubber stamp? There have been cases where you have actually been turned down for a new program approval?

Mr. RAINES. Yes, HUD has in fact indicated that they would turn things down. And, quite frankly, if we thought in our interactions with them that they thought it was inappropriate, we wouldn't go ahead and propose it.

So you have had the normal back and forth between the regulatee and the regulator in the definition of this, and I stress, through multiple Administrations and multiple Secretaries of HUD.

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The CHAIRMAN. Is it true to say that there are some new programs potentially that could cause a safety and soundness issue?

Mr. RAINES. Well, there certainly could—you can imagine our trying to get into some area that could cause a safety and soundness issue. And that is one of the things that HUD would have to determine at the time.

The current process by which that is done is that HUD would consult with OFHEO and get their advice as to whether it caused a safety and soundness issue.

Although, typically, in most of these, it comes to a question of capitalization. OFHEO would typically look at an activity and say because of its risk, you have to have more capital, as opposed to simply saying there is no way you could possibly undertake that activity.

The CHAIRMAN. Well, this committee may be faced with an issue as early as next week in terms of the markup and trying to determine how we deal with the program approval, at the same time deal with the safety and soundness, because, as you know, the Treasury proposal is very heavily tilted towards Treasury and that whole milieu of issues.

And at some point we are going to have to wrestle with how we balance that between Treasury in the safety and soundness issue, which I think that is the gut issue has been decided, I think, my sense is, but the other issue in terms of the programs is still kind of out there.

From your perspective, and having experience in that area, what would you suggest?

Mr. RAINES. Well, we have had extensive discussions with Treasury as to what their rationale is for a change. And I have to say that our focus in discussions with them and with others has been more on what the decision-making criteria are, as opposed to the location.

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It is far more important, we believe, that wherever the authority lies, that Congress make it clear that the intention is for the company to innovate.

And within the context of the Treasury discussions, you know, they have indicated to us that in fact they believe that a prior approval regime isn't necessary at all, that they believe that that isn't a requirement. And that has some attractive features obviously from the point of view of innovation.

However, we have been also talking to a wide range of our friends in the housing industry who have a very substantial concern that putting together the approval of our new program activities with the safety and soundness regulator might have a detrimental impact on housing. And we share a lot of those concerns.

And so I would say to you, Mr. Chairman, that from our standpoint, wherever the committee decides to physically locate it, the most important issue is that there be a standard that encourages innovation and that we not ignore the fact that it has been through innovation that we have been able to serve more and more people.

It is not from just doing that same plain vanilla 30-year fixed-rate mortgage we started doing in 1938. It is by having new programs, with low down payments, and with the ability to deal with people with impaired credit and other innovations that have really allowed us to expand affordable housing.

The CHAIRMAN. Are you suggesting the innovation standards be in the statute?

Mr. RAINES. We believe that the regulator, whoever it is, should have a Congressionally determined standard as to on what basis could they turn down innovation. We have no question that on a safety and soundness basis if it were deemed not to be safe and sound, no question that the regulator, whoever it is, should be able to turn that down.

But that has rarely been the issue. The issue has been more likely that someone doesn't want innovation because sometimes innovation means cutting cost. Sometimes innovation means new products coming in, competing with old products. And sometimes those who support the old products don't see it as an innovation, they see it as an invasion of their turf.

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But just as the antitrust laws aren't there to protect competitors; they are there to protect competition. And we believe that the new program approval authority should be there to protect consumers and not to protect competitors.

The CHAIRMAN. Mr. Gould, do you have any comments in that regard, from the Freddie standpoint?

Mr. GOULD. Well, we feel, as I think Mr. Raines has suggested, that HUD has had a long experience in determining mission and programs, whereas the Treasury has not had that background. The Treasury would be very satisfactory to us in terms of safety and soundness, that is something that is their focus and I am sure that they would do well. But the expertise that HUD has developed, the history that HUD has had, makes us inclined to have those powers remain with HUD.

Now, yes, I think it is important what the criteria are. That obviously is really a threshold question. Whether one can codify those criteria I think is another matter. There has been a long evolution of the method of financing in the housing market, which has benefited the homeowner and has benefited the consumer in that respect. A lot of that has been innovation that we would be anxious not to stultify people's imagination as to what products or programs could be created as long as they are safe and sound.

I am not convinced that when one writes laws, that one can anticipate the future to that degree, and I think there has to be discretion left to the regulator.

The CHAIRMAN. Well said.

The gentleman from Pennsylvania?

Mr. KANJORSKI. Thank you, Mr. Chairman.

Speaking of innovation, I suspect if there hadn't been innovation on accounting processes, we wouldn't be here today, Mr. Gould.

Just to take a second of your time, I talked to another member of Congress who is holding a hearing on the Freddie Mac problem, and it seems that monies were transferred for a very short period of time with investment bankers for the purposes of not showing the income in a particular time frame, but to spread the income over a period of time.

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And in private corporations, I know they do that on a regular basis, but whether or not with your special feature, having at least in the marketplace the implication of full faith and credit of the government, whether we like the idea that there is so much attention being paid by the board or the corporate family as to what profits look like and for reasons that I am trying to determine in my mind, why is the board so worried whether or not there are spikes in income.

And only potentially suggesting—I won't ask you to answer it—as we get into corporate governance and since we know salaries sometimes are determined on options and benefits, the motivation could easily be questioned here as to why Freddie Mac got into this difficulty.

But all that being said, I can't wait until we are able to get your responses up here to tell us what really happened.

Mr. GOULD. Well, there are a number of ways to look at it, depending on where one is coming from in a sense. I think it is worth stepping back and saying what the issue is here. And its most fundamental characteristic is the timing of the recognition of income.

What our new auditors have disagreed with, to some extent with the old auditors and to some extent with Freddie Mac's own policies, was when to recognize income that wasn't created out of air, but in fact existed—this is not an Enron, this is not a WorldCom. The question was whether that income should have been recognized in earlier years or whether it should be spread out in many cases over the life of an asset. And that is really where the issue has taken place.

Now, Generally Accepted Accounting Practice is a must. There is no doubt that Freddie Mac and any other company should adhere to the rules of GAAP. Some of the more recent ones that had to do with derivatives, so-called FASB 133, are relatively new, there is some difference in interpretation that has gone on, and there is not a lot of precedent in history.

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Nonetheless, we must adhere to GAAP. But there was a feeling on the part of Freddie Mac's former management that GAAP alone did not reflect the underlying economics of Freddie Mac's business. Freddie Mac was a much steadier vehicle, and sometimes the way things had to be reported, marked to the market as influenced by interest rate fluctuations, made it appear that there was more volatility than was inherent in their basic business.

And as best I can determine, I think that was a driver here in some of the attempts that were made.

Now not adhering to GAAP simply cannot be allowed to happen. But there was I think on the part of former management, who did make their mistakes, but who also had a genuine concern as to how best to represent the company's underlying earning power and nature to the public market.

Mr. KANJORSKI. I am looking forward to those explanations.

I do want to get to Mr. Raines, though. I looked at your testimony, and you don't seem to use the same magic words as the Secretary of the Treasury: strong, independent, world class.

Is that for the particular reason that maybe you agree with the Treasury and how they use independent is not necessarily independent?

Or maybe I should frame it in a direct question: What would you have against your regulator being unfettered and coming to Congress and being able to speak without having prior vetting by the Secretary of Treasury?

And, two, why do you consider, with your large institutions, it is important that the Secretary of the Treasury work on the policy matters for the regulator and why we can't have a separate policy decision made by the regulator?

Mr. RAINES. Well, Mr. Kanjorski, as to the language, I thought you and the Secretary explored the language quite well when he was here with you last time, so I didn't think I could add anything to that.

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But to your specific question——

Mr. KANJORSKI. Well, do you want an independent regulator that doesn't get vetted and that doesn't have his policy reviewed by the Secretary of Treasury or not?

Mr. RAINES. Well, I think there were three issues that you discussed with the Secretary, and let me just discuss each of those three that go to independence.

One of them had to do with the finances of the regulator. We believe we should have a well-funded regulator; but we don't believe that anyone should have unfettered ability to set their own budget without anyone looking at it. Within the banking context, that is regulated by the fact that banks can change regulators and so there is a constraint on how large their budget can be.

We would be the only one who would have a regulator who could set an unlimited budget. So we do not favor independence if it means that there is no one looking at the budget.

As it goes to regulation and independence, my understanding is that currently our regulator's regulations are reviewed by OMB and so that would not be a change on that.

On the issue that you specifically raised about testimony and about policy, that to me is an issue solely between the Congress of the United States and the Treasury Department. We have no view as to the resolution of that. And I understand the views of Congress, that you want an unfettered approach, and I understand the views of the Department, but we have no views as to how to resolve that third issue.

But on the first issue, we do have a point of view; on the second issue we think it is the status quo; and on the third issue, I think it is simply up to whatever the will of the committee is as to how you want to resolve that.

Mr. KANJORSKI. Mr. Raines, you are certainly well familiar, as a former Director of OMB, do you have review rights over OCC? Did you at the time?

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Mr. RAINES. You know, I don't remember. I don't remember whether—and it may depend on the nature of the regulation, but I just don't remember whether OCC had to go through the OMB process.

Mr. KANJORSKI. I appreciate that. We will have to examine it.

Can I just ask one more question of our Federal Home Loan?

Obviously we have a difference of opinion here. The question is always arising, Mr, Schlutz, you referred to it in your testimony, there may be a difference in the interest rate and the market may look at your credit instruments in the future with a different eye as opposed to Freddie and Fannie. And that obviously worries you. But you said ‘‘it may.’’ You were very careful not to use ‘‘it will.’’ And I appreciate that.

Do you have that same fear, that there may be some difference in how the credit markets look at your paper as compared to Fannie and Freddie and could it put you at a disadvantage, Mr. Hehman, or do you feel that the system will work that out without a problem?

Mr. HEHMAN. I think the financial markets will work that out. I am not as concerned as some other folks who have speculated that our funding costs will change.

I think what is most critical is that we have good, solid reporting, and in our case we think that is through the SEC. And we think the financial markets will look at the underlying risk of the institution, its capital levels, its interest rate risk and so forth, not necessarily to whomever the regulator may be. So I am not that concerned about it.

The CHAIRMAN. The gentleman's time has expired.

The gentleman from Oklahoma, Mr. Lucas?

Mr. FRANK LUCAS OF OKLAHOMA. Thank you, Mr. Chairman.

And like all of my colleagues, I share those concerns about safety and soundness.

Mr. Raines, in particular, one of the challenges of being from Oklahoma and having a state with a tremendous amount of cultural diversity, people from every continent, by historic and ethnic origin, as well as 39 recognized Native American tribes, is that we have particular challenges when it comes to housing issues. And your folks have been very aggressive, very successful in my tenure in Congress in doing things to help facilitate efforts to address those kind of issues.

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Could you for a moment speak to the issue that probably I think gets to the core of what a lot of us are concerned about, and that is the questions as addressed earlier about how the proposed legislation would affect your ability to create those new opportunities? Thinking about my Native Americans in Oklahoma, how would this legislation, this proposal as you understand it, impact those efforts?

Mr. RAINES. Well, Congressman, depending on how the committee writes the bill, it can either accelerate our ability to innovate or it can basically turn us into another stultified bureaucracy.

And I say that advisedly. We have 54 partnership offices around the country that we established for the sole purpose of working closely with local communities to try to bend our national programs to fit local circumstances.

And we have been remarkably successful in doing this and able to innovate, whether it is on Indian tribes and now that we are one of the only people who will buy mortgages on Indian reservations that are governed solely by the Indian judicial system, or whether it is in New Orleans where we are one of the first people to try to help them to move housing from being very small, shotgun class, into housing that moderate income and working people could own, all over the country.

But we have been able to innovate because we as a private company could say ‘‘yes’’ within the time frame that people needed.

But if, on the other hand, every time we had a new idea, a new activity, a new product, we had to go and get prior approval, that would not only slow the process down, I think it would discourage us from even trying because by the time we got it done, all of our partners would have been frustrated by our lack of ability to respond.

So a lot hinges on how it is written. And I think if it is written as I am thinking Congress intended in 1992, to encourage innovation, under a broad set of programs that had been approved, then I think we can continue to make an enormous amount of progress.

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On the other hand, if we go backward and change the standard and make it so that if every time we change a process or an activity then that has to be approved, then I think it will bring innovation within the housing finance industry to a screeching halt.

Mr. LUCAS OF OKLAHOMA. Well, I appreciate that. And certainly of my 39 tribes, 16 of which are in my congressional district, every one has a different tribal charter, a different governing system, a different perspective. Most have uniquely different courts, tribal courts to work within. I appreciate that.

I think, Mr. Chairman, I would like to yield back the rest of my time at this time.

The CHAIRMAN. Gentleman yields back.

The gentleman from California, Mr. Sherman?

Mr. SHERMAN. Thank you, Mr. Chairman.

I think we all agree we need the strongest possible regulator of the financial soundness of the housing GSEs. And I think that we all agree that Treasury would be the entity that the markets would respect the most. That is why I am glad we are having a hearing and hopefully a markup of H.R. 2575, which is the subject of this hearing.

I am concerned, and I will ask the panel to bear with me on this, but this is a special concern, I think, for many of you, but especially from anyone from California, that H.R. 2575 currently still contains section 110, which would lower the conforming loan limit on single family units from $332,000 to $275,000. And that would be an anathema to those of us from high cost areas, including Los Angeles.

Now, I am told that it is the plan of the authors to delete that provision and I hope very much that that occurs. However, if it does not occur, then I think it would be germane for me to offer an amendment to raise the conforming limit in those states that contain a standard statistical metropolitan area in which housing prices on median exceed $322,000, or whatever the conforming loan limit is.

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I am going to be leading up to a question here. But I will be interested to focus on not who should be the financial soundness regulator, but which entity should give new program approval to the housing GSEs.

I fear that if we take that away from HUD, it would be like taking the ‘‘H’’ from HUD and we would have to rename it UD, because housing would no longer be its province.

I understand that new programs may raise safety and soundness issues. So if HUD approved the new program, Treasury could then step in and say well, that is a riskier program, here are the reserves that you need. That is the proper purpose of a safety and soundness regulator.

But if the mission of developing new types of mortgages that will help those, say with tarnished credit histories, get financing, if that is moved over to an organization whose mission and expertise has nothing to do with getting people, particularly first-time home buyers into housing, I think that would be a problem. So I hope that we can keep the ‘‘H’’ in HUD.

Now, currently HUD does have as its primary responsibility, Mr. Raines and others for a oversight mission and it is their responsibility, as I have said, of approving new programs.

You have indicated that you support the Administration proposal to bifurcate these mission oversight duties, which would, as I have stated, result in HUD retaining its goal of providing affordable housing and Treasury would be the primary regulator of financial soundness.

Perhaps, Mr. Raines, you could explain why would it make sense to split these two functions? And do you think that HUD has more expertise in your mission goals of providing housing to, and particularly home ownership to those who currently don't own their homes?

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Mr. RAINES. Well, I certainly believe that HUD does have that expertise. And we have been a partner with HUD over many years in working together to try to expand the availability of affordable housing. So clearly HUD has the housing expertise within the Federal Government, no question about that.

And that is why we are very focused on the issue, from our standpoint, of what the standard is on deciding as opposed to the geography of who decides. For us, if the wrong standard is there, we wouldn't want it in HUD. If the right standard is there, then we are open to where it can be. And ultimately, obviously, this committee is going to have to make up its own mind about that location.

But we don't see any magic in it being in one place or the other. There is nothing that is going to make it better by moving it to Treasury ipso facto. The question is what the standard is and how will that authority be used and will it be used to encourage innovation or will it be used instead for other purposes?

Mr. SHERMAN. So HUD has as its mission a dedication to providing affordable housing and home ownership to those who otherwise wouldn't have it. It has the expertise to evaluate your new programs to see whether they achieve that goal. And yet you are an agnostic on whether the agency with the mission and the expertise would have that as its function. I, however, am a true believer that we should keep the ‘‘H’’ in HUD.

And I yield back the balance.

The CHAIRMAN. The gentleman yields back.

The chair recognizes the gentleman from Louisiana, the chairman of the Capital Markets Subcommittee.

Mr. BAKER. Thank you, Mr. Chairman.

Mr. Gould, in your testimony you have a statement that says, ‘‘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 the safety and soundness oversight.’’

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Beginning with that, I assume that absent the issue of capital and new product approval, using the Treasury testimony as your point of reference, do you generally support the proposal as outlined in the hearing before the committee by Treasury? Or are there issues of concern beyond capital and new product approval that you would like to bring to our attention for the committee's consideration?

Mr. GOULD. Well, again, there has been great deal of conversation on the earlier panel of independence. I think if one used the model of OTS or OCC, we would find that certainly to be acceptable given the independent decision-making. It wasn't totally clear to me from Secretary Snow's testimony whether that model was being totally followed. But that is what we would think is the proper way to do it.

And we stick with HUD on the mission because they have had experience, they do have perspective. That is their job. The Treasury has had no background in that. And it certainly is necessary to make sure that it is not restrictive, as opposed to allowing innovation.

But nonetheless, there is an agency that is experienced. And I think it is fair to say that Freddie Mac's experience working with HUD in that regard has been quite satisfactory.

Mr. BAKER. Thank you.

Mr. Raines, you have a similar comment in your testimony about the advisability of an independent regulator being constructed. Are their other issues on your list beyond the capital question and the new product approval or perhaps the independence issue that you would want to bring as concerns with the Treasury recommendation?

Mr. RAINES. Yes. The other item that we have emphasized is that our experience with our Presidential directors has been a good one. And it would be our preference to keep them as members of our board. And so I think that is a difference with the Secretary's proposal.

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But fundamentally, with regard to no change in our status, in our charter, in our mission, we are in agreement with the Secretary.

With regard to capital in terms of no statutory change in minimum capital but more flexibility for the regulator with regard to risk-based capital, we are in agreement with the Secretary.

And as we just discussed, where it comes to innovation in housing, the key has to be to make sure that innovation in housing can occur. And if a standard can be established on that, then I think that probably we could get broad agreement in terms of location.

Mr. BAKER. Well, my reason for the question is we have a platform from which we can begin to construct an effort, and identifying those areas where we have outstanding differences are, I think important because by and large there is broader agreement than one might first perceive on the necessity to move forward with a new regulatory structure.

Some members today have questioned the advisability of any change in current regulatory form. And I wanted to have both your perspectives that you do believe it advisable, assuming that Congress conducts business properly from your perspective, absent those identified issues on which there is some concern on your part.

With respect to the Secretary's position on minimum capital, I asked an initial question during the hearing to which Mr. Ney asked a follow-up question.

There was another person just before the hearing concluded. I would like to read my question and the Secretary's response.

‘‘Just for point of clarification, Mr. Secretary, on the capital issue, I understand the position currently is that we do not seek nor do we expect to change any capital standard immediately on establishing whatever this regulatory body would look like.’’

But coupled with that is the statement, ‘‘We do not, however, wish to limit our authority to change capital standards as we see fit both with regard to minimum or risk-based, based on staff analysis of risk assessment of the institution's leverage, or whatever standards you may choose to use. You do not want to have a regulatory system that constrains your ability to act in the public interest.’’

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Secretary Snow: ‘‘That is right. That ought to be the decision of the regulator.’’

Now subsequent to that, there was a request by somebody to clarify further, and there was another statement issued relative to the capital standard issue.

‘‘The Administration is not proposing legislation itself change any capital standard’’—that is a point I agree with.

‘‘We also are not suggesting that the statutory minimum capital of 2.5 percent be changed’’—I agree with that.

‘‘We are recommending that the new agency have full, more flexible authority over setting risk-based capital standards’’—I agree with that.

So I guess our only point is, if we are not going to change minimum, do we construct a new regulator like every other financial regulator of every other financial institution who has that tool in his resume, recognizing that we are not going to change the minimum capital standards, but if risk profiles change and there is a need to change it, why should we have to come back to the Congress in order to adopt a minimum capital modification?

And I am out of time, and he is ready to push a button, so let me throw one more thing.

If we were to——

The CHAIRMAN. Was that a rhetorical question?

Mr. BAKER. I am just still kind of continuing the same question, because I figured you might cut me off if I stop and said this is question two.

So continuing in defining that question: If we were to take the advice of Mr. Royce and others and roll the Home Loan Bank System into a new single regulator, what would be the Federal Home Loan Bank's view of adopting your capital standard, which some bright legislators a few years back came up with this class A, B stock, where if you are class A you have to have 5 percent, class B, 4 percent, if you are blended somewhere between that.

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Would you, based on your operational experience and your ability to make credit available to your customers and your ability to move in the markets, have you found that capital standard to be an inhibition to your success—either one of the Home Loan Bank folks—and would you recommend to us that if we were all together, everybody would have the same capital standard?

Mr. SCHULTZ. Speaking for myself, we have not found operating under the capital standard in the Federal Home Loan Bank Act to be a problem. I think as capital plans diverge as a result of the changes after Gramm-Leach-Bliley we may see competitive differences emerge among the banks. But the capital standards remain the same for all the banks and they have not been a problem.

Mr. BAKER. Mr. Hehman, do you want to respond?

Mr. HEHMAN. I would agree with that.

We have implemented our capital plan, Congressman. It is working. It is working quite well. And we think it is an appropriate level of capitalization for our balance sheet.

Mr. BAKER. Mr. Raines, do you want to respond?

Mr. RAINES. I wanted to respond to the first part of the compound question——

Mr. BAKER. Briefly.

Mr. RAINES.——which went to the Treasury's position on capital.

And I think having inquired of them very carefully as to what their position is, I would like to be sure that we don't have a misunderstanding.

My understanding of the Treasury's position, as they have reiterated it, is that they do not support a change in the statutory level of minimum capital. They do favor additional flexibility for risk-based capital. Therefore, the regulator would not be able to change the minimum capital standard, but could change the risk-based capital standard.

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And the reason they would change the risk-based capital standard is if risk changed. So if an event occurred, then you would change the risk-based capital standard. There would be no reason to change the minimum capital standard because of a risk reason.

So the only reason I can imagine to change the minimum capital standard is that if you want to reduce the level of activity that we can carry out. And right now, our minimum capital standard is about 400 times our losses. The bank minimum capital standard is more like 50 times their losses.

So I would be concerned about a provision that said that they could change the minimum capital standard without Congress's approval, because that is a question that goes to how much you want us to do. The risk-based capital standard goes to how we handle the risk.

So I believe that we and the Treasury are in absolute agreement on that, that in their proposal, there is not a proposal to allow the regulator at a later date to change the minimum capital standard.

Mr. BAKER. Mr. Chairman?

The CHAIRMAN. The gentleman's time has expired.

Mr. BAKER. Just one further caveat: There is just an honest dispute here. I have had lengthy discussions with Treasury over many months over capital adequacy. And my view is just different from the gentleman's. But I think it is something we should appropriately resolve and look forward to doing so.

Thank you.

The CHAIRMAN. The gentleman from Missouri.

Mr. CLAY. Thank you, Mr. Chairman, and thank the panel for their testimony today.

In 1992, after exhaustive study, this committee made improvements to the charter for Fannie Mae and Freddie Mac. One improvement was intended to help close the housing gap which still exists between minority and majority homeowners.

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While the gap remains at over 30 percentage points, I do not fault the GSEs for lack of trying. They work on a daily basis to create innovative products and programs which meet the needs of those denied the American dream of home ownership. Fannie Mae and Freddie Mac help to bring the dream of home ownership to thousands of my constituents on a regular basis.

I have serious concerns that as we rectify the problems at one GSE that Congress does not give in to the business opponents of these GSEs who profit from predatory and subprime lending at the expense of affordable housing.

The minority home ownership achievements of these GSEs are on the right track.

And, Mr. Chairman, I ask unanimous consent to submit my statement in its entirety into the record.

[The prepared statement of Hon. Wm. Lacy Clay can be found on page 110 in the appendix.]

The CHAIRMAN. Without objection.

Mr. CLAY. Thank you.

And for Mr. Raines. Last week in Secretary Martinez's testimony, he pointedly stated that you, Fannie Mae, does not lead the market in providing financing for low-income and minority home ownership. Could you please explain that to me? I am very interested to see if that was accurate.

Mr. RAINES. Well, with all due respect to the Secretary, we do disagree with the statement that was made, and in some ways I think it was a result of his referring to somewhat outdated information.

Fannie Mae is the largest single provider of financing for low-and moderate-income households in the country. Last year we provided $279 billion. We provided $136 billion to support minority families' ability to own homes.

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To give you some perspective, that is more than the top four direct lenders combined, that Fannie Mae has done.

So no one is even close to the level of what Fannie Mae has done. Indeed, we finance far more in the way of first-time home buyers and minority home buyers than the FHA, where that is their major endeavor.

So we do lead the market. If you look at 2002 and 2001, we led the market with regard to low and moderate income borrowers and with regard to minority lending we led the market. And in the sub-categories, with regard to African-American lending and Hispanic lending, we led the market.

But we not only led the market, we led the market with the lowest-cost product so that people were not just getting a loan. They were able to get the lowest-cost loan that was in the market.

So whether it is our housing goals, which we have met every year, or whether it is low and moderate income borrowers, or it is borrowers in underserved areas, or whether it is minority goals, which we set ourselves—HUD does not have the authority to set a minority goal, we set that ourselves—in all those cases we lead the market, and we are quite proud of it. And it hasn't been easy. But it is a fundamental to who we are and what we do.

And the last thing I would say is, there are many ways of looking at leading the market. One of them is obviously provision of mortgages. But it is also leading the market to make sure that people have the information they need so they know how to get a loan. It is also leading the market to make sure that discriminatory practices are taken out of underwriting. And it is also leading the market to be the largest investor in low-income housing tax credits, which is the single largest vehicle for financing affordable rental housing. None of those are captured by the HUD goals.

So we lead the market by their terms, and we lead the market by the terms of the housing industry.

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Mr. CLAY. I thank you for that explanation and clarification.

Also, Mr. Raines, I understand that you currently have to meet certain housing goals. And my understanding is that you have never failed to meet those goals. Is that correct?

Mr. RAINES. That is correct.

Mr. CLAY. Could you tell me then why HUD wants to create new categories of sub-goals in this area, or do you know?

Mr. RAINES. I don't understand that, because HUD has authority currently to provide incentives for us to pursue particular types of loans that they believe are important.

For example, the last time they changed our goal level—and they have been changing our goal level periodically and raising it—they showed an interest in expanding our activity with small multi-family projects, five to 50 units. And they provided an incentive in the goal in order to do that.

So they have the authority now to have incentives to encourage us to do more in areas that they think are important for housing purposes.

Mr. CLAY. I thank you for that.

Thank you.

The CHAIRMAN. The gentleman yields back——

Mr. GOULD. Would I have a chance, Mr. Chairman, just to make——

The CHAIRMAN. Of course.

Mr. GOULD. Fannie Mae has done a very fine job on doing these goals. But I wouldn't want it to sound as though Freddie Mac is not part of this process. We joined with Fannie Mae in committing between the two of us, and Fannie is larger than we, so they can afford a bit more, a trillion dollars, the initiative President Bush announced, by 2010.

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We continue to meet the permanent housing goals of HUD. There is more we can do. We are currently, for example, talking to the manufactured housing industry in terms of how we could innovate and with safety and soundness standards provide a flow of funds to that industry where people could perhaps have housing at a lower cost.

There is much to be done in housing in the future to fulfill our mission. But we are very much part of that mission and doing our percentage share I think, for example, of the trillion dollars, our share is roughly $450 billion.

Mr. CLAY. Mr. Gould, I had no intentions of——

Mr. GOULD. No, sir, I know that. But I just thought for the record.

Mr. CLAY.——overlooking Freddie Mac, because you all do play an essential part in Missouri also.

Thank you.

The CHAIRMAN. The gentleman from California, Mr. Royce.

Mr. GOULD. I have never found Fannie Mae bashful about these things.

Mr. ROYCE. Thank you, Mr. Chairman.

And just for the record, Mr. Chairman—Mr. Gould, yesterday Freddie Mac sent a letter to Chairman Oxley and the committee members here outlining your position on this debate. And let me just say that I was surprised to see Freddie Mac fighting against sound regulatory policy.

Furthermore, I could not believe that Freddie Mac was offering advice about placement of regulation for the Federal Home Loan Banks.

It would be my concern that Freddie Mac wants the banks left out so that you will have a cost-of-funding advantage in this situation. And I think that Freddie Mac should be a little more concerned about trying to produce some financial statements with integrity and a little less about trying to disadvantage a competitor.

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I would like to ask Mr. Schultz a question, and specifically, Mr. Schultz, there is a history of tension, or in some cases antagonism, between banks and Treasury. If a new agency under Treasury regulates the banks, will this situation change or will it continue? And if the latter, would that be a positive regulatory change?

Mr. SCHULTZ. Thank you for your question.

The aphorism of what you see is a function of where you sit is applicable here. We have been listening to—I have been listening and learning from discussion about where regulatory approval is vested with respect to mission.

We do not have that issue. The Federal Housing Finance Board is our mission regulator and our safety and soundness regulator.

Our understanding, our hope is that if the Federal Home Loan Banks are included in this bill—and, again, I would like to state that it is not simply the cost-of-funds of question, it is the decision to create a world class regulator for the GSEs that causes me to say that we should be included as well.

But if we are included, then I hope that the Congress, this committee, will include language that protects the mission of the banks and protects the independence of the regulator, similar to what our other colleague GSEs would like to see, or Freddie Mac, and that that language go a long way toward resolving the concerns about whether or not Treasury would be—a Treasury-independent regulator would be a problem, hostile to the mission of the bank system.

Mr. ROYCE. Well, let me ask a question then of your colleague, Mr. Hehman.

And that question would be—going to that same premise—if we ensure sufficient mission protection—let us say that was possible—and we ensure agency independence, and that independence is under Treasury, really, in that situation, how far apart would the 12 Federal Home Loan Banks be? And in that context, would you still object to moving regulatory authority? Or do you think that in theory that might be possible to get that type of concurrence?

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Mr. HEHMAN. Clearly, if you had those written into the legislation, the 12 banks would come probably closer in our view of this.

Again, our view is that the Finance Board has been an adequate regulator, does not need to be a part of the Treasury, or our regulator needs to be a part of the Treasury.

We do have some concerns about that at the Cincinnati bank, clearly.

Obviously, whatever the Congress decides in their wisdom, the Home Loan Banks are going to live with that.

The position that our board took is that the independent regulator—and independent is critical—who is also our mission regulator, ought to be left alone. That is the view that our board of directors took, Congressman.

Mr. ROYCE. I appreciate that.

If we go back to Mr. Schultz—again, Mr. Schultz, if we move the functions of the Finance Board to Treasury, how do you think that new agency could be structured? Would you give us your insights into how you think that would most effectively be done?

Mr. SCHULTZ. Thank you.

I believe that the differences between the Federal Home Loan Banks and Fannie Mae and Freddie Mac have been discussed in other people's testimony. But basically we are talking about a cooperative with par value stock, and that is the way we get private capital to use for public purpose.

And there are a host of issues that arise that make us different from Fannie Mae and Freddie Mac. And for that reason, we would suggest that a separate office be created in this regulator for the Federal Home Loan Banks, which would assess the banks and use those funds to for its operations, and that the mission language and independence language be included in the statute.

We do think it is important that the activities of the regulator be funded through the banks.

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Mr. ROYCE. Thank you, Mr. Schultz.

Mr. BAKER. I yield back, Mr. Chairman.

The CHAIRMAN. The gentleman yields back. The gentleman from California, Mr. Baca.

Mr. BACA. Thank you very much, Mr. Chairman.

First of all, I would like to thank our distinguished guests for appearing before us. I particularly want to thank Frank Raines and George Gould.

The work you do in the Latino community is very important. Both companies have impressive track records of expanding minority home ownership. Hispanic home ownership rates have increased from 44.7 in 1998 to almost 50 percent today.

In the year 2000, Fannie Mae financed over $135 million in loans to almost 1 million minority families. In my district, Freddie Mac purchased almost $1 million in mortgages that financed home ownership for over 800,000 families in the year 2000.

My question is for Mr. Frank Raines. Factoring immigration and population growth over the next 10 years, isn't there a common concern where the mortgage money will come from—or where it will come from to meet the demands going forward? That is question number one.

And shouldn't this be carefully factored in any legislation that do not encumber a well-working housing finance system?

Mr. RAINES. Congressman, I think that is absolutely right. We are going to need to find an additional $6 to $7 trillion of financing for home mortgages over the next 10 years—an additional $6 to $7 trillion.

We got the first $6 to $7 trillion over the last 200 years. And we are going to need to come up with another $6 to $7 trillion over the next 10 years.

So this is a very important debate that this committee is having as to the structure of the regulation of these entities that are so crucial for reaching around the world to find that $6 to $7 trillion.

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One-third of the funding that Fannie Mae brings to its portfolio comes from outside the United States.

So it is very important that we have a structure in place that gives confidence to investors that they will continue to invest in American homes. Because if they don't, we will end up with a capital shortage.

Already, the U.S. mortgage market is the fastest-growing capital market in the world.

And so it is not as though we just can assume that another $6 to $7 trillion would come automatically. It will come through a lot of hard work and through well-financed, well-capitalized intermediaries who will attract that capital into our system and then provide it to lenders so that they can lend it to individual families.

Mr. BACA. Good. And isn't it true that home ownership will increase amongst the Hispanic community, as we look at right now we represent approximately 14 percent of the population, 42 million people? That includes Puerto Rico. Is it true then that the majority of the future home ownerships could come from the Hispanic community?

Mr. RAINES. Well, we are going to see tremendous growth in the Hispanic community. By 2020, we are going to see the growth in the Hispanic community of about 75 percent growth, 28 percent growth in the African-American community, 80 percent growth in the Asian community, at the same time the non-Hispanic white community's going to grow by 9 percent.

So quite clearly, the future of home ownership, the future of housing in America is going to be around this growing population that is going to need not only access to capital in theory, but in fact.

And this has been the area where we have had to work the hardest to make sure that the capital system is working for these families. And again, if we fail, if we fail to come up with $6 to $7 trillion, the people who will be hurt will be that part of the population that is growing and that part of the population that has not heretofore benefited from home ownership.

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Mr. BACA. Thank you, I know that the minority community both appreciates Freddie Mae and Freddie Mac and the services it is providing in minority communities. So thank you.

The CHAIRMAN. The gentleman yields back.

The gentleman from Connecticut, Mr. Shays.

Mr. SHAYS. Thank you, Mr. Chairman, and I thank the gentlemen who are before us. I have significant respect for all of them. But I do think that we need to be asking some tough questions, and I do want the answers to a few questions.

Mr. Gould, back in June 25, Freddie Mac indicated its earnings could be restated by as much as $4.5 billion and that its accounting lapses are more serious and more pervasive than previously announced. Today, the company announced the restatement would be a minimum of $4.5 billion.

In the company's statement, I quote, ‘‘the disclosure process and disclosure in connection with these transactions and policies did not meet standards that would have been required of Freddie Mac had it been an SEC registrant.’’

The company further stated, ‘‘Freddie Mac is committed to strict compliance with generally accepted accounting principles and meeting fully the spirit and intent of all rules and regulations surrounding financial reporting.’’

This is my question. Given everything that has happened at your company, and the fact that you have acknowledged not living up to the disclosure standards required by the SEC of all other public traded companies, and also the fact that Freddie Mac now claims to be committed to strict compliance with all financial reporting requirements, how can you still argue that Freddie Mac should be outside the jurisdiction of the SEC and the Securities Act of 1933?

Mr. GOULD. Well, as you know we are going to become a registrant under the 1934 Act. As you know Freddie Mac is a constant financier. Compared to the average American company, therefore, the average registrant, we finance many, many, many times a year more than they do. And we have looked at the absolute requirements of the 1933 Act as a drag on that financing, because an additional cost which could get passed along in our cost structure to mortgages, to a slowdown, to——

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Mr. SHAYS. So it would be basically your argument that it would provide additional costs and requirements, correct?

Mr. GOULD. Well, yes, but let me try to be more specific and give you examples.

Mr. SHAYS. You know, I don't want too long an answer.

Mr. GOULD. Okay.

Mr. SHAYS. Only because I am given five minutes.

Mr. GOULD. All right, sir.

Mr. SHAYS. Thank you. Regarding your reinstatement, my understanding is that the minimum $4.5 billion by which you may have underreported income is after tax. Is that correct?

Mr. GOULD. That is correct.

Mr. SHAYS. So your before tax is going to be—the minimum is going to be much higher than $4.5 billion?

Mr. GOULD. That assumes a 35 percent tax rate.

Mr. SHAYS. Can you give me an estimate of how much money your accounting practices have cost the Federal Government?

Mr. GOULD. Have cost the Federal Government in what sense?

Mr. SHAYS. In taxes that haven't been paid that should have been.

Mr. GOULD. Oh, gosh, the amount of taxes, if any, additional taxes payable would be minuscule compared to that amount of money.

Mr. SHAYS. Why, you don't pay—I know you don't pay Federal, I know you don't pay local and state taxes. But do you mean you don't pay Federal taxes?

Mr. GOULD. No, sir. There is a confusion there. Much of that money in the restatement is a function of marking instruments to market, which is not a taxable event. It is not a matter of having sold something and not reported the income or profit on the sale. It is a matter, particularly in a time of declining interest rates, of marking assets to the market, which therefore are worth more and should have been marked to the market, but were not at the time. But that is not a taxable event.

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Mr. SHAYS. A June 17th story in the Hill newspaper quotes a Freddie Mac lobbyist as saying, ‘‘We feel good about these hearings because this is a great story to tell. The restatement of earnings is going to be up, not down.’’

Do you agree with this assessment that, in my words, that accounting fraud is good news as long as it is up?

Mr. GOULD. No, sir, I do not agree with your statement that it is fraud.

Mr. SHAYS. You don't think this was fraud?

Mr. GOULD. No, sir, I do not, nor does Mr. Doty, who was the investigator that I hired to look into this in the first place, as he testified today in the Energy and Commerce Committee.

Mr. SHAYS. Does the Government think it is fraud?

Mr. GOULD. Sir?

Mr. SHAYS. Does the Government think it is fraud?

Mr. GOULD. I do not know who the Government is in that respect, sir.

Mr. SHAYS. So the fact that you haven't complied with general accounting practices and have understated your earnings by over $4.5 billion, if someone in the private sector did that, wouldn't that be fraud?

Mr. GOULD. Well, I do not have a legal background, and I don't want to get past territory with which I feel familiar, but my understanding, for what it is worth, in that regard is that fraud also implies intent.

Mr. SHAYS. When do you intend to come under the 1934 Act?

Mr. GOULD. We have no present intention of doing so.

Mr. SHAYS. 1934 Act.

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Mr. GOULD. Oh, I am sorry, 1934. I am sorry, I thought you said 1933. The 1934 Act is as soon as we can. We cannot do that until our financials are current. And that will probably, as Director Falcon said this morning on the first panel, that will probably take into the middle of next year. As soon as our financials are current, we will do so.

The CHAIRMAN. The gentleman's time has expired.

Gentleman from Massachusetts.

Mr. FRANK. Let me ask Mr. Gould and Mr. Raines on behalf of Freddie Mac and Fannie Mae, do you feel that over the past years you have been substantially under-regulated?

Mr. Raines?

Mr. RAINES. No, sir.

Mr. FRANK. Mr. Gould?

Mr. GOULD. No, sir.

Mr. FRANK. And let me ask now the gentleman from the Federal Home Loan Bank, do you believe that the Federal Home Loan Bank System has been substantially under-regulated?

Mr. HEHMAN. No, sir.

Mr. FRANK. Mr. Schultz?

Mr. SCHULTZ. No, sir.

Mr. FRANK. Okay. Then I am not entirely sure why we are here, but we killed the afternoon anyway, so we might as well go forward.

I must say, I am inclined to agree with that. I don't see any financial crisis. You can always make things better, but I do think we should dispel the notion that we are here because there is something rotten that has gone on.

And I am not one who has been impressed with the history of results improved by reorganizing boxes, so I don't know whether OFHEO goes to Treasury or not, whether it makes a big deal, I am not going to fight it.

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I am concerned about the housing piece.

And, Mr. Raines, I would differ with one question you were asked about whether you should be given—whether HUD should be given the ability to do sub-goal. And you said: Well, they already have the ability to give you incentives to do that.

Yes, but maybe they ought to have the right to give you orders to do it. I mean, I understand, we all would rather only do things that we were incentivized to do, but sometimes maybe we should be told to do things to do. And that to me is kind of an open question.

I think the current arrangement is a good one; I think we have benefited. I think we have benefited with regard to Fannie and Freddie in reducing the cost of housing in general.

As I have said, apparently there are people in this country, investors, who knowing everything they should know, are prepared to lend you money at a little less than they would charge other people. I am glad they do. I think housing benefits. Nobody should be under any illusions that there is any guarantee, implicit, explicit, whatever-plicit. It just ain't there.

And I find it ironic, frankly, that some of those who are the most interested in trying to—who are worried about this—the only people who it seems to me to be creating the impressions that there is a guarantee are the people who are your opponents, who keep saying there is one. If they would stop saying there is one, then they wouldn't have to worry about people thinking there was one, because it is a self-fulfilling prophecy.

But I am interested in doing a better job on the housing area.

Now, let me ask Mr. Schultz and Mr. Hehman, because this is something that really originated right here in this room, the affordable housing fund that the Federal Home Loan Banks have, is that an obstacle, the existence of that, is that an obstacle to your being able officially to perform the market functions that you perform?

Mr. SCHULTZ. We don't find the affordable housing program to be an obstacle.

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Mr. FRANK. Mr. Hehman?

Mr. HEHMAN. No, sir, it is an incredibly efficient way to disperse that subsidy into the private sector.

Mr. FRANK. Absolutely right. And it is one of the few production programs we have right now, other than the low income tax credit, it is one of the few direct production programs we have, I think many of us are very pleased with it. I should say it initiated here, in this room, under the chairmanship of the late Mr. Gonzalez of Texas.

We had a tough fight on the floor of the House. It only survived on the floor of the House by two votes, and now everybody is all for it. And it is a very impressive kind of program, and I salute the Federal Home Loan Banks for the flexibility with which they run it.

And so then the next question is, Mr. Raines, Mr. Gould, have you ever thought about something like that? You know, you do a good job in reducing the cost and passing along the lower cost of funds. Here is a more specific form of subsidy. Have either agency thought about that?

Mr. Raines?

Mr. RAINES. Well, in 1992, the last time this committee dealt with our charter, there was a debate as to whether or not we should have a grant program such as the Home Loan Banks had or whether we should have goals. And the committee, after quite a bit of debate, chose goals instead.

Mr. FRANK. Right. I didn't ask that. I asked what does Fannie Mae think about that. You would rather have goals than grants?

Mr. RAINES. No, I didn't say that. No, I think we would be delighted if we got the same treatment the Home Loan Banks have, which is that they essentially get them as a credit against the taxes that they otherwise would owe.

Mr. FRANK. No, we should look at that.

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I would be careful. If I were you, Mr. Raines, and I am a great supporter in general of your mission, but once you start saying, ‘‘I would like to be treated like everybody else,’’ there is a lot of people that would like to be treated like you. So I think if I were you, I would do kind of stand-alone discussions.

Mr. RAINES. I didn't say that.

Mr. FRANK. Well, I understand that. But I mean, you are saying that an affordable housing program, if there was some tax credit aspects to it, would be a reasonable thing.

Mr. RAINES. No, I am simply saying, we pay at the full Federal rate.

Mr. FRANK. No, I understand that. But you said you thought that that wouldn't be a bad program if you had favorable tax treatment over it.

Mr. RAINES. I am sorry. I did not hear——

Mr. FRANK. Didn't you say that if you were treated the same and the tax—that it was a credit against your taxes, that it would be a reasonable thing to do? I thought I heard that.

Mr. RAINES. Yes. You are right. But even without that, today, Fannie Mae alone invests about $2 billion a year in low-income housing.

Mr. FRANK. Okay, but I didn't ask you about that. You know, I only talk about what I was asking about, which was that it is different, the affordable housing subsidy is a little bit different.

One other question for both of you.

A little indulgence here.

And I do think we should be doing more.

I have been disappointed, maybe I am wrong, and I will ask you and I will make it clear that this is not conclusive, but the people who work for me have told me that in the rural area, the 515 housing program which is the assisted housing that, frankly, neither one of you has done as much there as it seems to me should be done, like almost nothing. And we are running into an increasing problem here in rural subsidized housing, we have got rural housing that was built under Federal loans, assisted housing, it is going to expire and we are going to lose a lot of housing.

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So I would ask, you can respond in writing, because we are running out of time, what you are doing with regard to the 515 rural housing.

And with that, Mr. Chairman, could I just put into the record a letter from Michael Jessee, who is President and Chief Executive Officer of the Federal Home Loan Bank of Boston, expressing the board of directors of the Boston bank—of the Federal Home Loan Bank—opposes at this time inclusion of the Federal Home Loan Bank in legislation creating a new regulator for Fannie Mae and Freddie Mac, absent credible evidence the Federal Home Loan Banks would be otherwise disadvantaged from a cost of funds basis.

And I would like to put that in the record.

[The following information can be found on page 256 in the appendix.]

The CHAIRMAN. Without objection.

The gentleman from Delaware, Mr. Castle.

Mr. CASTLE. Thank you, Mr. Chairman.

I realize we have another panel and we are out of session, so I will try to be relatively brief, and I may not even have any questions.

And Barney mentioned he is not impressed by reorganizing boxes, but we are apparently in the process of reorganizing boxes, and that is what it is all about.

I mentioned to Mr. Baker earlier today the remarkable change in some of the testimony we have had from people from not just this panel, but all day long, compared to what they might have said a year ago.

But I don't think that is bad. I just ironically noted that there has been a changed circumstance here.

I just would like to say this. These are huge—of all the things this committee has jurisdiction over and Congress has jurisdiction over, from an economic point of view, with the direct jurisdiction that we have over these particular entities, this is probably about as big as it comes.

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And I have no way of judging by the size of it how well we have really done with helping with minority housing or with low-income, middle-income housing, but my sense is that has actually gone well. I think you have carried out your mission well.

You couldn't prove it by me. When you start talking about, what, $3.3 trillion in debt and some of the assets which you have, it is just very hard for the average Member of Congress, frankly, to totally comprehend.

But I think there would be more criticism if you had not done well. And I have heard a lot of praise over the years, so I think that has gone well.

On the other hand, I, for one, do feel that we do need regulatory change. From what I have read about the Freddie Mac investments, while I am not suggesting there is anything illegal about that or anything the government should be interested beyond that, I do believe we do have the oversight interest of making sure that is being handled correctly. The security of these entities is of tremendous significance.

Understanding the role of the Federal Home Loan Banks is also very difficult, frankly, for me, and I think for some other members here, in terms of where they should be in this reorganization of the boxes which may go on.

And obviously your mission and your goals as opposed to the regulation is something else that we all have to pay attention to.

But my only hope is that everybody in this room, because I think there is a lot of people out in the audience as well as the members up here, will be very focused on what is the right way to get those boxes stacked to make absolutely sure that we are carrying out the basic missions of housing, which we all view to be perhaps the most important issue of what you are doing, making absolutely sure that we don't set up something that lacks sufficient regulation so that maybe unintentionally we could have financial mishaps which could be a tremendous problem and which in my judgment would affect our whole economy in the United States and frankly the worldwide economy.

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And so I hope when you have your meetings and you come before us and you testify, and again, not just the four of you, but everybody who is doing this, that everybody has given a lot of thought not to just their own interest, but to the overall balance of what our responsibility is, I mean ours collectively, not just Congress, but all of us in terms of helping the housing market in this country.

Because while you are in the instances of Freddie Mac and Fannie Mae private entities, you also have a tremendous public purpose in what you do.

So it is my hope that the people who are really knowledgeable can work together and really make a difference and end up with something which everyone is going to look back on and say, those were positive changes.

And I yield back.

The CHAIRMAN. The gentleman yields back.

The gentlemen from Alabama, Mr. Davis.

Mr. DAVIS. Thank you, Mr. Chairman.

Mr. Raines, you touched on something earlier that I want to talk about for a minute or two. And in the earlier hearing, I talked with Mr. Falcon about what I think is a very significant problem that may not have received as much attention.

If we are going to expand HUD's oversight authority to go not just from new programs to new activities, I am concerned—and I suspect from your comments earlier today that you are concerned about a very basic problem, and it is this: a lack of transparency in how HUD goes about making that evaluation or how Treasury would go about it. Whatever the regulator, I think the question is, What are the standards for making an evaluation of what is permissible new activity and what is not?

One concern that I would have is that, as we look at the vicissitudes of HUD or the changes from Administration to Administration, it doesn't seem that we are going to have a lot of practical guidance in how HUD is going to look at these questions.

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So can you talk for a minute or elaborate on your earlier answer about the appropriate standards that should be employed? Mr. Falcon, I think, said that he would be comfortable taking the broad public policy standard that exists now for evaluating the programs and importing that into a new activity standard.

And so, I suppose we would be left with that fairly amorphous public policy standard. We would be left with a—not as amorphous, but not a terribly meaningful standard around what is within the guideline of the charter.

I am not really comforted by either one of those. So can you talk about that a little bit?

And, Mr. Gould, you also.

Mr. RAINES. Well, thank you for the opportunity to elaborate. I think the standard I have in mind is quite a simple one, and that is that a new program is consistent with the charter and consistent with the mission. That strikes me as being a sufficient standard; the bias should be that it will be approved as the current statute says unless it is not consistent with the charter and consistent with the mission.

The concern that I have is—and I have spent time in the Government and I have spent time in the private sector—that if it depends on a Government agency approving everything and making up its own mind about each and every item, it will take forever to get approvals done simply by the normal process of Government. So the bias should be toward ‘‘it is approved’’ unless it is found not to be consistent with the charter and not consistent with the mission.

I will give you an example. If we had an innovation that was a new program, but it involved Fannie Mae originating loans, well, that is against our charter. There is a prohibition in our charter for originating loans, and HUD would properly turn that down.

On the other hand, if we came up with a product that was a conventional mortgage, but it simply had different underwriting standards or it had new features, well, then, that wouldn't even rise to a decision because it is not a program, it is not something that is large, it is simply a change in a product. And even if it were a program, it would be consistent with our charter and consistent with our mission. So it is not a very elaborate standard that I am talking about.

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What concerns me with a broad public purpose standard is that, depending on who is making that judgment, some could come to the conclusion that the public purpose is to restrict the expansion of housing, because they believe that the American people are investing too much money in housing.

Now, some would say, ‘‘Who would do that?’’ And I could go and round up most of the economists who have opined on this issue. They believe that we have invested too much in housing in this country, and they would say it was in the public interest to stop it.

Now, I don't think that is what this committee or this Congress would intend, but a broad public purpose or public policy standard would allow someone to have that position and they could come to that conclusion.

Now, I do not think that is what Congress intended in 1992, and I would hope that we could make it clear that that is not what Congress intends today.

Mr. DAVIS. Well, let me add one follow-up since my time is running a little bit low.

One of the other things that does not appear to be terribly controversial but which still concerns me is this notion of bifurcating the safety and soundness analysis from the mission analysis.

In one sense it sounds like an easy enough thing to do, but, you know, a number of us here are lawyers and we write whole textbooks about the difference between substantive and procedural. We write whole textbooks about whether something is truly new law or not.

So given that backdrop, I am not terribly comfortable that we would be able to sort out frankly what fits in a safety soundness box and what fits in the mission box.

Closely related to that, I am not clear who would be empowered to really break a tie. I am not clear who would be empowered to make an analysis. In virtually every Administration, with all due respect to HUD, Treasury is going to be the weightier department.

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So can either of you, either Mr. Raines or Mr. Gould, comment? While, I understand—if I could have just a little bit of indulgence, Mr. Chairman—while I understand that both of you, I think both of you endorsed the notion of splitting safety and soundness from mission, can you talk as a practical matter about how we are going to differentiate between the two in every instance and who would have the authority to make the call if there were ever a tension between safety and soundness of mission?

Mr. GOULD. Well, I think the system has basically been working now in a bifurcated way. I mean, you have HUD focusing on the mission and OFHEO looking at safety and soundness. So I perhaps do not see that as the major change that you might, Mr. Davis.

But the Treasury I think is uniquely qualified to determine things in a safety and soundness basis, particularly having had an operational precedent with OCC and OTS. So that doesn't bother me and I have in my testimony recommended it.

I felt, however, that the Treasury would be starting from scratch in terms of determining mission and would have to build up to it, whereas that is really part of HUD's mission, if you will. Their expertise was worth retaining in that regard and although it may not be perfect to have a bifurcation, in fact it is taking advantage of both organizations' expertise and experience, and it is worth trying and seeing how it goes.

Now, if they disagree, who is the judge? Perhaps that would have to be determined by the Congress.

The CHAIRMAN. The gentleman's time has expired.

The gentleman from Texas, Mr. Hensarling?

Mr. HENSARLING. Thank you, Mr. Chairman.

Mr. Raines, forgive me, I missed part of your testimony, but I would like to make sure I have a very firm understanding of one point.

In your testimony you speak of supporting the Administration's proposal, but specifically in transferring the new product approval from HUD to Treasury. I understand your concerns about innovation and efficiency, but with regards to transferring new product approval to Treasury, are you for it or against it?

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Mr. RAINES. I am in favor of a proposal, as I understand the Treasury has proposed it, where there would be an automatic approval of new housing innovations by Fannie Mae if that authority were moved to the Treasury. That is why I say it is so important what the standard is.

What Treasury has said is that there would be an automatic approval, but that if it were determined that there were a safety and soundness issue, they would have the right to later come in and take action. If that were not the standard, then I would not be in favor of the movement.

But in any event, I believe that there ought to be a very clear standard, even if the authority stays at HUD.

Mr. HENSARLING. So would the standard be regulatory or statutory?

Mr. RAINES. There ought to be a statutory standard, in my view, because I think it is very hard for regulatory agencies to create the standards under which they are operating, because they are essentially making the political decision.

So whether it is our regulator or any regulator, I believe Congress ought to establish what it is the Congress is asking the regulator to do. In this case I urge and I believe it has been the history of this committee that it wants the regulator to encourage housing innovation. That ought to be the first thought, is does this encourage housing finance innovation?

If Congress doesn't establish that standard, you are leaving it then to a regulator to invent their own standard. And that standard could be that we believe that there is too much investment in housing and therefore we are going to stifle innovations.

So I do not think you want to leave that to be an open question. I think Congress ought to tell the regulator in what direction you want to go.

And clearly, I think everyone in the housing finance industry believes that we have an impending housing crisis in this country and that there is a need to invest more in housing, not invest less.

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Mr. HENSARLING. A question for the gentleman from the Federal Home Loan Banks. Obviously we have a divergence of opinion here, but specifically I would be interested to know your thoughts on being included in the same regulator as your brethren to your right.

How do you view that with respect to competitiveness? What is it about having the same regulator that will make you more or less competitive with Fannie and Freddie?

We could start with you, Mr. Schultz.

Mr. SCHULTZ. Sir, as I mentioned earlier, the concern that leads to our wanting to be included with the same regulator is that the market's perceptions are critical in terms of our cost of funds and our ongoing ability to access the markets, both domestically and abroad. And if there is a perception that, well, with the other two housing GSEs, the world class regulator is appropriate but the federal home loan banks do not need that kind of supervision, people may begin to question is it really a GSE? Is it really the same thing as those entities?

Or if there is a reason to criticize the regulatory structure that we are involved in owing to something that happens in one of the banks, will there be a permanent increase in our cost of funds, which would be reflected through our not being able to achieve our mission?

So those are the concerns about competitiveness. And if you ask me to delineate all of the things I can think of, I can't go very far beyond that because I can't see the future. But I would be concerned with being treated differently if you choose to move the other two entities to a different regulator.

Mr. HENSARLING. Well, once again I apologize for plowing over old ground, but I missed part of the testimony.

Mr. Hehman, would you comment please?

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Mr. HEHMAN. Yes, sir. Our concern about being put together with the other two GSEs is very simple, that we are not like them. We are a banking system that lends money to community-based institutions. We are a different animal. We are a different GSE.

So our concern is really to be lumped in with two other GSEs who do something, who are very involved in housing, clearly, but have a totally different delivery system, in my judgment, than the core mission of the Federal Home Loan Banks.

So our position is that the Home Loan Banks are different enough that the current regulatory system has done the job and that, in a sense, leave well enough alone.

Mr. HENSARLING. Thank you.

I see my time has expired.

The CHAIRMAN. Gentleman yields back.

The gentleman from Georgia, Mr. Scott?

Mr. SCOTT. Yes, thank you very much, Mr. Chairman.

To Mr. Raines and to Mr. Gould, I want to make sure we are clear here because I am tending to get kind of a schizophrenic response from the two of you in terms of your two feelings about the proposed legislation, the President's proposal, Administration's proposal.

On the one hand, I am hearing you say you basically support the Administration's proposal. In your interchange with Mr. Baker, I think you have tended to say you support basically that. But there was—Mr. Baker came back and said there was one point of disagreement there that I did not get picked up, but I want to.

This is an extraordinarily important hearing in that the people of America, I think, are listening and watching to get a clear signal where we go because what you all do is so critically important in the mission.

But on the other hand, I hear you saying that you are very fearful of moving from where we are, from HUD, because it may lower the priority in terms of the housing goals that we reach. And I am very concerned about this. I represent a district in Georgia where we have four of the fastest growing counties, 11 counties around metro Atlanta.

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And just to point out my concern, you were tacking off some figures about what you have done, and I commend you for that. But if you look at what happened between 2001 and 2002 in terms of home ownership rates among white, black, Hispanic, other races, central cities and the suburbs, in every single category there was a little bit of movement.

For example, among whites, from 74.3 percent to 74.5; from Hispanic, 47.3 percent to 48.2; central cities, 58 to 59, 74.6 to 74.7.

The only area which there was a decrease was in the home ownership of African Americans, one of the four most critical groups to be sustained.

So I would like to give me a little answer to that as to why that decrease? Why the African American community? Is there something going on in that community that they are faced with that no one else has? I think we want to know that.

And if you could give us some clarity on how, on one hand, you favor what the Administration is doing, but then on the other hand you are fearful of what it is doing.

Mr. RAINES. Well, if I might start, Congressman. I think you put your finger on the conundrum that we face. We are vitally committed to our housing mission. It is what we do. It is who we are. And it is our number one priority.

Our housing mission, however, does require us to raise capital around the world. Our investors invest in Fannie Mae not because they necessarily share our housing mission, but because they think that Fannie Mae will be a good steward of the capital.

And so we need to have a regulatory regime that both helps us raise the capital and helps us do our mission. And finding that right mix is the conundrum you point to. And what we are struggling with here is what is that right mix of things that helps us raise the capital and helps us do our mission.

As I understand the Treasury proposal—and we don't agree with every line of the proposal—but as I understand the Treasury proposal, it would help us raise the capital and if properly prepared would help us do our housing mission.

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If it would not help us do our housing mission, then we would oppose the legislation. And that is why, for example, we were quite firm on the point, if the proposal is to increase our minimum capital standards, we will oppose the proposal. And there should be no question I think in anyone's mind about that. Why? Because it would undermine our housing mission. It would allow us to do less. If you double our minimum capital, you cut in half what we can do.

But this is why I think you are feeling this tension, is that we need both. We need the access to the capital markets in order to do our mission. And that is why I, in my testimony, tried to lay out the history of how the Congress has dealt with this. And each time, it has, I believe, reached the right balance in those things.

It has not said that safety and soundness is more important than our mission. If that were true, then they should shut us down. The most safe and sound course is to have no obligations outstanding. But instead, Congress has reached a different balance.

So today, do we have a lot of obligations? Absolutely. But for every $2 that we have in debt and obligations, we have got $3 in collateral in American homes. And that has been successful.

The CHAIRMAN. The gentleman's time has expired.

The gentleman from North Carolina, Mr. Miller?

Mr. BRAD MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman.

Mr. Raines, you just said the word balance. And that is the first time I think I have heard this, because I think most of the debate has been about either considering safety and soundness or considering how to make credit available for home ownership, particularly among underserved populations, racial and ethnic minorities and just low-wealth families in general.

But I have seen this as a balance, as trying to strike a balance between those competing concerns. And we strike balances all the time in every area of the law. Harry Truman said he wanted to meet a one-handed economist because he got tired of hearing on the one hand, on the other hand from his economists. But he really should have talked to a lawyer if he wanted to hear about on the one hand, on the other hand.

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Most of the debate, I have thought about which box to put this product approval in had to do with whether in striking that balance the bias would be on the side of safety and soundness or the bias would be in favor of encouraging home ownership. Those who oppose putting it in Treasury thought the bias would be in favor of safety and soundness. Those who wanted it—opposed having it in HUD thought the bias would be in favor of encouraging home ownership at the expense of safety and soundness.

I understand that you have said earlier that you do not care where it is, which box it is in, but that you think that the standard by which it should be subject, new product approval should be subjected, should be judged, should not consider safety and soundness at all? At the initial stage it should not—that product approval should not—it should be about whether it is consistent with your charter, and that is the extent of the analysis.

Mr. RAINES. And then the safety and soundness regulator would determine what the capital would be to ensure safety and soundness.

So there is a separation between consistency with our charter and our mission and what the appropriate capital is for it.

The safety and soundness regulator will always establish what the capital is, whether it has gone through the approval process or not. Anything we come up with, they establish the capital requirement.

Mr. BRAD MILLER OF NORTH CAROLINA. But my understanding of what you said earlier—and I have had the same experience everybody else had of being in and out of this hearing, it is a great frustration of serving in the House and trying to be a conscientious member of a committee—but my understanding is that your proposal or what you favor, that would come later.

Mr. RAINES. No, I think in reality what has happened currently is it comes almost simultaneously because the two of them will consult. That is what happens today. Today, OFHEO has the ability to establish whether or not it meets safety and soundness standards and what the capital should be and HUD decides whether or not it is consistent with our charter and our mission.

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So we have that bifurcation today. And I think that part of the process works reasonably well.

I think the greater difficulty is simply what the standard is. On what basis should I decide this is okay or not okay? And I always thought it was clear. But some of our experience says there seems to be some ambiguity about it, and I am asking the committee to resolve the ambiguity in favor of housing.

Mr. BRAD MILLER OF NORTH CAROLINA. I yield back.

The CHAIRMAN. The gentleman yields back.

The gentlelady from Indiana?

Ms. CARSON. Thank you very much, Mr. Chairman.

I am probably the only one on the committee having some unreadiness about transferring all this oversight and stuff like that because it appears to me that if Treasury can indeed establish some safe and soundness in terms of your capital risk and your capital investment then it ought to expand that work out to the whole United States of America, since we are on the brink of economic disaster.

But I do not understand the part that is proposed in terms of the Treasury Department having oversight and decision-making in terms of new missions and how this new regulator discerns what is a legitimate or a necessary new mission, new goals, new modus operandus.

And I heard all of you wonderful gentleman talk about you agree with all of this. But how does the Treasury Department discern what is a viable mission, what is a viable new mission or a new investment or—am I making my question clear?

Mr. GOULD. Well, in my testimony——

Ms. CARSON. I apologize, I have been——

Mr. GOULD. That is perfectly all right.

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The way Freddie Mac has looked at it is that the mission goals and the definition of the mission has been set by HUD for many years. We think that is still appropriate for them to do so. They have the experience and the background to do so.

At the same time, it helps us do our mission and serve affordable housing to have the lowest cost of funding that we can achieve. And that is best achieved by having the market perceive us to have a very credible regulator. Credible in the sense of saying that we are safe and sound. And there is no better entity in that regard than the U.S. Treasury.

So this bifurcation, we feel, serves both our purposes: a safety and soundness regulator with credibility and an experienced organization in terms of what our mission should be.

Now, I do agree very much with Mr. Raines that we must be very careful of dampening innovation, particularly because the point that Mr. Scott made, Mr. Davis made and others, is as we go forward here, a clear part of our mission is going to be to try to serve the underserved parts of America.

And that means in order to remain safe and sound in doing so that we are going to need some innovation. We are going to need some financial vehicles that can provide funds flow to those areas and still not engender something that would disturb the markets in being unsafe.

So there is work to be done here. But neither one of these decisions are going to be made in the abstract. The Treasury should not just sit there and make safety and soundness decisions without consultation with the person in charge, HUD in our view, of our mission. That is not the way things should work and not the way things really do work.

So there is going to be a constant interchange or so-called working together here in order to accomplish what we have to do, which is to get the percentage of housing for minority groups in this country higher so that it is matching the white population. And that is going to take some innovation and that is going to take some work and that is going to take some commitment.

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And I know Fannie Mae has spoken out about this and we have too. This is something we are both dedicated to and we are trying to find the best way to do it.

Ms. CARSON. If I may ask one more quick question, Mr. Chairman? And maybe this is not the right group to pose the question to.

In Indianapolis, where I am from, we have the highest rates of home foreclosures in the country. A lot of that has been naivete on the part of the consumer and all that and we recognize all of that and that needs to be fixed, that is broken.

But more importantly, our economy, our jobs are dissipating. We just last week got word that our biggest foundry is closing, 1,000 employees. United was there, they left, 2,000 people. For the most part, those people are homeowners.

Now, do you get the blame for all of these foreclosures that come up when you have been out in the market with these innovative programs?

And I might hasten to add that at the foundry especially 80 percent of those are people of color. They are going to lose their homes.

Do you have in this risk, capital risk management apparatus some forecast that say, ‘‘Hey, you better not loan that guy that money because he is going to lose his job next year’’?

Now, that sounds like a dumb question and perhaps this isn't the panel that should address that.

Mr. RAINES. No, it is not at all an inappropriate question because it is the heart of what we do. We always are trying to find how can we help more and more people and do that within safe and sound principles.

And our experience has been quite good actually. Our experience has been quite good. Indeed, even for people who get into trouble and get behind in their mortgages, we have found that we have been able to keep half of them in their homes and not go to foreclosure by working with them as they work through periods of unemployment or sickness or divorce or other issues. So it is exactly the right question.

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And avoiding foreclosure is as important as making the original loan. It doesn't do anyone any good to put someone into a home and then as soon as they get into a little bit of trouble, foreclose on it. And it doesn't do any good to have a bunch of foreclosed houses sitting abandoned in a community. That is why Fannie Mae fixes up houses before we

sell them back so that people are getting a house that is in good shape. And we do that very quickly.

But it is absolutely a critical part of what we and our lenders do, is to ensure that people who get into homes can stay there and to take whatever steps we need.

But I can tell you, we have been expanding into low down payment lending and to credit-impaired lending and the results have been very good. And what that says to me is giving more people a chance has been good business.

The CHAIRMAN. The gentlelady's time has expired.

Ms. CARSON. I think you have done a good job.

Thank you very much, Mr. Chairman.

The CHAIRMAN. Let me thank all of you, particularly our traveling folks from San Francisco and Cincinnati. We worked you pretty hard today, but I think the committee learned an awful lot. And that is obviously the purpose of these hearings. We thank you very much.

And the second panel is dismissed. And the third panel, the lucky third panel can now come forward.

Produce our third panel, beginning with Mr. D. Russell Taylor, President and CEO of Rahway Savings Association on behalf of America's Community Bankers. Mr. C. Kent Conine, Conine Residential Group, Inc., on behalf of the National Association of Home Builders. Mr. Allen Fishbein, Director of Housing and Credit Policy, Consumer Federation of America. Ms. Terri Montague, President and Chief Operating Officer of the Enterprise Foundation. Dr. William E. Spriggs, Executive Director of the National Urban League, Institute for Opportunity and Equality. And Mr. John Courson, President and CEO of Pacific Mortgage Company on behalf of the Mortgage Bankers Association of America.

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And our last witness of the day, if you can't go to hell, be the last witness on the third panel, the gentleman from Texas, our former colleague, the Honorable Steve Bartlett, President and CEO of the Financial Services Roundtable.

Mr. FRANK. Mr. Chairman, that is what he gets for letting his seniority lapse. If he hadn't done that, he would have been way up there.

[Laughter.]

The CHAIRMAN. We thank all of you for your patience in waiting through this weighty subject and two panels before you. Again, it could be worse. It could be a Friday afternoon.

So with that, Mr. Taylor, let me recognize you for your testimony.STATEMENT OF D. RUSSELL TAYLOR, PRESIDENT AND CEO, RAHWAY SAVINGS INSTITUTION, REPRESENTING AMERICA'S COMMUNITY BANKERS

Mr. TAYLOR. Absolutely. Thank you, Chairman Oxley, and thank you, Ranking Member Frank and members of the committee.

I am Russ Taylor. I am the President and CEO of the Rahway Savings Institution, a small mutual institution located in central New Jersey. I am also this year's chairman of America's Community Bankers.

Many of our members are specialists in mortgage lending and actively involved in the secondary market. Therefore, we appreciate this opportunity to provide our comments to the committee on GSE regulatory reform.

ACB has an intense interest for several reasons.

First, we strongly support the secondary market role of Fannie Mae and Freddie Mac and the important housing mission they fulfill.

Second, we strongly support efforts to improve regulation to better ensure safety and soundness and focus on mission.

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And three, our members are business partners with Fannie Mae and Freddie Mac and investors in their securities.

In fact, my own institution has active relationships with all of these entities.

ACB commends Chairman Baker and Representative Royce in their efforts. Their years of background work will make it easier for Congress to craft sound legislation.

We strongly support many of the provisions of their bills that provide substantial independence for the new agency.

My written testimony details the key elements of independence that are currently provided to other financial regulators. This to us is an essential element of GSE regulatory reform.

The new agency must also be able to fund itself without going through the annual appropriation process. ACB strongly endorses the Administration's position that the new agency have the authority to review both current and future programs of Fannie Mae and Freddie Mac.

For over a decade, HUD has not exercised its current program approval authority, and as a result Fannie Mae and Freddie Mac have engaged in, or at least attempted to engage in, activities inconsistent with their secondary market responsibilities.

The Administration, and pending bills, make it clear that HUD will still set affordable housing goals for Fannie Mae and Freddie Mac. HUD would actually gain authority to set goals and to enforce them. That, plus a new independent agency with a mandate to enforce the company's housing mission, should maintain their support for housing.

ACB strongly agrees with the Administration position that there should be no limit on the new agency's ability to increase capital requirements for Fannie Mae and Freddie Mac if necessary.

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Let me be clear that we are not proposing the capital requirements be increased. But capital is the foundation for the safety and soundness of our financial system and must remain a flexible tool available to the regulator.

We recognize that any solution that Congress develops for Fannie Mae and Freddie Mac may have a direct impact on the Federal Home Loan Bank System. That is a system that we deeply care about. In fact, Secretary Snow testified that the Federal Home Loan Banks should also be regulated by the new agency.

ACB has traditionally supported separation between the regulation of Fannie Mae and Freddie Mac and that of the bank system. The Federal Home Loan Banks are cooperatives, not public companies, and pose different regulatory issues.

However, our members who do support a merged agency are concerned that Fannie Mae and Freddie Mac will enjoy a cost-to-funds advantage if the bank system is not included.

They also know that Federal Home Loan Banks, Fannie Mae and Freddie Mac, are all engaged in extensive interest rate risk management. A combined agency would, in their view, be better able to supervise these risks. ACB's board is weighing these arguments as we speak today.

I wish to again express ACB's appreciation for your invitation to testify on these important issues. We strongly support the committee's effort to strengthen the regulation of Freddie Mac, Fannie Mae and the Federal Home Loan Banks and look forward to working with you as you craft legislation to accomplish that goal.

Thank you.

[The prepared statement of D. Russell Taylor can be found on page 240 in the appendix.]

The CHAIRMAN. Thank you, Mr. Taylor.

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Mr. Conine?STATEMENT OF KENT CONINE, CONINE RESIDENTIAL GROUP, REPRESENTING NATIONAL ASSOCIATION OF HOMEBUILDERS

Mr. CONINE. Thank you, Chairman Oxley and members of the committee. My name is Kent Conine and I am President of the National Association of Home Builders, representing 211,000 members of our association, which employ over 8 million employees. Also President of Conine Residential Group, which is based in Dallas, Texas, specializing in both single-family and multi-family development and building.

I am pleased to comment on the recent proposals to restructure the regulatory framework for the housing-related GSEs.

On September the 10th, Treasury Secretary Snow and HUD Secretary Martinez unveiled before this committee the Administration's proposal to restructure the regulatory framework for the government-sponsored enterprises.

This pronouncement focused almost exclusively on improving the safety and soundness of the regulation of Fannie Mae and Freddie Mac.

While the nation's home builders support most of what has been put forth by the Administration to ensure a strong and credible regulatory framework, we have grave concerns about a shift from the narrow regulatory focus to a larger referendum on the housing finance system in general.

Housing mission and the GSE's role were largely omitted from the discussion during the September 10th hearing. We are pleased that this committee, by virtue of conducting today's hearing, recognizes that some of the concepts outlines by the Administration deserve more rigorous review and discussion.

Specifically, the Administration's proposal to remove the mission oversight or new program approval from HUD and place it in Treasury marks a fundamental shift in perspective about the role of HUD as well as how the GSEs engage in their day-to-day business and undertake new programs.

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We strongly oppose such a change and urge you to retain HUD's oversight of new programs as well as the annual affordable housing goals and enforcement of our nation's Fair Housing Act.

In focusing on the safety and soundness regulation, we urge the committee not to lose sight of the core missions, which is consistent with the congressional intent creating the housing GSEs; that is to provide liquidity, capital and stability to the housing market.

Program oversight is key to this core mission.

The Administration's proposal blurs the mission of Fannie and Freddie, and thereby rationalizes its proposal by treating new program authority as an exclusive function of safety and soundness.

This has never been the case and fundamentally ignores the legislative history in the 1990 Treasury studies creating the 1992 GSE Act.

The objective and focus of program oversight is not safety and soundness, as HUD Secretary Martinez testified, it is mission compliance. An example would be furthering the Administration's goal of increasing minority home ownership.

Applying safety and soundness criteria in conjunction with Treasury's longstanding bias against programs that facilitate the flow of capital to housing would severely retard the development of new programs continuously needed by Fannie Mae and Freddie Mac to fulfill their housing mission and to adjust to market conditions.

It will stifle innovation necessary to provide liquidity to the housing credit markets, particularly in areas that otherwise would not be adequately served.

Such activities by definition involve higher risk and would be greatly constrained if program approval is solely a component of safety and soundness regulation.

For example, the highly successful Mortgage Revenue Bond program is being held hostage today by Treasury because they have failed to adjust the home purchase price limits since 1993.

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On the issue of capital requirements, NAHB agrees with Secretary Snow that there is a need for stability in capital standards and that capital standards should not be subject to frequent change. NAHB applauds Secretary Snow's decisions not to recommend any changes in the GSE's risk-based capital regulation at this time, given that the standard took 10 years to develop and has been in effect for only about a year.

We are pleased that Treasury has given risk-based capital standard a chance to work.

Due to the low-risk nature of home mortgages, NAHB recommends against any changes in the GSEs minimum capital standard requirement as well.

Finally, the Administration is proposing to strengthen HUD housing goals authority over Fannie Mae and Freddie Mac. NAHB has a longstanding history of supporting housing goals. We supported the increases in the goals implemented by HUD's 2000 rule.

This rule also provided for bonus points for the 2001 to 2003 period for units financed for GSE mortgage-backed purchases in small, 50 to 50 unit multi-family properties and for units in two to four unit owner-occupied units.

NAHB feels that more needs to be done to encourage the GSEs to increase their activities in some market segments, such as rural areas and multi-family production.

At the same time, NAHB believes that any proposed changes to the housing goals should undergo careful examination. Fannie Mae and Freddie Mac were created to serve a broad range of housing needs, and we would not want to overly stringent the goals to impede that particular mission.

Continual increases in the percentages targets will also have diminishing returns and run the risk of adversely impacting other housing programs like our FHA single family program.

In conclusion, I appreciate the opportunity today to express our position on restructuring the regulatory oversight on the housing GSEs, particularly our opposition on moving the mission oversight from HUD.

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I hope to work with you in the coming days to have a chance to work with you to craft a bill that will accomplish this mission.

Thank you.

[The prepared statement of C. Kent Conine can be found on page 127 in the appendix.]

The CHAIRMAN. Thank you, Mr. Conine.

Mr. Fishbein?STATEMENT OF ALLEN FISHBEIN, DIRECTOR, HOUSING AND CREDIT POLICY, CONSUMER FEDERATION OF AMERICA

Mr. FISHBEIN. Thank you, Mr. Chairman, and Mr. Frank and members of the committee.

My name is Allen Fishbein and I am the Director of Housing and Credit Policy for the Consumer Federation of America.

CFA is a nonprofit association of some 300 consumer organizations with a combined membership of 50 million that was founded in 1968 to advance consumer interests.

CFA and many of its members have a longstanding interest and involvement in housing finance matters, including advocating for expanding the role of the GSEs in serving important housing needs.

My own background, which I want to mention, is that I served a tour at HUD as Senior Adviser for GSE Oversight. My duties included helping to supervise the setting of the present affordable housing goals for Fannie Mae and Freddie Mac.

We thank you for affording us this opportunity.

CFA believes that the GSEs play an important, indeed essential role in promoting a sound housing market and by providing expanded home ownership and other housing opportunities. Through their statutory mandates, the GSEs are required to serve a dedicated percentage of their business to address the needs of low-and moderate-income households and underserved communities.

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Changes to the GSEs regulatory structure, therefore, must be undertaken with great care and precision, so as not to work at cross-purposes with the GSEs ability to carry out these important mission activities.

In short, the charge should be do no harm to the GSEs' housing mission.

To summarize the key points from my written testimony, number one, we believe that it is in everyone's best interest to have a strong oversight regulatory structure. The tremendous growth in the size of the GSEs over the past decade has raised the stakes for regulatory oversight. Certainly, consumers, whether they are existing or future home buyers, renters or investors, along with other stakeholders have a strong interest in effective oversight of the enterprises.

Thus it would be hard to argue against the need for Congress to review the adequacy of a regulatory structure that was put into place a decade or more ago.

Second, there is recognition that OFHEO does not have all the powers it needs to perform this oversight. Listening to the testimony today, maybe that is an understatement.

Unlike banking regulators, OFHEO does not have authority to assess the financial institutions it supervises for the full cost of oversight, and the funds for its budget are provided through a congressional appropriations process which has limited the agency's funding in comparison to banking regulatory agencies.

In addition, OFHEO is not equipped with a full range of enforcement tools commonly afforded to financial regulators.

Third, we believe the simplest way to correct this problem would be upgrade OFHEO, but we know that some on this committee have concluded that a mere upgrade alone would not be sufficient and that further changes in the regulatory structure are also needed.

For example, Mr. Baker's bill would abolish OFHEO and switch the functions of safety and soundness and some mission oversight functions to the Office of Thrift Supervision.

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Also the Administration in their testimony before the committee outlined proposals for making even more extensive changes to the existing regulatory structure.

It is our belief, however, that strengthened financial oversight could be achieved without making major sweeping changes to the existing regulatory structure.

CFA is supportive of steps to enhance GSE safety and soundness oversight. Along these lines, we believe that providing GSE regulators with the authority to assess the enterprises themselves for the reasonable cost of oversight and removing funding for these activities from the annual appropriations process would go an extremely long way in addressing many of the concerns that have been cited.

Improving the mechanism used to fund the cost of GSE oversight would enable these regulators to increase their capacity and bring on additional financial expertise needed to perform their important functions.

However, again, we are not convinced that OFHEO is inherently flawed in its capacity to serve as a safety and soundness regulator.

Moving the GSE regulator to Treasury, while it is viewed by some as providing certain benefits in stature, could also carry with it disadvantages, not the least of which are likely to be administrative disruptions, at least in the short term. And because Fannie and Freddie are major issuers of debt in the capital markets, along with the Treasury Departments questions about potential conflicts of interest could conceivably arise from the Department's exercise of its new oversight powers over the GSE activities.

We also are troubled by the suggestion that the new Treasury bill would not be established as a fully independent office, along the lines of OCC and the Office of Thrift Supervision.

However, whether or not a safety and soundness regulator is ultimately shifted to Treasury, CFA believes that the charter oversight and new program approval should remain at HUD. Switching this authority to Treasury we fear would detract from maintaining important regulatory focus on the GSE's housing mission performance.

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And fifth and finally, we would like to see steps taken to strengthen the GSEs' obligation to support its affordable housing related activities. We were pleased that Secretary Martinez in his testimony before the committee made a number of constructive proposals aimed at spurring additional improvements in the GSEs' affordable housing performance.

In particular, we were pleased that the Secretary asked for authority for HUD to impose enforceable sub-goals. Sub-goals are a logical tool to ensure that the GSEs adequately consider the most underserved segments of the mortgage market.

However, the Secretary's proposal is not sufficient unless HUD places greater emphasis than it has on performing these important responsibilities. For example, HUD let slip the establishment of new goals for 2004 and beyond. The existing goals were originally set to end at the end of this year, and HUD's failure to take action this year means that the current levels will roll over for at least another year.

In addition, we also believe that much more can be done to improve GSE performance in meeting their goals through expanded public focus on the GSEs' activities. And in my written testimony, I mention two of these areas.

One would be to improve the GSE public use data base which is administered by HUD to permit better local analysis of the GSEs' activities, and, two, to have better reporting to Congress on the GSEs' affordable housing activities and its departmental plans for establishing new goals or explanations for why a goal periods would need to be extended.

The CHAIRMAN. Can you sum up, Mr. Fishbein?

Mr. FISHBEIN. I am going to close by reiterating that we believe it is in everyone's interest to have strong regulatory oversight of the GSEs and in doing so we urge the committee to proceed with caution and resist the urge to make needless changes that detract from the GSEs' ability to perform their mission obligations.

Thank you, Mr. Chairman.

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[The prepared statement of Allen Fishbein can be found on page 153 in the appendix.]

The CHAIRMAN. Ms. Montague?STATEMENT OF TERRI MONTAGUE, PRESIDENT AND CEO, THE ENTERPRISE FOUNDATION

Ms. MONTAGUE. Thank you, Chairman Oxley and Ranking Member Frank and members of the committee, for this opportunity to testify. I am Terri Montague, President and Chief Operating Officer at the Enterprise Foundation.

Enterprise provides private capital to support affordable housing and economic development in low-income communities. To date, we have invested in excess of $4.4 billion to finance more than 144,000 affordable homes for low-income people, including more than 12,000 in 2002.

Fannie Mae and Freddie Mac are among Enterprise's most important partners. Without them much of our work simply would not be possible.

Congress is considering significant changes to the Federal Government's regulations of these GSEs. We encourage Congress to deal with these issues as expeditiously as possible to avoid any uncertainty in the mortgage markets.

As many have already testified, we too strongly support safety and soundness regulations. And we support strong affordable housing requirements.

We agree with the Administration that there is no reason to change the GSEs' mission, charter or status. We also agree with the Administration that HUD should remain responsible for ensuring the companies' compliance with their congressionally mandated affordable housing responsibilities.

Briefly, we have recommendations regarding three issues, the location of prior approval authority, the scope of approval authority, and the establishment and enforcement of the GSE affordable housing goals.

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On the first point, the location of prior approval authority, the Administration has proposed transferring this authority from HUD to a new safety and soundness regulator. The new agency would consult with HUD on new programs.

We agree with Chairman Baker and other members of the committee that HUD should retain this responsibility. We are not aware of any evidence that HUD has failed to exercise approval authority appropriately. We see no advantage to shifting approval authority to a new safety and soundness regulator.

After all, HUD is the only federal agency with expertise in housing finance and a mission to advance affordable housing and only HUD has the benefit of more than a decade of experience evaluating new GSE housing programs.

Secondly, the scope of authority issue. Current law requires the GSEs to obtain HUD approval for any new program. H.R. 2575 would substantially broaden this authority. It would require the companies to obtain HUD approval before engaging in a wide range of activities, not just new programs.

Again, HUD has not used its approval authority inappropriately. HUD also has the authority under current law, which it has previously exercised, to itself initiate a request for information from the GSEs regarding what it considers possible new programs.

Requiring the companies to seek federal signoff on new activities could curtail their ability to respond effectively to changes in the mortgage markets, such as rising interest rates. It also almost certainly would impede the GSEs' ability and incentive to innovate.

Low-income consumers and communities which often benefit most from GSE innovations could lose out.

We wonder whether Fannie Mae would have been able to pioneer use of the low-income housing tax credit if the company had been subject to the approval requirements the bill would impose.

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As you may recall, in the credits early days, hardly any corporations were willing to commit capital to the program, as it was seen as too risky. And few Federal officials understood the program in that it was too new.

Fannie Mae stepped up when others would not and helped convince other corporations to invest. Fannie Mae and Freddie Mac committed to this fledgling Federal incentive, and in doing so, sent a strong signal to the marketplace that the credit was a sound investment.

The housing credit is now perhaps the most important Federal incentive for the development of rental housing for low-income people. And it is truly impossible to imagine such success without Fannie Mae and Freddie Mac's early and sustained participation.

On the third issue: In 1992, the GSE legislation requires the GSEs to dedicate substantial portions of their business to serving low-income people and communities. The Administration has proposed expanding HUD's ability to establish and enforce the GSE affordable housing goals.

We see no reason to change the statutory framework for the affordable housing goals at this time. HUD has the authority already to increase the percentage of business targets in each statutory-goal category.

HUD also has the authority under current law to incent the GSEs to achieve more specific affordable housing objectives. HUD has utilized this authority effectively in the past, resulting in substantial increases in the GSE's affordable housing financing.

HUD's most recent regulatory revision of the affordable housing goals resulting in the GSE's increasing their mortgage financing for low-income and underserved people and communities by nearly half a billion dollars between 2001 and 2011.

Let me be very clear: Enterprise has long urged Fannie Mae and Freddie Mac to increase their affordable housing activity. The companies could and should do more. We welcome the opportunity to work with HUD, the GSEs and other housing organizations to explore strengthening the goal levels and objectives. But we urge Congress and HUD not to proceed with any affordable housing goal revisions without seeking the advice and assistance of a wide range of housing organizations, as it always has in the past.

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I would be pleased to answer any questions that you have.

[The prepared statement of Terri Y. Montague can be found on page 191 in the appendix.]

The CHAIRMAN. Thank you for your testimony.

Dr. Spriggs?STATEMENT OF WILLIAM SPRIGGS, EXECUTIVE DIRECTOR, INSTITUTE FOR OPPORTUNITY AND EQUALITY, NATIONAL URBAN LEAGUE

Mr. SPRIGGS. Thank you, Congressman, and thank you, Congressman Frank, for this opportunity.

My name is William Spriggs. I am the executive director for the National Urban League's Institute for Opportunity and Equality. I am joined today Marvin Owens, who is the head of our housing department out of our New York headquarters.

The Congress here has gathered because the size of the securities and mortgage-backed security instruments issued by GSEs is now almost as large, in fact, a little larger than the U.S. Treasury-note market. And so that means that all of us should be concerned about the safety and soundness of these enterprises, and that they are very important to the security of the American economy, if not the world's capital markets.

However, it is equally important to remember why Congress created the GSEs, and that has to do with capital markets.

In the case of the housing GSEs, the purpose was to create an effective market for residential mortgages, and this was in response to the lessons taught by history.

The leverage given to the housing GSEs by Congress was to establish increasing access to home mortgages for underserved areas, and this mission must remain paramount in assessing different measures of safety and soundness.

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For instance, the risk-based capital standards that were put in place last year are an example of how it is important to try and keep the minimum capital requirements low so that we can have a larger pool of funds available for mortgages.

The primary concern of the League in this issue is the maintenance of the housing GSE mission. Our housing office partners with both Fannie Mae and Freddie Mac to deliver a set of services that we integrate with programs from the banking industry, the Department of Housing and Urban Development and others to try to increase home ownership in the African-American community.

There is no simple answer to the disparity in home ownership rates between African-Americans and whites. Access to credit is one part of the answer. Credit counseling is another part of the answer.

As an example, our program with Fannie Mae began in November 2002 with the signing of a five-year memorandum of understanding that launched a demonstration project in six and then seven and now eight of our affiliates, including Houston, Dallas, Tucson, Rochester, Seattle, Atlanta, and Stamford.

Working with J.P. Morgan Chase, the project has put more than 500 families into homes and got an additional 200 families prepared for home ownership, and it has moved over $43 million in loans.

Several of those affiliates are now at various stages in creating community housing development organizations, the next step in solving housing problems for low-income and African-American households in their cities.

So the Fannie Mae relationship is a catalyst that those affiliates have leveraged. The League has a similar program with Freddie Mac.

The key lesson learned from the experience of the National Urban League's housing department is that increasing home ownership requires a comprehensive approach. It was with this foresight that the housing GSEs were put within HUD. The housing GSEs should be viewed as a tool among others that can address the complexity of causes of the disparity in home ownership rates in America.

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And it is in that regard that the National Urban League would be very concerned if program oversight were moved from HUD, even if safety and soundness oversight was moved to Treasury as some have proposed.

Program oversight should ensure that the housing GSEs keep to their charter and mission, but should also ensure that the housing GSE programs fit into a coherent set of programs at HUD to create the largest affordable housing stock available for America, and that huge disparities in home ownership faced by African-Americans and Hispanics can be closed.

We would be concerned if the programs of the housing GSEs are evaluated out of context, out of the context of a comprehensive housing program, and that faulty conclusions could be reached from the effectiveness or appropriateness of the programs of the housing GSEs, and that inappropriate safety and soundness standards might then cloud the mission of the housing GSEs.

Still, we believe that important improvements could be made in program oversight. Organizations like the National Urban League, and you heard from The Enterprise Foundation just a second ago, and other community-based and nongovernment organizations have worked to address the housing needs of underserved communities.

Beyond comments to proposed rules, we hope that Congress will create a new way of rule-setting to ensure a transparent mechanism, to ensure HUD incorporates the views of such organizations in setting rules and regulations toward goal-setting for the housing GSEs and in program oversight.

To us, the key is not just mission, but whether the program proposals from the housing GSEs would actually lead to the housing targets established by HUD. And as I just explained, we think this is the responsibility of HUD, not just of the housing GSEs, that is, reaching affordable housing targets.

We think that this would incorporate the lessons learned by these organizations—Enterprise, the National Urban League, and others—on the front lines of address the housing problem and into assessing the likely effectiveness of the proposed program enclosing the home ownership gaps experienced by underserved markets.

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Thank you.

[The prepared statement of William E. Spriggs can be found on page 236 in the appendix.]

Mr. BAKER. Thank you, Doctor.

Mr. Courson?STATEMENT OF JOHN COURSON, PRESIDENT AND CEO, PACIFIC MORTGAGE COMPANY, ON BEHALF OF THE MORTGAGE BANKERS' ASSOCIATION OF AMERICA

Mr. COURSON. Thank you, Mr. Baker, Ranking Member Frank, distinguished committee members, thank you inviting the Mortgage Bankers to speak at this important hearing.

MBA members originate loans in the primary market that Fannie Mae and Freddie Mac purchase. MBA, therefore, has a keen interest in maintaining the safety and soundness of our country's real estate finance system.

Fannie Mae and Freddie Mac play two important roles in the American finance system. First, they provide market liquidity, and second, they buy affordable housing loans from lenders so that lower-income Americans, and those living in underserved areas, can get access to housing credit.

Obviously, it is imperative to have effective oversight of the GSEs. The Mortgage Bankers endorse the principles for GSE regulation played out by Secretary Snow and Secretary Martinez before the committee earlier this month. And further, the Mortgage Bankers support certain core principles for effective regulation of Fannie Mae and Freddie Mac.

First, effective safety and soundness oversight is vital. The Treasury Department's successfully regulates both national banks and federal thrifts and has successfully demonstrated its ability to fulfill the role of a financial safety and soundness regulator. The Mortgage Bankers support establishing Treasury as the safety and soundness regulator for Fannie Mae and Freddie Mac.

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Second, the GSE regulators both within Treasury and HUD need to have adequate funding if they are to live up to their important duties. The Mortgage Bankers urge this committee to look at the Office of Thrift Supervision funding arrangement in drafting legislation.

Third, the safety and soundness regulator needs flexibility in setting capital standards. MBA does not mean to imply that today's capital requirements are inappropriate or inadequate in any way. Rather, MBA believes that the regulator needs the tools to respond to changing marketplace conditions.

Capital standards are a fundamental tool in this regard. A statute should not unduly tie a regulator's hand.

Fourth, a regulator needs adequate enforcement authority to correct any problems that may arise, and, more importantly, to deter problems in the first place.

The Mortgage Bankers believe that the banking enforcement tools have proven their effectiveness over the years, and support including such tools for a GSE regulator.

Within these four core principles, one issue stands out to MBA as fundamentally important for the mortgage industry—the safety and soundness of GSE programs and activities.

The activities of Fannie Mae and Freddie Mac have ramifications throughout the American mortgage market, and indeed throughout the domestic and international economies.

For these reasons, all their activities must be safe and sound, not just some. We believe that the approval of new programs and activities is fundamentally linked to financial safety and soundness.

The safety and soundness regulator is in the best position to evaluate the appropriateness of new or proposed GSE programs. Congress should draw a clear line between the primary and secondary mortgage markets.

In no event should the GSEs be permitted to encroach upon the mortgage origination process, or use their Government-sponsored benefits to distort the competitive landscape of the primary mortgage market.

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The Mortgage Bankers also believe that it is important that the regulator not micro-manage the GSE, and that it not unduly constrain the GSEs' ability to innovate in a timely manner to meet the marketplace needs.

Fannie Mae and Freddie Mac have Government sponsorship so they can assist Americans with their housing needs. Effective safety and soundness oversight ensures that the GSEs are able to meet these housing needs.

MBA strongly supports the affordable housing goals for Fannie Mae and Freddie Mac, and endorses HUD's role in setting and enforcing those goals. The Mortgage Bankers strongly urge Congress to reform the oversight of Fannie Mae and Freddie Mac in this manner, so that they can continue in their role of supporting housing, especially affordable housing.

Congressman Baker, thank you, and I am happy to answer any questions.

[The prepared statement of John Courson can be found on page 139 in the appendix.]

Mr. BAKER. Thank you, sir. And welcome back to our former colleague, Mr. Bartlett.STATEMENT OF STEVE BARTLETT, PRESIDENT AND CEO, THE FINANCIAL SERVICES ROUNDTABLE

Mr. BARTLETT. Chairman Baker, Ranking Member Frank, and Congressman Scott, this is about as close to a special order as I have done in any time in the last 12 years.

I notice Congressman Scott is looking at the clock. If you have a flight or something, and you want to take my time to ask a question, I will gladly yield. If that is the issue, that would be fine.

Well, I will stay within my five minutes. My name is Steve Bartlett, I am President of the Financial Services Roundtable and our newly formed Housing Policy Council.

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Collectively, Mr. Chairman, and members of the committee, our member-companies represent the strongest commitment to housing in America today, originating some 70 percent of the residential mortgages in the United States.

Our members strongly support the goal of home-ownership for all Americans, and we help to meet it every day. We understand the functions and operations of both the primary and secondary mortgage markets.

Toward that end, our council has adopted five principles that we believe should guide this committee. Those principles are consistent with the proposal that Secretaries Snow and Martinez offered to the committee.

They include: One, the regulatory agency should be independent and housed within Treasury, much as the OCC and OTS are structured an operate within Treasury.

Second, the agency should be funded by nonappropriated funds.

Third, all supervision and regulation should be in one agency, not divided.

Fourth, the agency should have an abundance of staff qualified to understand, analyze and supervise the quality and the quantity of assets and liabilities of Fannie and Freddie.

And fifth, its securities disclosure should be the same as applicable to all other publicly traded companies.

Now, last week, Mr. Chairman, the council met and considered and added a sixth principle. The new bureau within the Treasury should also have regulatory and supervisory responsibility over the Federal Home Loan Banks.

Thus, the council strongly supports the Administration's proposal that an independent regulator within Treasury, free from the appropriations process, the safety and soundness regulation including the authority to review and approve new GSE activities.

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The regulator should establish capital standards and have enforcement capabilities, and those should be a strong as that of banking regulators.

Speaking of banking regulators, I want to cite as an example the OCC. The OCC has offered a clear road map to follow. It has the authority to supervise all aspects of a national bank's operations, including review of new activities.

There is no need to re-invent the wheel or create new procedures. Now, the council, and I personally I must say, intend in no way to criticize, and it hasn't happened here today, the dedicated personnel at OFHEO or the Federal Housing Finance Board.

I find them to be professional, ethical, dedicated, knowledgeable individuals. They have not had the statutory authority to do their jobs. The Housing Policy Council and the Roundtable believes that under these new proposals they will have an opportunity to do a world-class job.

So in conclusion, the members of the Housing Policy Council believe in our system of housing finance, and we want to strengthen it. We recognize that the housing GSEs have an important role to play, but there is no question that the system of housing finance would benefit from a strong, independent regulator.

Inn conclusion, one statistic which I looked up this morning, the OCC regulates national banks with approximately $3.9 trillion of assets. OFHEO regulates GSEs with approximately $3.3 trillion in assets, owned and guaranteed, almost the same.

The OCC does its job with 2,800 employees, and full statutory independent authority. OFHEO has been asked to regulate almost the same size of assets with 115 employees, and no independent statutory authority.

Therein lies the challenge of this committee, Mr. Chairman, to provide statutory authority for a strong and independent regulator for this critical segment of the nation's financial marketplace and the home-ownership opportunities for all Americans.

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The time to act is now, this session. Thank you.

[The prepared statement of Hon. Steve Bartlett can be found on page 123 in the appendix.]

Mr. BAKER. Thank you, Mr. Bartlett.

Mr. Taylor, it is my understanding that Rahway Savings Institution, as a regulated entity under the Office of Risk Supervision, has to comply today with what is known as community re-investment standards.

Mr. TAYLOR. That is correct.

Mr. BAKER. At issue is whether another entity other than HUD can adequately supervise a social mission compliance in an effective manner. What is your experience with OTS in your responsibilities as an institution in meeting your CRA criteria?

What is the supervision like, and what are the consequences of your failure to meet those standards?

Mr. TAYLOR. If I could just make one correction. We are not OTS-supervised; we are a state chartered bank. So we are supervised by the Department of Banking of the State of New Jersey, as well as the FDIC, as a Federal regulator.

And with regard to that and its relationship to an independent regulator under the Treasury for these GSEs, it has been very simple for us to be able to met our CRA requirements.

We do utilize, I must say also, the GSEs in question to help us attain those goals, in terms of utilizing their services and their programs, which is one of the main reasons why they are so beneficial to us and to the industry.

With regard to a regulator having oversight and having those kind of mission-directed responsibilities, we believe that if an independent agency under Treasury, a truly independent agency, is given the mission statement and the mission of housing as its key measure for these GSEs, that there should be no reason why the housing needs are not fully met.

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Mr. BAKER. Do you share the view of other witnesses that Fannie and Freddie perhaps could do a better job in meeting the needs of low-income minorities and inner-city individuals than they do today?

Mr. TAYLOR. Tough question to answer. I think they have tried, and I commend them for what they have done. I think they have made some great strides.

They do come out with some innovative programs. Our members have taken advantage of them, ACB has entered into relationships with both Fannie Mae and Freddie Mac that deliver mortgages to them, both of which are conventional mortgages as well as CRA-related mortgages.

So I know the endeavor and the attempt on their part has been sincere, as it has been for the industry at large.

Mr. BAKER. Thank you. Mr. Bartlett, a capital-related question. As you know, I have raised the issue with Mr. Raines and others today about the adequacy of maintaining authority for the new regulator to appropriately review risk and adjust minimum capital.

As the rules now stand, the risk-based capital standard only recently promulgated is not yet in effect in the sense that the minimum capital required by statute of 2.5 percent is the actual currently required amount by a GSE.

In order for a regulator, currently OFHEO, to act under the statute, you must be critically undercapitalized, that is a level of 1.25 percent.

By allowing a regulator in the future, not today, no one is suggesting the immediate or imminent adjustment to either risk based or minimum capital standards—what would be your view, from your organization's perspective, given your broad scope of mortgage finance activities, as to the effect of allowing the regulator to have that authority? Would that enhance confidence? Would it have any effect on the ability to make credit available? What is the consequences of following the path that I have suggested?

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Mr. BARTLETT. Chairman Baker, that path should be followed, as Secretary Snow proposed in his testimony. He was quite clear. I read: ‘‘The regulator should also have authority with regard to capital for the GSEs.’’

So it is essential that this regulator be given authority over capital. This is the only regulator in the United States of America that does not have authority over—financial regulator—over capital and that should be an essential part.

Now that authority over capital would enhance the safety and soundness and also enhance the confidence in the system. But I think that's sort of a starting point, and it's a mistake that should be corrected.

Mr. BAKER. Thank you.

Dr. Spriggs, I just have one observation, and I would like to hear your comment with regard to it. I have been involved in the initiation of a Hope 6 grant in my community. And it is a good project but it is potentially flawed unless it involves a number of aspects of community investment.

For example, merely making a line of credit available to an individual to acquire a home may not turn out to be a good event if at the same time you are not providing services in the community, creating jobs in the community and turning a blighted area around to become an economic model for all those who live there.

When we talk about providing resources for affordable housing, should we be looking beyond just the ability of Fannie and Freddie to address the access to capital by low income and perhaps look at it as a community renewal effort? I have been impressed by the community investment programs, CIP program under the Federal Home Loan Bank. And it is a much broader in scope program than what is now required of the two other housing GSEs. Can you comment on the advisability or the nature of that enhancement for the mission compliance for the two GSEs?

Mr. SPRIGGS. That's exactly my point, I think we have to look at it in a comprehensive way. And I would hope that HUD, because they run Hope 6, would think of how do you piece together the whole pie to make a successful Hope 6 project.

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And it does take many different elements. It takes a very strong community-based organization with good technical skills to come into the ground and do as you observed, piece together some of these other things.

Some of them are HUD programs, but sometimes it takes an organization that deals with other federal agencies and put together the whole package from an array of what needs to be in place to make a community work.

Congressman Scott had been concerned that African-American home ownership had been dropping. But you know, this is going to be a key reaction to the recession and the loss of people's job.

So it isn't, as you were just saying, jobs, the structure of the neighborhood are as important, getting credit counseling is as important.

So that's why I think it is important for HUD to think of the goals that they set for the programs they approve for Fannie Mae and Freddie Mac as within that array. And only, in my view, HUD has the ability to think comprehensively about what should the program be to meet our housing goals because they have the other programs. As you were just mentioning, they have the other programs to put into place so we can meet those goals.

And I do not think we should look at Fannie Mae and Freddie Mac and point fingers and say you are a silver bullet, you have not done it. They are not a silver bullet. They are a necessary tool and we need their partnership. But we need to have this viewed as you have just mentioned in a comprehensive way.

Mr. BAKER. Thank you, sir.

Mr. Frank?

Mr. FRANK. I would agree with that. I think basically the point that you just made in the conversation here is that we want to go beyond lower loans and maybe get into some deeper subsidies. But I have a couple of things here.

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First of all, I have to disagree with the gentleman from Louisiana that there is some analogy between the low-income housing goals of Fannie Mae and Freddie Mac and CRA, Community Reinvestment Act. I have defended the Community Reinvestment Act, but it is not a very strong mandate. And I think it is really qualitatively different from the affordable housing goals, which go much more specific. The Community Reinvestment Act says you lend in your own area. And it is not just a comparable mandate.

And yes, I would like to see deeper subsidies. I think the analogy that I asked about before was the affordable housing program of the Federal home loan bank, which was created here under the chairmanship of the late Henry Gonzales. And that is an element of subsidy.

But here is my problem, and I ask you to address this. I worry about increasing the capital requirements and the inconsistency there with the subsidy program. I would like to get Fannie and Freddie more deeply into helping low-income housing and possibly moving into something that is more explicitly a subsidy.

My concern is that this would not be what would be a regulator at Treasury's idea of the best way to promote safety and soundness. And in fact, there is a tension between increasing the capital requirements and increasing the subsidy. I just think you cannot argue it at both ends.

Members of the panel, Mr. Fishbein, let me start with you, if you would comment on that.

Mr. FISHBEIN. Well, I agree with you, Mr. Frank. There was a lot of talk in the discussion today about bifurcation of function. But the reality is that safety and soundness regulation and capital requirements interrelate with public mission. There is always going to be a give and take and a certain tension between these various functions. Hopefully it is a creative one.

Therefore, the regulatory structure that is put into place and the way that communications occur and decisions are made are an extremely important detail that should be part of any restructuring legislation. One of our concerns about placing the vast part of both safety and soundness and mission oversight at Treasury is that we believe that Treasury's emphasis will tend to be on safety and soundness. This will make it hard, therefore, for some close calls about mission to prevail in that kind of environment.

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So there has to be a balance. And the balance has to include equally strong regulatory structures that are in position to bring forth the counter balance and expertise in analysis to ultimately make sound judgments and make sure that one side of regulation does not automatically prevail.

Mr. FRANK. Anyone else wish to address that?

I believe there has been more alarm raised about potential unsafety and unsoundness than, in fact, exists. And it has been my experience that when that happens, people start worrying that things are not secure. And the first thing that happens is the poor people get tossed over the side because, after all, they are the least good risk.

Mr. Bartlett?

Mr. BARTLETT. Ranking Member Frank, this is the same tension that occurs with the OTS and OCC. The point is that because of that tension, the capital standards should not be set by statute. It should be set by a transparent regulatory process, which is in place for all other regulators, and should be authorized by——

Mr. FRANK. Well, I agree. I think my colleague may be asking you whether you think the regulator here, in fact, should more resemble the OTS and the OCC than some of the proposed statutes do.

But I would say this, yes, there is that same tension. But it is not the mission of either the OTS or the OCC to promote low-income housing. And that's the difference.

I don't want to treat Fannie Mae and Freddie Mac the same as I treat a regular bank. If I wanted them to be just like a regular bank, then we wouldn't need a Fannie Mae and a Freddie Mac. We could have a regular bank.

The theory is that we have these separate government-sponsored enterprises that do have some statutory advantages in return for which they focus on housing, and, specifically, we give them goals. We have the Community Reinvestment Act. Maybe if I filed a bill that gave every bank the same kind of low-income housing goals as Fannie and Freddie and some ability to—maybe I could get it passed. I don't think so.

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And they are very different. OCC and OTS have a safety and soundness mandate entirely, with a little bit of social consciousness with the CRA. But the CRA basically says, ‘‘Do not suck too much money out of the community and do not put any back in.’’

It should be qualitatively different than the mandates we have given to Fannie and Freddie.

So I guess that may sum up to me why some of us have some differences on this. I do not want Fannie and Freddie to be just another bank. If they were not going to do more than another bank would because they have so many advantages, then we do not need them.

And so therefore, I do think I do not want the same kind of focus on safety and soundness that we have in OCC and OTS. I want to roll the dice a little bit more in this situation towards subsidized housing.

My time has expired, Mr. Chairman.

Mr. BAKER. Mr. Kanjorski?

Mr. KANJORSKI. Thank you, Mr. Chairman.

Listening to that discussion, I tend to agree that this is a very delicate area on how we handle mission and how we deal with what really independent strong role plus regulation will be and to tailor those two situations to these particular entities, not counting the fact that we have some earlier testimony about throwing in the Federal home loan bank system, which creates an entirely different problem we would have to address.

First of all, is anyone on the panel aware of a crisis situation where we have to do this in the next two or three weeks?

Do you really believe that some of the issues that have been raised here in the discussion with this panel, that this can all be accomplished with deliberative speed in a short period of time, like two or three weeks?

Mr. BARTLETT. Mr. Kanjorski, our organization and our companies have been quite concerned about this from a safety and soundness as well as a mission for the last several years. We have communicated that concern. But recently, that concern seems to have been highlighted by a number of factors.

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So, yes, sir, I believe there is an urgency that is to the tune of some $3.3 trillion that is either owned or guaranteed by these two agencies that all the testimony that you have heard today bring in some question as to whether they are being properly regulated. So we think they are not being properly regulated. And we believe that with $3.3 trillion, you do not want to wait too long. And now is the time to act.

Mr. KANJORSKI. I would not suggest that everyone has questioned whether or not we can construct a better regulatory authority than what we presently have. I do not know whether we want to put a qualitative standard on what has existed. But my question is, we have so many fundamental questions, particularly missions and what is a strong independent regulator.

It seems to be we are going to have to wrestle a lot of things. Somebody suggested we write the mission. I think it was Mr. Raines. I venture to say I could anticipate taking weeks and weeks and weeks hammering that around and just what that description in statute should be of what the mission is so that it can be more readily applied.

My problem is I think we have a lot of haste here. We are going to run down and, Steve, having served on this committee before, you know what happens in haste. We sometimes do not dot all of our i's and cross all of our t's. And we can leave some awfully large holes in this mission.

Example, we are just starting to get down to people using the same description of what—you use the term independent and strong independent regulator and gave the example of the OCC and the OTS.

The Secretary, last week, said independent, strong, world-class regulator and gave the example of the IRS. I see a world of difference in that. And he may be more correct than we are or vice versa. But it seems we have to work.

If we are not defining our terms in the same way, we are going to put out a news release that Congress has passed a world-class, strong, independent regulator who cannot come up and talk to Congress, who cannot decide policy questions, who has limitations on supervision, has limitations on prosecutions, et cetera, et cetera, and going right down the line.

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Or else, if we all put our minds to it and things do crystallize, we can come up with it.

I am just worried about doing in the limited amount of time left in this session. And I, myself, would like to have the legislation float for a while, so a lot of people could give us critiques of some of the problems that they see every day.

I left this session three or four times and met with people who critiqued me on various things happening here. I find that very informative and helpful, because, obviously, I do not think any of us on the committee are real experts in this area.

We are trying to craft language that will reflect expertise beyond the committee, actually.

With that, I appreciate all of the testimony of the panel. I look forward to hearing from you. As one member of Congress, look, if you see something happening, our names, you just have to call the Capitol operator and get a hold of us, give us some insight and some input as to, you know, how that big truck isn't going to fit in that little garage before we construct the garage.

And other than that, let's hope we can do something really contributory here to this system instead of ending up with just a whitewash on the garage door because there has been some circumstances that have brought this along.

With that, thank you very much for your testimony.

Mr. Chairman, I yield back.

Mr. BAKER. Mr. Scott?

Mr. SCOTT. Thank you, Mr. Chairman. I appreciate it so much.

Needless to say, this is an extraordinarily important issue to my constituents. I represent four of the fastest growing counties in the United States—middle-class, moderate, and lower-income. There is no greater need than housing.

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The fundamental question that I have, and I would like to get a response first from Mr. Bartlett and Mr. Spriggs, because I think between the two of your testimony rests one of the fundamental issues that must be resolved. And that is this: There are some special reasons that Freddie Mac and Fannie Mae were put together. They have a special mission.

And there is much concern that this shift away from HUD over to the Treasury Department is in effect, throwing the baby out with the bath. There are concerns, especially from the minority community, and of those minority communities, as I pointed out, from this home-ownership rates, there is not one group within the minority groups that are suffering more than the African-Americans.

It is the only group in this country in which home ownership rates have gone down in this past year.

The others have increased bit by bit, and in African-American communities, it has gone down.

The reason I point that out is because there are some special peculiarities, sensitivities, that obviously affect the African-American community in terms of home ownership than any other group.

We are concerned that in this move that, at least with HUD, in terms of its comprehensive dealing with housing, the history, all of that there, that something will get lost in the move of this oversight to the Treasury Department.

I have some great appreciation for the safeness and the soundness aspect of this measure, and I certainly commend Congressman Baker on that pursuit.

But I think he along with all of us here on this panel must be assured that we are not losing any priority, any understanding, and in fact will strengthen any effort to move, or we don't move it, because I don't think that the American people would go along with that. The American people are fair people, and understanding people, and keep in mind there is a mission here that must not be compromised.

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And I would like to hear from you, Mr. Spriggs, and you, Mr. Bartlett, because I think the two of you, again, represent a solution to this, coming from two different sides. You are supporting this move to the Treasury, and Mr. Spriggs is saying there must be caution on it.

But first, Mr. Spriggs, what safeguards, what assurances would you be looking for in this area?

Mr. SPRIGGS. Well, again, because I think the reality is that the housing problem is complex, and it can't be solved only pointing at mortgage bankers or only pointing at Fannie Mae. And if a regulator has the responsibility of soundness primarily and comes from an institution that looks that way, I fear it would be like CRA. And those of us in many organizations have big struggles over getting the Community Reinvestment Act meaningfully enforced.

It is very rare to see a bank get a bad grade on their CRA. And it is not as if they are doing fantastic things. But it is just simply not the primary responsibility in evaluating them, to get meaningful about what are their real CRA activities.

And we are asking Fannie Mae to participate in something key and fundamental. As you said, Congressman, Americans are fair. And there are certain common values we have. Home-ownership is just one of those mom-and-apple-pie things. We all think that part of the American dream is to be able to own a home. And all Americans think that we should figure out how to solve home-ownership.

So that is much more specific than the CRA requirement. And I think it affects people differently when they think about whether you are meeting that target. If I get on Fannie Mae or Freddie Mac for not meeting the home-ownership, I think people react differently than if I say a bank didn't do 30 percent of loans in some neighborhood, and I am amorphous about whether those are business loans or whatever. I mean it just doesn't sound—it sounds like I am forcing the bank to do something bad.

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Home-ownership is something everybody agrees is something we want to take place. So if it is a specific goal, it is a goal that needs to be integrated into a whole program; you can't just do it with one program. And it needs a whole Department, like HUD, to think through what are all the components, what is the realistic goal, because HUD has to deal with this. They can't give an unrealistic goal. What is the realistic goal?

And then to look at a program and be able to say, ‘‘Well, we have these programs. We know what they can do.’’ If you are coming up with a program that is not going to get to that goal, we have all the metrics to compare it and tell you, that is not really a meaningful program. It may sound good on paper, but it is not a meaningful program.

So the theory is that we want it with an agency that has the expertise, that will set and is used to setting these specific and reasonable goals, and is thinking in a comprehensive way about how does that goal and how do the programs that are in place to meet that goal, how do they all fit together.

And I would be afraid of giving this to someone else who didn't have all that in front of them and, I would fear, drop the ball and let it escape or approve a program in a way that might be not as critical or disapprove of a program because they were not getting or were not as concerned about the goal.

Mr. SCOTT. Mr. Bartlett?

Mr. BARTLETT. Congressman Scott, thank you for the question.

First, Congressman, setting the GSE affordable housing goals under the Secretary's proposal, the two Secretaries, would remain at HUD. We believe and they believe that the process would be strengthened because there would be a transparent regulatory process that would be open for comment for all, and that is not the case today.

Secondly, I do agree that there is a special mission of Fannie and Freddie and the GSEs. In fact, and you have no way of knowing this, I was one of the principal authors of the 1983 act that started this, when it was much smaller.

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And we set that mission, in layman's terms, as providing liquidity in the residential secondary mortgage market. It has succeeded beyond the wildest imagination, because by 1992, that was changed and Fannie would contend that it was significantly expanded.

But nevertheless, the regulatory structure was not caught up to it. A regulator was created that took—without the authority to adopt capital standards that every other regulator has always had, and it took eight years for them to issue their first regulation because of the statutory hamstring, not bad people.

So it has gotten to a $3.3 trillion overhang over the nation's economy. And unless strong, independent regulation is provided, the housing goals for Fannie and Freddie will go in the tank because the system will ultimately be in jeopardy. The system would be in jeopardy.

And that is why we are here, is to achieve those housing goals and make sure that we have strong capital standards to achieve them.

So I think this is a hearing and will be legislation that is designed to strengthen the system so that it can continue to provide housing and not allow it to be weakened.

Mr. FISHBEIN. Mr. Scott, can I answer that question as well?

Mr. SCOTT. Yes.

Mr. FISHBEIN. I certainly agree. It is our position, too, that mission responsibility should remain in HUD. But, in saying that, I would like to make some additional points.

First, that HUD is underfunded to do its present mission responsibility; that there are no special appropriations to perform this regulation; that HUD pays for funding for the staff—who are very dedicated, by the way, and very experienced from the general HUD operating budget. This sometime means that HUD has to make difficult budget choices.

So providing full funding, whether it be through an assessment process or a special appropriation, is absolutely critical.

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Second, if the public mission function does get transferred, to Treasury, it is necessary to ensure that the director of this new office accountable for both functions. They should be judged by their ability to conduct safety and soundness oversight well, but also by their ability to discharge the function as public mission regulator.

Combining both functions into a single office is very difficult which is why we have some concerns about such a move.

Should the Congress in its wisdom decide to go ahead and do that, it is very important these two functions be viewed as equally important. Ultimately, the person who heads this office should have the responsibility for discharging both duties with equal seriousness.

Mr. BAKER. Mr. Scott, in H.R. 2575, we have an independent assessment formula not only for safety and soundness within the OTS, but we also have a separate assessment in HUD for HUD's functions. So that is a very strong new, additional authority to ensure that your concerns about mission compliance is in hand.

Mr. TAYLOR. Could I comment on that last point?

We have heard today and we have talked a lot today about a world-class regulator. And I think we have heard testimony from Fannie Mae Chair Raines on this issue, and that is that he has investors that are not just in the United States but international, and that we are looking to create something to bring credibility to the marketplace.

And I would ask the question, what makes a regulator world-class if we take away its independence? What if it does not have the ability to look at or set capital standards and has no oversight on product and services? So at the end of the day, if the idea behind this is to have a world-class regulator for the GSEs, and then we limit its ability to regulate, what have we really done?

Mr. BAKER. You done?

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Okay, thank you, Mr. Scott.

Just for the record, I want to establish that the current bill pending, 2575, was actually introduced on June 24th. Since the 106th Congress, I have been a part of or participated in 15 hearings on the subject of GSE regulation. And with the conclusion of this panel, you will be pleased to know you are part of 81 witnesses who have come before the Capital Market Subcommittee or the full committee on this subject. I would hope that in view of that record one would come to the conclusion we are not particularly rushing to judgment here.

But with all that aside, I want to express my appreciation to each of you for your perspectives that you have brought to the table. I do believe it will be helpful to us in formulating whatever the final product will ultimately look like.

I think the combination, frankly, of safety and soundness with mission compliance are not mutually exclusive, that we can take actions that are not only good for the enterprises and their shareholders, but we can take action that is also beneficial to the taxpayer. There is a net win to this process and the mere examination of the subject has not caused the housing market nor interest rates to go anywhere but down.

Since 1991, when we first began the discussion of creation of OFHEO, and you look at all the hostilities back and forth from controversial matters that were introduced or hearings that were engaged in, I suggest to you the Alan Greenspan effect is much more powerful than all of this combined. And we are enjoying record-low interest rates for an extraordinarily long period of time. And if we are ever to engage in reformation of regulatory function, this window is a rare one indeed.

So not that it is our intent to have any person denied access to home ownership, in fact, I think the GSEs can do a great deal more in that regard than the do today. And I will join with my friends in seeking out statutory provisions to ensure that compliance.

But at the end of the day, this is far too important. They have grown so fast for too long that this issue does need a world-class regulator with the appropriate skills.

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I also want to introduce into the record a statement by Mr. Rick Lazio, former member who now is President of the Financial Services Forum who could not be here but wanted to have that in the official hearing record.

[The following information can be found on page 246 in the appendix.]

Unless there are further comments, I thank you for your long-suffering patience. Meeting adjourned.

[Whereupon, at 4:20 p.m., the subcommittee was adjourned.]


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