Government-Sponsored Enterprises
A Framework for Strengthening GSE Governance and Oversight
Gao ID: GAO-04-269T February 10, 2004
Congress established government sponsored enterprises (GSE)-- such as Fannie Mae, Freddie Mac, the FHLBank System, and the Farm Credit System--to facilitate the development of mortgage and agricultural lending in the United States. Although the federal government does not explicitly guarantee the GSEs' approximately $4.4 trillion in financial obligations, the potential exists that the government would provide financial assistance in an emergency as it has done in the past. Recent financial reporting problems at Freddie Mac have raised concerns about the quality of the GSEs' corporate governance and regulatory oversight. To assist Congress in reviewing the adequacy of GSE oversight, this testimony provides information on GSE corporate governance, regulatory oversight, and mission compliance measures.
GSEs should lead by example in connection with governance, accountability, integrity, and public trust issues. GSEs should strive to achieve model corporate governance structure, provide reasonable transparency of financial and performance activities, and adopt compensation arrangements that focus on both long-term and short-term results. However, GSE corporate governance has not always reflected best practices. For example, currently, the Chief Executive Officers (CEO) of Freddie Mac and Fannie Mae also serve as the chairmen of their respective GSE boards, which is not consistent with model governance standards that call for officers to work for an independent board. GAO notes that as part of its regulatory agreement, Freddie Mac has agreed to separate the position of CEO and the position of chairman within a reasonable period of time. However, Fannie Mae has yet to take this step. With respect to compensation arrangements, Freddie Mac's focus on short-term financial results as performance targets appears to have contributed to the GSE's recent financial reporting problems. GSE regulators must be capable, credible, strong, and independent. However, the regulatory structure for the housing GSEs--Fannie Mae, Freddie Mac, and the FHLBank System--is fragmented with safety and soundness and mission oversight responsibilities divided among three regulators. A single housing GSE regulator offers many advantages over this fragmented structure including prominence in government, the sharing of technical expertise, and the ability to assess trade-offs between safety and soundness considerations and certain mission compliance activities, such as affordable housing initiatives. Although there are advantages of a single director model for the new housing GSE regulator, GAO believes on balance that a board or a hybrid board and director might make the most sense to oversee the GSEs' safety and soundness and mission oversight. To be effective, the single GSE regulator must also have all the regulatory oversight and enforcement powers necessary to carry out its critical responsibilities. Because of a lack of clear measures, it is difficult for Congress, accountability organizations, and the public to determine whether the benefits provided by the GSEs' activities are in the public interest and outweigh their financial risks. Available evidence and data indicate that the housing GSEs have made, in some cases, progress in benefiting homebuyers. For example, it is generally agreed that Fannie Mae and Freddie Mac's activities have lowered mortgage interest rates, although there is debate over the degree of these benefits. However, it is not clear that the housing GSEs' large holdings of mortgage-backed securities benefit borrowers. There is also limited information as to the extent to which the FHLBank System's more than $500 billion in outstanding loans to financial institutions have facilitated mortgage lending.
GAO-04-269T, Government-Sponsored Enterprises: A Framework for Strengthening GSE Governance and Oversight
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Testimony:
Before the Committee on Banking, Housing, and Urban Affairs, U.S.
Senate:
United States General Accounting Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EST:
Tuesday, February 10, 2004:
Government-Sponsored Enterprises:
A Framework for Strengthening GSE Governance and Oversight:
Statement of David M. Walker Comptroller General of the United States:
GAO-04-269T:
GAO Highlights:
Highlights of GAO-04-269T, a testimony before the Committee on
Banking, Housing, and Urban Affairs, U.S. Senate
Why GAO Did This Study:
Congress established government sponsored enterprises (GSE)”such as
Fannie Mae, Freddie Mac, the FHLBank System, and the Farm Credit
System”to facilitate the development of mortgage and agricultural
lending in the United States. Although the federal government does not
explicitly guarantee the GSEs‘ approximately $4.4 trillion in
financial obligations, the potential exists that the government would
provide financial assistance in an emergency as it has done in the
past. Recent financial reporting problems at Freddie Mac have raised
concerns about the quality of the GSEs‘ corporate governance and
regulatory oversight.
To assist Congress in reviewing the adequacy of GSE oversight, this
testimony provides information on GSE corporate governance, regulatory
oversight, and mission compliance measures.
What GAO Found:
GSEs should lead by example in connection with governance,
accountability, integrity, and public trust issues. GSEs should strive
to achieve model corporate governance structure, provide reasonable
transparency of financial and performance activities, and adopt
compensation arrangements that focus on both long-term and short-term
results. However, GSE corporate governance has not always reflected
best practices. For example, currently, the Chief Executive Officers
(CEO) of Freddie Mac and Fannie Mae also serve as the chairmen of
their respective GSE boards, which is not consistent with model
governance standards that call for officers to work for an independent
board. GAO notes that as part of its regulatory agreement, Freddie Mac
has agreed to separate the position of CEO and the position of
chairman within a reasonable period of time. However, Fannie Mae has
yet to take this step. With respect to compensation arrangements,
Freddie Mac‘s focus on short-term financial results as performance
targets appears to have contributed to the GSE‘s recent financial
reporting problems.
GSE regulators must be capable, credible, strong, and independent.
However, the regulatory structure for the housing GSEs”Fannie Mae,
Freddie Mac, and the FHLBank System”is fragmented with safety and
soundness and mission oversight responsibilities divided among three
regulators. A single housing GSE regulator offers many advantages over
this fragmented structure including prominence in government, the
sharing of technical expertise, and the ability to assess trade-offs
between safety and soundness considerations and certain mission
compliance activities, such as affordable housing initiatives.
Although there are advantages of a single director model for the new
housing GSE regulator, GAO believes on balance that a board or a
hybrid board and director might make the most sense to oversee the
GSEs‘ safety and soundness and mission oversight. To be effective, the
single GSE regulator must also have all the regulatory oversight and
enforcement powers necessary to carry out its critical
responsibilities.
Because of a lack of clear measures, it is difficult for Congress,
accountability organizations, and the public to determine whether the
benefits provided by the GSEs‘ activities are in the public interest
and outweigh their financial risks. Available evidence and data
indicate that the housing GSEs have made, in some cases, progress in
benefiting homebuyers. For example, it is generally agreed that Fannie
Mae and Freddie Mac‘s activities have lowered mortgage interest rates,
although there is debate over the degree of these benefits. However,
it is not clear that the housing GSEs‘ large holdings of mortgage-
backed securities benefit borrowers. There is also limited information
as to the extent to which the FHLBank System‘s more than $500 billion
in outstanding loans to financial institutions have facilitated
mortgage lending.
What GAO Recommends:
GAO recommends several steps that GSEs, regulators, and Congress can
take to strengthen GSE oversight. These steps include strengthening
GSE corporate governance, creating a single housing GSE regulator, and
establishing standards to measure GSE mission compliance.
www.gao.gov/cgi-bin/getrpt?GAO-04-269T.
To view the full product, including the scope and methodology, click
on the link above. For more information, contact Thomas J. McCool at
(202) 512-8678 or mccoolt@gao.gov.
[End of section]
Mr. Chairman, Mr. Ranking Member, and Members of the Committee:
I appreciate the opportunity to participate in today's hearing to
discuss oversight of the government-sponsored enterprises (GSE), namely
Fannie Mae, Freddie Mac, the Federal Home Loan Banks (FHLBanks), the
Farm Credit System (FCS), and the Federal Agricultural Mortgage
Corporation (Farmer Mac). I note that the GSEs had combined
obligations, including mortgage-backed securities (MBS) and other debt
obligations, of $4.4 trillion as of September 30, 2003, and, as I will
explain in detail later, the potential exists that the federal
government may choose to provide financial assistance to the GSEs in an
emergency. Accounting and financial reporting problems related to
earnings disclosed by Freddie Mac last year have raised several
concerns about the company's management and board of directors as well
as the effectiveness of regulatory oversight that is designed to
protect taxpayers from the risks associated with the GSEs. Recently
reported investment losses at the FHLBanks have also served to raise
public concerns regarding the well-being of GSEs. These events prompted
Congress to consider the need for meaningful reforms to help strengthen
the oversight of GSEs. In my view, our past experience in the savings
and loan industry, the recent accountability breakdowns in the private
sector, and the importance of gaining public trust for regulatory
agencies that oversee our financial institutions and our capital
markets is directly relevant to the ongoing debate on appropriate
regulatory oversight of GSEs.
It is clear that many parties have different views on what needs to be
fixed and how to do it. My comments today are intended to frame GSE
oversight issues broadly and provide our views on some of the questions
and options that must be addressed to better oversee the GSEs going
forward. Although my comments will largely focus on the housing GSEs--
Fannie Mae, Freddie Mac, and the FHLBank System---given the themes of
our discussion today, I will also use examples from the other GSEs to
illustrate my points. We look forward to working with Congress to
provide assistance in defining these issues, exploring various options,
and identifying their implications in order to address any weaknesses
that could serve to threaten confidence in our financial markets and
that inhibit improvements in the current regulatory structure.
My testimony today is divided into two sections. In the first part, I
will provide an overview of the GSEs and their missions, discuss the
risks they pose to taxpayers and financial markets, and then I will lay
out principles to help ensure effective governance and oversight of the
GSEs. Second, I will provide our views regarding the extent to which
GSE governance and oversight structures are consistent with these
important principles.
In summary, to ensure that the GSEs operate in a safe and sound manner,
it is essential that effective governance, reasonable transparency, and
effective oversight systems are established and maintained. In
particular, the GSEs should lead by example in the area of corporate
governance; GSE regulators must be strong, independent, and have
necessary expertise; and GSE mission definitions and benefit measures
need to be established. However, our work found that GSE corporate
governance does not always reflect best practices; for example, Fannie
Mae's Chief Executive Officer (CEO) serves as chairman and its Chief
Operating Officer (COO) and Chief Financial Officer (CFO) both serve as
vice chairmen of the board, which is not consistent with model
governance theory that calls for an independent board and chair. I note
that Freddie Mac's CEO is also the chairman of that company's board but
Freddie Mac has agreed to split these functions in the future.
Furthermore, the regulatory structure for the housing GSEs is
fragmented and serious questions exist as to the capacity of GSE
regulators to fulfill their responsibilities. In each of these areas, I
will summarize steps that Congress, GSEs, and regulators can take to
improve GSE governance and oversight. In particular, I believe that
Congress should establish a single housing GSE regulator that would be
governed by a board or a hybrid board and director and provided with
the authorities necessary to carry out its mission.
To prepare for this testimony, we relied heavily on a substantial
amount of work that we had done on GSEs and their regulatory oversight
in the past, but we also reviewed our historical positions in light of
the current regulatory structure and GSE activities. The attachment
lists reports representing this body of work. In addition to reviewing
our past work, we solicited views of officials from the Office of
Federal Housing Enterprises Oversight (OFHEO), the Department of
Housing and Urban Development (HUD), and the Federal Housing Finance
Board (FHFB). We also reviewed financial data on the GSEs, best
practices standards for corporate governance, and regulatory reports on
such issues as the GSEs' effects on financial market stability. We
conducted our work in Washington, D.C., between November 2003 and
January 2004 in accordance with generally accepted government auditing
standards.
Overview of GSEs, Their Risks, and Principles for Effective Governance
and Oversight:
I would like to begin by summarizing the roles and responsibilities of
the GSEs, describing their potential risks to taxpayers and the
financial markets, and offering certain principles on governance and
oversight to help ensure that the GSEs' activities are safe, sound, and
consistent with their public missions.
What are the GSEs and How Do They Carry Out Their Missions?
Over the past century, Congress established GSEs to address concerns
that private financial institutions were not adequately meeting the
credit needs of homebuyers and agricultural interests (see table 1).
The GSEs are government-sponsored, privately owned and operated
corporations whose public missions are to enhance the availability of
mortgage and agricultural credit across the United States. It is also
generally understood that the housing GSEs' public missions include the
obligation to meet the needs of targeted groups of borrowers.[Footnote
1] The GSEs generally carry out their missions by (1) borrowing funds
in the capital markets and purchasing assets from financial
institutions or making loans to the institutions or (2) securitizing
assets and providing a credit guarantee to security holders. These
activities may provide mortgage or real estate credit to homebuyers,
businesses, or farmers at rates or conditions more favorable than those
that would be available in the absence of these GSEs. It is important
to note that the GSEs' debt and security offerings are not explicitly
guaranteed or insured by the U.S. government.
Table 1: Overview Information on the GSEs as of September 30, 2003:
Dollars in billions:
Fannie Mae (1938);
Financial obligations: $2,187[A];
Structure: For profit publicly traded;
Regulator: OFHEO - safety & soundness;
HUD - mission.
Freddie Mac (1970);
Financial obligations: $1,388[A];
Structure: For profit publicly traded;
Regulator: OFHEO - safety & soundness;
HUD - mission.
FHLBank System (1932);
Financial obligations: $716.9[B];
Structure: 12 District Banks;
Member-owned cooperatives;
Regulator: FHFB.
FCS (1916);
Financial obligations: $97.1[C];
Structure: 5 banks and 99 Associations;
Member-owned cooperatives;
Regulator: Farm Credit Administration.
Farmer Mac (1987);
Financial obligations: $7.2[D];
Structure: For profit publicly traded;
Regulator: Farm Credit Administration - Office of Secondary Market
Oversight.
Sources: OFHEO, FHLBank System Office of Finance, Federal Farm Credit
Banks Funding Corporation, and Farm Credit Administration (FCA).
[A] Includes short-and long-term debt and MBS held by investors.
Freddie Mac data are as of December 31, 2002, and are subject to change
as Freddie Mac is currently restating its 2002, 2001, and possibly 2000
financial statements.
[B] FHLBank System consolidated obligations.
[C] Total liabilities, including securities, bonds, and other
liabilities.
[D] On-balance sheet liabilities and off-balance sheet liabilities,
including agricultural mortgage-backed securities (AMBS) held by
investors.
[End of table]
Let me now briefly discuss the missions and activities of each of the
GSEs:
* Fannie Mae and Freddie Mac's mission is to enhance the availability
of mortgage credit across the nation during both good and bad economic
times by purchasing mortgages from lenders (banks, thrifts, and
mortgage lenders) that use the proceeds to make additional mortgages
available to homebuyers. Most mortgages purchased by Fannie Mae and
Freddie Mac are conventional mortgages, which have no federal insurance
or guarantee. The companies' mortgage purchases are subject to a
conforming loan limit that currently stands at $333,700 for a single-
family home in most states. Although Fannie Mae and Freddie Mac hold
some mortgages in their portfolios that they purchased, most mortgages
are placed in mortgage pools to support MBS. Fannie Mae and Freddie Mac
issued MBS are either sold to investors (off-balance sheet obligations)
or held in their retained portfolios (on-balance sheet obligations).
Fannie Mae and Freddie Mac guarantee the timely payment of interest and
principal on MBS that they issue.
* The 12 FHLBanks traditionally made loans--also known as advances--to
their members (typically banks or thrifts) to facilitate housing
finance and community economic development. FHLBank members are
required to collateralize advances with high quality assets such as
single-family mortgages. More recently, the FHLBanks initiated programs
to purchase mortgages directly from their members and hold them in
their retained portfolios. This process is similar to Fannie Mae and
Freddie Mac's traditional business activities, although the FHLBanks do
not currently have the authority to securitize mortgages.
* FCS, of which Farmer Mac is an independent institution, is a
nationwide network of borrower-owned financial institutions and
specialized service organizations. FCS consists of six Farm Credit
Banks and one Agricultural Credit Bank, which provide funding and
affiliated services to locally owned Farm Credit associations and
numerous cooperatives nationwide. Among other activities, FCS provides
credit and related services to farmers, ranchers, producers, and rural
homeowners.
* Farmer Mac's mission is to provide for a secondary marketing
arrangement for agricultural real estate and rural housing loans
subject to its underwriting standards. Farmer Mac purchases mortgages
directly from lenders for cash and purchases bonds from agricultural
lenders. Farmer Mac securitizes mortgages and issues AMBS and, like
Fannie Mae and Freddie Mac, guarantees the timely payment of interest
and principal on these securities. Farmer Mac holds most of the AMBS
that it issues in its retained portfolio.
What are the Risks of the GSEs?
As a result of their activities, the GSEs' outstanding debt and off-
balance sheet financial obligations are large. The GSEs' financial
obligations were $4.4 trillion as of September 30, 2003. By comparison,
the U.S. Treasury had $6.8 trillion in total obligations for the same
date. The GSEs face the risk of losses primarily from credit risk,
interest rate risk, and operational risks.[Footnote 2] Although the
federal government explicitly does not guarantee the obligations of the
GSEs, it is generally assumed on Wall Street that assistance would be
provided in a financial emergency. In fact, during the 1980s the
federal government provided financial assistance to both Fannie Mae and
FCS when they experienced difficulties due to sharply rising interest
rates and declining agricultural land values, respectively. The
potential exists that Congress and the Executive Branch would determine
that such assistance was again necessary in the event that one or more
of the GSEs experienced severe financial difficulties. Because the
markets perceive that there is an implied federal guarantee on the
GSEs' obligations, the GSEs are able to borrow at interest rates below
that of private corporations, which--as I discussed earlier--allows
them to extend credit to financial institutions at favorable rates.
The GSEs also pose potential risks to the stability of the U.S.
financial system. In particular, if Fannie Mae, Freddie Mac, or the
FHLBank System were unable to meet their financial obligations, other
financial market participants depending on payments from these GSEs,
may in turn become unable to meet their financial obligations. This
risk, called systemic risk, is often associated with the housing GSEs
because of the sheer size of their financial obligations. For example,
as discussed in OFHEO's 2003 report on systemic risk, if either Fannie
Mae or Freddie Mac were to become insolvent, financial institutions
holding the enterprise's MBS could be put into a situation where they
could no longer rely on those securities as a ready source of
liquidity.[Footnote 3] Depending on the response of the federal
government, the financial health of the banking segment of the
financial services industry could decline rapidly, possibly leading to
a decline in economic activity. As another example, derivatives
counterparties holding contracts with a financially troubled GSE could
realize large losses if the GSE were no longer able to meet its
obligations. If such a hypothetical event were to occur, widespread
defaults could occur in derivatives markets.
How Can GSE Risks Be Mitigated?
To prevent the need for the federal government ever to have to provide
financial support to a GSE and to minimize the risks of financial
instability, it is critical to ensure that proper corporate governance,
reasonable transparency, and effective oversight systems are in place.
There are several lines of defense to ensure that GSEs' activities are
conducted in a safe and sound manner including management, boards of
directors, auditors, and regulators. As we have seen in recent private
sector instances such as Enron and Worldcom, these critical lines of
defense can and do fail. Consequently, the private sector, Congress,
and regulators have initiated actions--such as the passage and
implementation of the Sarbanes-Oxley Act--to ensure that the risk of
such failures of governance and oversight are minimized. In my view, it
is all the more important that strong safeguards are established for
the GSEs because such institutions are not subject to the same degree
of market discipline as other privately run businesses. As a result of
the perception of an implied guarantee of GSE obligations, customers
and creditors may be less willing to monitor the companies' risk-
taking, which could encourage managers to take on excessive risks.
I would now like to offer, on the basis of both my own experience and
past GAO work, several specific and pragmatic principles to ensure
effective GSE governance and oversight:
The GSEs Should Lead by Example in Terms of Corporate Governance and
Accountability:
Not only should GSEs be sensitive to good governance but it is all the
more important they lead by example in connection with accountability,
integrity, and public trust. In particular, GSEs should strive to have
a truly independent board, compensation arrangements consistent with
their public mission and private shareholder obligations, and
appropriate transparency of their financial activities. Under model
governance theory, the board of directors works in the best interest of
the shareholders and the CEO works for the board. Board members should
be independent and be able to provide strategic advice to management in
order to help maximize shareholder value. The board should also help
manage risk to shareholders and have a clear responsibility to hold
management accountable for results both currently and over time. I note
that in the context of the GSEs, boards could also have a
responsibility to ensure that the GSEs' activities fulfill their public
missions. In some cases, there can be a tension between maximizing
shareholder value and fulfilling public missions. GSE boards and
executives must have the requisite commitment and talent to respond to
this challenge.
To adhere to model governance theory, it is also important for the
board to ensure that overall executive compensation is aligned with
achievements related to the company's long-term strategic objectives
and less on short-term accomplishments such as quarterly or annual
earnings. Further, it is not just the total amount of compensation but
the form and structure of executive compensation arrangements that is
important as well. Finally, transparency through timely and reliable
financial and performance information and reasonable disclosures is
necessary to enable capital markets and investors to understand related
values and risks associated with the GSEs. Market discipline works best
when firms fully and publicly disclose their financial obligations and
activities.
The GSEs Require a Strong, Independent, and Capable Regulatory System:
A regulatory system of GSE oversight must have the necessary strength,
independence, and capability to protect against the significant risks
and potential costs to taxpayers posed by the GSEs. We have
consistently supported and continue to believe in the need for the
creation of a single regulator to oversee both safety and soundness and
mission of the housing GSEs, which, as I will describe later, are
currently divided among OFHEO, HUD, and FHFB.[Footnote 4] A single
regulator could be more independent and objective than separate
regulatory bodies and could be more prominent than either one alone.
Although the housing GSEs operate differently, the risks they manage
and their missions are similar. We believe that valuable synergies
could be achieved and expertise in evaluating GSE risk management could
be shared more easily within one agency. In addition, we believe that a
single regulator would be better positioned to oversee the GSEs'
compliance with mission activities, such as special housing goals and
any new programs or initiatives any of the GSEs might undertake. This
single regulator should be better able to assess these activities'
competitive effects on all three housing GSEs and better able to ensure
consistency of regulation for GSEs that operate in similar markets.
Further, a single regulator would be better positioned to consider
potential trade-offs between mission requirements and safety and
soundness considerations, because such a regulator would develop a
fuller understanding of the operations of these large and complex
financial institutions. Some critics of combining safety and soundness
and mission have voiced concerns that doing so could create regulatory
conflict for the regulator. However, we believe that a healthy tension
would be created that could lead to improved oversight. The trade-offs
between safety and soundness and compliance with mission requirements
could be best understood and accounted for by having a single regulator
that has complete knowledge of the GSEs' financial condition, regulates
the mission goals Congress sets, and assesses efforts to fulfill them.
To be effective, the single regulator must have all the powers,
authorities, and technical expertise necessary to oversee the GSEs'
operations and compliance with their missions.
Measures Must Be Established to Help Ensure That the GSEs' Benefits
Outweigh the Financial Risks That Their Activities Pose to Taxpayers:
Without clearly defined measures of the GSEs' benefits, it is not
possible for Congress, accountability organizations, and the public to
determine whether the federal government should be subject to the
financial risks associated with the GSEs' activities. I acknowledge
that developing such measures may prove challenging for several
reasons. First, isolating the GSEs' effects on mortgage and
agricultural credit markets is a complex and technical undertaking.
Second, the GSEs' financial activities have evolved over the years and
become increasingly sophisticated, which further complicates any
analysis of the GSEs' benefits and costs. Third, in some cases, there
is a lack of measurable mission-related criteria that would allow for a
meaningful assessment of the GSEs' mission achievement or whether the
GSEs' activities are consistent with their charters. Nevertheless, past
actions by Congress and regulators demonstrate that developing such
quantifiable measures is possible. For example, in 1992, Congress
required HUD to set numeric housing goals for Fannie Mae and Freddie
Mac to help ensure that their mortgage purchases served the needs of
low-income households as well as other targeted groups.
The GSEs' Corporate Governance, Regulatory Oversight, and Mission
Compliance Reporting Can Be Strengthened:
Now that I have laid out the risks associated with the GSEs and
principles for effective governance and oversight, I would like to turn
my attention to how the current system compares with those principles.
While there is some positive information to report about the GSEs,
there are also weaknesses in the areas of corporate governance,
regulatory oversight, and mission compliance reporting. In each of
these areas, there are steps we believe Congress, the regulators, or
GSEs can take to address weaknesses in GSE governance and oversight
that we have identified.
GSE Corporate Governance Practices Can Be Improved:
The GSEs' corporate governance practices are not fully consistent with
the principles that I previously mentioned. The first principle I
discussed is independence of the board and the role of the board of
directors. There are instances where the GSEs can further their efforts
in ensuring board independence. To illustrate:
* Like CEOs at many other publicly traded companies, the CEO of Fannie
Mae and the CEO of Freddie Mac currently serve as chairman of their
respective boards of directors. In addition, Fannie Mae's COO and CFO
both serve as vice chairmen of the board. All too frequently, such
individuals will have significant influence over who is asked to join
the board and who is asked to leave it. OFHEO, in its special
examination of Freddie Mac (OFHEO report), recommended that Freddie Mac
should separate the functions of the CEO and the board chairman to
improve the effectiveness of the board of directors and Freddie Mac has
agreed to do so.[Footnote 5] I also note that OFHEO recently submitted
proposed corporate governance reforms to the Office of Management and
Budget that would require the GSEs to separate the CEO and chair
positions; and:
* A recent FHFB study on board governance of the FHLBanks found that
the selection process for board and committee chairpersons and
assignment of committee memberships at some FHLBanks lacked
transparency or inclusiveness.[Footnote 6] The study concluded that
committee selection processes relying on only one person or the
recommendations of senior management may diminish the independence of
directors. FHFB recommended the FHLBanks strengthen their boards of
directors by using a transparent and inclusive selection process.
In practice, GSE boards may face difficulties in complying with modern
governance standards because of statutory and regulatory requirements
regarding the structure, selection, and composition of such boards. For
example,
* Fannie Mae and Freddie Mac's boards include five seats that are
appointed annually by the President, serve one-year terms, and
represent various interests including the real estate industry, the
mortgage lending industry, and consumer interests.[Footnote 7] Treasury
has proposed eliminating the presidentially appointed directors at
Fannie Mae and Freddie Mac because the perceived roles of these
directors contradict best practices of corporate governance.[Footnote
8] OFHEO agrees with Treasury's position because it has found that the
appointed members do not play meaningful roles on the GSEs' boards.
While there may be reasons to eliminate these positions, should
Congress decide to retain them, it should consider (1) lengthening the
terms of the appointed directors so that they have sufficient time to
understand the GSEs' complex activities, (2) establishing criteria to
ensure that qualified individuals serve on the boards who have
expertise in financial activities and understand the GSEs' mission
responsibilities, and (3) establishing fiduciary responsibilities to
serve the special public purpose of the GSE.
* I would also like to point out that FHFB appoints at least 6
directors, known as public interest directors, to serve on the board of
the FHLBanks, whose boards each consist of at least 14 members. We
believe that a selection process that uses a regulator to select the
directors of the regulated entities could jeopardize the independence
of those directors as well as FHFB.
* As another example, our recent study of Farmer Mac provides an
illustration of how congressionally established board structure can
complicate a GSE's compliance with board independence requirements. We
noted that the statutory structure of the Farmer Mac board requires a
majority of the directors to come from institutions that utilize Farmer
Mac's services.[Footnote 9] This raises questions as to the
independence of that board.
In the area of compensation, there are indications that the structure
of executive compensation arrangements and the process of determining
compensation levels at the GSEs are not in line with best practices for
corporate governance. As examples,
* According to the OFHEO report, approximately 54 percent of the total
cash compensation (salaries, bonuses, and other compensation) paid by
Freddie Mac to executive officers for performance in 2001 was based on
corporate performance for that year. The study found that the
compensation of senior executives, in particular, the size of the bonus
pool, was tied, in part, to meeting or exceeding annual specified
earnings per share targets. OFHEO concluded that the importance of
achieving such targets contributed, in part, to the improper accounting
and management practices of the GSE. As such, OFHEO recommended that
Freddie Mac should develop financial incentives for executives and
employees based on long-term goals.
* Our study at Farmer Mac also identified an aggressive stock option
vesting plan whereby stock options for employees and directors were
fully vested within 2 years. By comparison, companies have average
vesting periods of 4 to 5 years. Farmer Mac has since changed its
vesting program to be more aligned with those of other companies.
Finally, in my view, adequate transparency is important because the
housing GSEs engage in complex transactions, such as securitizations,
guarantees, and hedging of risk which introduce many financial
reporting complexities. With the exception of Farmer Mac, GSEs are
exempt from the securities laws, and are not required to file
disclosure documents with the Securities Exchange Commission (SEC) with
respect to their securities issuances. Nevertheless, in October 2000,
Fannie Mae and Freddie Mac adopted six voluntary commitments aimed at
increasing their financial disclosures. More recently, Fannie Mae has
registered its stock with SEC on a voluntary basis and Freddie Mac has
stated its intention to do the same. Although financial disclosure may
improve transparency, its impact on the GSEs and their customers or
funding parties may be limited if the GSEs are perceived to have
implicit government backing. For this reason, while market discipline
can play a role in curbing risky behavior by GSEs, it also has its
limitations. Effective oversight thus takes on more importance as a
means for limiting inappropriate risk-taking behavior by the GSEs. Now
let me move on to the last line of defense, that is, oversight by
regulators.
Housing GSE Regulatory Structure Does Not Ensure Effective Oversight:
Unfortunately, the current housing GSE regulatory structure is
fragmented, which limits the federal government's ability to oversee
the GSE's activities. Congress now has the opportunity to rationalize
the current GSE regulatory structure through the creation of a single
regulator that would oversee the housing GSEs' safety and soundness and
mission activities. Congress should also ensure that the new GSE
regulator has the authorities necessary to carry out its critical
responsibilities.
GSE Regulatory Structure Can Be Consolidated:
Although the housing GSEs share similar risks and missions, there are
three regulators overseeing either their safety and soundness, their
missions, or both. Currently, OFHEO regulates Fannie Mae and Freddie
Mac on matters of safety and soundness, while HUD is the mission
regulator. FHFB serves as the safety and soundness and mission
regulator of the FHLBanks. Available evidence raises questions about
the capacity of the current regulatory structure to effectively monitor
the GSEs' safety and soundness and mission compliance. To illustrate:
* OFHEO did not identify the substantial financial accounting problems
at Freddie Mac at an early stage. In fact, OFHEO's 2001 and 2002
examinations of Freddie Mac gave high marks to the GSE in such relevant
areas as corporate governance and internal controls, despite the
widespread deficiencies later identified in these areas. OFHEO's
current director has stated that the agency plans to strengthen its
examination program, create an office of the chief accountant, and
elevate the important area of corporate accounting into its oversight
process.
* As of July 2002, FHFB employed just 10 examiners to review the
increased risks and complexity of the 12 FHLBanks and the agency's
reviews of key activities--such as internal controls--were
limited.[Footnote 10] Although FHFB has initiated a program to triple
the number of examiners to 30 by the end of FY 2004 and has revised its
examination program, it is too soon to judge the effectiveness of
FHFB's initiatives.[Footnote 11] For example, as FHFB continues the
process of developing a sufficient and capable force of examiners, it
must cope with the fact that several FHLBanks reported losses or weak
financial results in late FY 2003 and some FHLBanks continue to expand
their mortgage purchase programs.
* HUD officials we contacted said that the department lacks sufficient
staff and resources necessary to carry out its GSE mission oversight
responsibilities. HUD officials said that although the GSEs' assets
have increased nearly six-fold since 1992, HUD's staffing has declined
by 4,200 positions and GSE oversight--which now consists of about 13
full-time positions--must compete with other department priorities for
the limited resources available. The President's 2005 budget includes a
proposal that would allow HUD to assess Fannie Mae and Freddie Mac for
the cost of its mission oversight.[Footnote 12] I also note that HUD
(1) has not proposed a rule to ensure that the GSEs' nonmortgage
investments (such as long-term corporate debt) are consistent with
their housing mission as the department committed to do in response to
a 1998 GAO report and (2) it is not clear that HUD has the expertise
necessary to review sophisticated financial products and issues, which
are associated with nonmortgage investments and new program
applications.[Footnote 13]
As I stated previously, a single GSE regulator offers many advantages
over the fragmented structure that exists today including prominence in
government, the sharing of technical expertise, and the ability to
assess trade-offs between safety and soundness considerations and
certain mission compliance activities.
In determining the appropriate structure for a new GSE regulator, we
note that Congress has authorized two different structures for
governing financial regulatory agencies: a single director and board.
Among financial regulators, single directors head the Office of the
Comptroller of the Currency (OCC), the Office of Thrift Supervision
(OTS) and OFHEO while boards or commissions run FHFB, SEC, and the
Board of Governors of the Federal Reserve System, among others. The
single director model has advantages over a board or commission; for
example, the director can make decisions without the potential
hindrance of having to consult with or obtain the approval of other
board members.
In our previous work, however, we have stated that a "stand-alone"
agency with a board of directors would better ensure the independence
and prominence of the regulator and allow it to act independently of
the influence of the housing GSEs, which are large and politically
influential. A governing board may offer the advantage of allowing
different perspectives, providing stability, and bringing prestige to
the regulator. Moreover, if the board included the secretaries of
Treasury and HUD or their designees, the potential exists that safety
and soundness and housing mission compliance concerns would both be
represented. We are mindful, though, based on recently completed work,
of some of the disadvantages of a stand-alone agency with a board of
directors that is divided along party lines.[Footnote 14] Tensions and
conflicts between board members potentially diminish some of these
benefits.
I would note that in other regulatory sectors--besides financial
regulation--Congress has established alternative board structures that
could be considered as potential models for the new GSE regulator. One
such alternative structure would be to have a presidentially appointed
and Senate confirmed director, and a board of directors comprised of
the secretaries from relevant executive branch agencies, such as
Treasury and HUD. Board members being from the same political party
could lessen some of the tensions and conflicts observed at boards
purposefully structured to have a split in membership along party
lines. A board comprised of members all from the same political party
may, though, not benefit from different perspectives to the same extent
as a board with members from different political parties. Therefore, an
advisory committee to the regulator could be formed, to include
representatives of financial markets, housing, and the general public.
This advisory committee could also be required to have some reasonable
representation from different political parties.
I would now like to comment on issues surrounding the potential funding
arrangements for a new housing GSE regulator. Similar to FHFB, OCC, and
OTS, OFHEO funds its operations through assessments on its regulated
entities, Fannie Mae and Freddie Mac. However, unlike these agencies
that are exempt from the appropriations process, OFHEO can only collect
the assessments when approved by an appropriations bill and at a level
set by its appropriators. While testifying on GSE regulatory reform,
the director of OFHEO noted that the appropriations process has placed
severe constraint on OFHEO's operations and has hindered its ability to
hire additional resources it needs to strengthen its
oversight.[Footnote 15]
Exempting the new GSE regulator from the appropriations process would
provide the agency the financial independence necessary to carry out
its responsibilities. More importantly, without the timing constraints
of the appropriations process, the regulator could more quickly respond
to budgetary needs created by any crisis at the GSEs. However, being
outside the appropriations process can create trade-offs. First, while
the regulator will have more control over its own budget and funding
level, it will lose the checks and balances provided by the federal
budget and appropriations processes or the potential reliance on
increased appropriations during revenue shortfalls. As a result, the
regulator would need to establish a system of budgetary controls to
ensure fiscal restraint. Second, removing the regulator from the
appropriations process could diminish congressional oversight of the
agency's operations. This trade-off could be mitigated through
increased oversight by the regulator's congressional authorizing
committees, such as a process of regular congressional hearings on the
new GSE regulator's operations and activities.
Congress Should Ensure That the New Housing GSE Regulator Has Adequate
Enforcement Authorities:
The new GSE regulator must have adequate powers and authorities to
address unsafe and unsound practices, respond to financial emergencies,
and ensure that the GSEs comply with their public missions. In our
previous work, we have stated that each GSE housing regulator
administers its own statutory scheme and these schemes contain various
types of powers and authorities, which although similar, are not
identical.[Footnote 16] Further, the GSE housing regulators' powers and
authorities differ from that of banking regulators in key areas. The
following describes some of these differences, which Congress may wish
to consider in determining the appropriate authorities for a new GSE
housing regulator:
* Unlike bank regulators and FHFB, OFHEO's (1) authority to issue Cease
and Desist Orders does not specifically list an unsafe and unsound
practice as grounds for issuance and (2) powers do not include the same
direct removal and prohibition authorities applicable to officers and
directors;
* Bank regulators have prompt corrective authorities that are arguably
more robust and proactive than those of OFHEO and FHFB. These
authorities require that bank regulators take specific supervisory
actions when bank capital levels fall to specific levels or provide the
regulators with the option of taking other actions when other specified
unsafe and unsound actions occur.[Footnote 17] Although OFHEO has
statutory authority to take certain actions when Fannie Mae or Freddie
Mac capital falls to predetermined levels, the authorities are not as
proactive or broad as those of the bank regulators.[Footnote 18] OFHEO
has also established regulations requiring specified supervisory
actions when unsafe developments are identified that do not include
capital, but OFHEO's statute does not specifically mention these
actions. FHFB's statute does not establish prompt corrective action
scheme, but FHFB officials believe they have all the authority
necessary to carry out their safety and soundness responsibilities;
and:
* Unlike bank regulators---which can place insolvent banks into
receivership---and FHFB, which can take actions to liquidate an
FHLBank, OFHEO is limited to placing Fannie Mae or Freddie Mac into a
conservatorship.[Footnote 19] I note that should Congress decide to
grant the new GSE regulator receivership authority, it should task the
regulator to develop rules and procedures that would reduce the adverse
impacts that a GSE liquidation could have on housing finance and the
stability of financial markets.
In summary, I believe Congress can review the regulatory authorities at
OFHEO, FHFB, and bank regulators and, where appropriate, ensure that
the new regulator has sufficient authorities to carry out its critical
responsibilities.
Measures Have Not Been Established to Determine Whether the GSEs'
Benefits Outweigh Their Risks:
In important cases, it is clear that the GSEs have fulfilled the public
missions for which they were initially created. Since the establishment
of Fannie Mae and the FHLBank System in the 1930s, for example, the
nation's mortgage finance market has progressed from a regionally based
system characterized by periodic credit shortages to a nationwide and
liquid system. Furthermore, it is generally agreed that Fannie Mae and
Freddie Mac's mortgage purchase activities have lowered the interest
rates on qualifying mortgages below what they otherwise would be. In a
1996 report, we estimated that Fannie Mae and Freddie Mac's activities
lowered the rate on qualifying mortgages by about 15 to 35 basis points
or a monthly savings of between $10 and $25 on a typical mortgage of
$100,000.[Footnote 20] Subsequently, federal agencies and researchers,
academics, and the GSEs have initiated studies that have estimated the
extent of the benefits provided by the GSEs' activities and the
recipients of such benefits (i.e., homebuyers vs. investors and
management), which have reached differing conclusions. Additional
studies may be needed to more precisely estimate the extent to which
the GSEs' activities benefit homebuyers.
In other areas, however, there is substantially greater uncertainty
regarding the benefits of the GSEs' activities and more research is
needed to clarify these issues. Although the GSEs have expanded rapidly
and become more complex in recent years, for example, it is not always
clear how the GSEs' growth and complexity have enhanced their public
missions. For instance, at year-end 2002, Fannie Mae and Freddie Mac
held a combined $1.4 trillion of mortgage assets in their retained
portfolios, including MBS, while the FHLBanks hold about a combined
$100 billion of MBS. Although holding mortgage assets in their
portfolios may enhance the profitability of the GSEs, it also exposes
them to interest rate risk, which requires the use of sophisticated
financial strategies--such as the use of hedging which includes the use
of derivatives--to manage effectively. In addition, derivatives may
also be used by financial institutions to take positions on interest
rate movements, which can enhance their profitability but which is also
inherently risky. Over the years, questions have been raised as to
whether the GSEs' portfolio investments in MBS generate benefits to
borrowers.
Additionally, the lines that initially existed between Fannie Mae and
Freddie Mac on the one hand and the FHLBank System on the other have
blurred. In addition to making advances to their members, for example,
FHLBanks have now purchased about $108 billion in mortgages directly
from their members, which is essentially Fannie Mae and Freddie Mac's
traditional business. Although the FHLBanks' mortgage purchases may
enhance competition in the market for secondary mortgage purchases,
they can just as easily raise questions as to whether there is a need
for an additional GSE performing essentially the same mission and
incurring similar risks.
In some cases, the absence of specific criteria and guidance
complicates efforts to assess the benefits of the GSEs' activities. Our
recent work concluded that Farmer Mac's statute contains broad mission
purpose statements and lacks specific or measurable criteria that would
help determine whether the GSE is meeting its policy goals. Farmer
Mac's nonmission-related assets--such as long-term corporate bonds--
declined from 66 percent of assets in 1997 to 37 percent in 2002.
However, the composition and criteria for nonmission investments could
potentially lead to investments that are excessive in relation to
Farmer Mac's financial operating needs or otherwise would be
inappropriate to the statutory purpose of Farmer Mac. We suggested that
Congress should consider establishing clearer mission goals for Farmer
Mac with respect to the agricultural and real estate market to allow a
determination as to whether Farmer Mac had achieved its public policy
goals.
Finally, I would also like to point out that there are other
limitations in the evidence and research on the benefits provided by
the GSEs' activities. The following are some examples that we have
identified:
* There is limited information as to the extent to which the FHLBank
System's more than $500 billion in outstanding advances, as of mid-year
2003, have facilitated mortgage availability. Although anecdotal
information is available on the benefits of FHLBank advances, studies
using quantitative analysis to assess the impacts of FHLBank advances
on housing and community development have not been produced.
* There is limited information available on the extent to which Fannie
Mae and Freddie Mac's investments in nonmortgage assets--such as long-
term corporate bonds--serve their public missions. As I described
earlier, HUD has not acted on its general regulatory authority to
review the appropriateness of the GSEs' nonmortgage investments as it
committed to do in response to a 1998 GAO report. Given that HUD has
not acted in this area for the past 6 years, we again recommend that
Congress legislate nonmortgage investment criteria for HUD or any new
GSE regulator that may be established through legislation.
* There is virtually no information available as to whether Farmer
Mac's activities have benefited agricultural real estate markets. For
example, the depth and liquidity of the demand for AMBS in the current
market is unknown.
Without quantifiable measures and reliable data, Congress and the
public cannot judge the effectiveness of the GSEs in meeting their
missions or whether the benefits provided by the GSEs' various
activities are in the public interest and outweigh their financial
risks. To improve the quality of information about the GSEs'
activities, I believe that the GSEs, the new housing GSE regulator, and
FCA--the regulator of Farmer Mac and FCS--should research the areas
that we have identified as well as others and periodically report their
findings to the public.
Mr. Chairman, this concludes my statement. In summary, I believe that
the following steps can be taken to strengthen GSE governance and
oversight:
* Fannie Mae and Freddie Mac should ensure that their executives report
to independent boards; FHLBank directors should be chosen through
transparent and inclusive processes; and GSE compensation packages
should include short and long-term performance measures;
* Congress should create a single housing GSE regulator that is
governed by a board or a hybrid board and director and has adequate
authorities to fulfill its safety and soundness and mission compliance
oversight responsibilities; and:
* Congress should provide clearer direction to the GSEs in fulfilling
their missions--such as in the case of the GSEs' nonmortgage
investments--and the GSEs, the new GSE regulator, and FCA should
research certain aspects of the GSEs' financial activities and
periodically report to the public as to how these activities are
consistent with mission requirements.
I would now be happy to respond to any questions that you or other
members of the Committee may have.
Staff Contacts and Acknowledgements:
For further information regarding this testimony, please contact Thomas
J. McCool at (202) 512-8678 or William B. Shear at (202) 512-4325.
Individuals making contributions to this testimony include Diane
Brooks, M'Baye Diagne, Rachel DeMarcus, Andrew Pauline, Wesley M.
Phillips, Mitchell Rachlis, and Karen Tremba.
[End of section]
GAO Government-Sponsored Enterprise Related Reports:
Farmer Mac: Some Progress Made, but Greater Attention to Risk
Management, Mission, and Corporate Governance Is Needed. GAO-04-116.
Washington, D.C.: October 16, 2003:
Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ
Significantly. GAO-03-973. Washington, D.C.: September 8, 2003.
Financial Regulation: Review of Selected Operations of the Federal
Housing Finance Board. GAO-03-364. Washington, D.C.: February 28, 2003.
OFHEO's Risk Based Capital Stress Test: Incorporating New Business Is
Not Advisable. GAO-02-521. Washington, D.C.: June 28, 2002.
Farm Credit Administration: Oversight of Special Mission to Serve,
Young, Beginning, and Small Farmers Needs to Be Improved. GAO-02-304.
Washington, D.C.: March 8, 2002.
Federal Home Loan Bank System: Establishment of a New Capital
Structure. GAO-01-873. Washington, D.C.: July 20, 2001.
Comparison of Financial Institution Regulators' Enforcement and Prompt
Corrective Action Authorities. GAO-01-322R. Washington, D.C.: January
31, 2001.
Capital Structure of the Federal Home Loan Bank System . GAO/GGD-99-
177R. Washington, D.C.: August 31, 1999.
Farmer Mac: Revised Charter Enhances Secondary Market Activity, but
Growth Depends on Various Factors. GAO/GGD-99-85. Washington, D.C.: May
21, 1999.
Federal Housing Finance Board: Actions Needed to Improve Regulatory
Oversight. GAO/GGD-98-203. Washington, D.C.: September 18, 1998.
Federal Housing Enterprises: HUD's Mission Oversight Needs to Be
Strengthened. GAO/GGD-98-173. Washington, D.C.: July 28, 1998.
Risk-Based Capital: Regulatory and Industry Approaches to Capital and
Risk. GAO/GGD-98-153. Washington, D.C.: July 20, 1998.
Government-Sponsored Enterprises: Federal Oversight Needed for
Nonmortgage Investments. GAO/GGD-98-48. Washington, D.C.: March 11,
1998.
Federal Housing Enterprises: OFHEO Faces Challenges in Implementing a
Comprehensive Oversight Program. GAO/GGD-98-6. Washington, D.C.:
October 22, 1997.
Government-Sponsored Enterprises: Advantages and Disadvantages of
Creating a Single Housing GSE Regulator. GAO/GGD-97-139. Washington,
D.C.: July 9, 1997.
Housing Enterprises: Investment, Authority, Policies, and Practices.
GAO/GGD-91-137R. Washington, D.C.: June 27, 1997.
Comments on "The Enterprise Resource Bank Act of 1996." GAO/GGD-96-
140R. Washington, D.C.: June 27, 1996.
Housing Enterprises: Potential Impacts of Severing Government
Sponsorship. GAO/GGD-96-120. Washington, D.C.: May 13, 1996.
Letter from James L. Bothwell, Director, Financial Institutions and
Markets Issues, GAO, to the Honorable James A. Leach, Chairman,
Committee on Banking and Financial Services, U.S. House of
Representatives, Re: GAO's views on the "Federal Home Loan Bank System
Modernization Act of 1995." B-260498. Washington, D.C.: October 11,
1995.
FHLBank System: Reforms Needed to Promote Its Safety, Soundness, and
Effectiveness. GAO/T-GGD-95-244. Washington, D.C.: September 27, 1995.
Housing Finance: Improving the Federal Home Loan Bank System's
Affordable Housing Program. GAO/RCED-95-82. Washington, D.C.: June 9,
1995.
Government-Sponsored Enterprises: Development of the Federal Housing
Enterprise Financial Regulator. GAO/GGD-95-123. Washington, D.C.: May
30, 1995.
Farm Credit System: Repayment of Federal Assistance and Competitive
Position. GAO/GGD-94-39. Washington, D.C.: March 10, 1994.
Farm Credit System: Farm Credit Administration Effectively Addresses
Identified Problems. GAO/GGD-94-14. Washington, D.C.: January 7, 1994.
Federal Home Loan Bank System: Reforms Needed to Promote Its Safety,
Soundness, and Effectiveness. GAO/GGD-94-38. Washington, D.C.:
December 8, 1993.
Improved Regulatory Structure and Minimum Capital Standards are Needed
for Government-Sponsored Enterprises. GAO/T-GGD-91-41. Washington,
D.C.: June 11, 1991.
Government-Sponsored Enterprises: A Framework for Limiting the
Government's Exposure to Risks. GAO/GGD-91-90. Washington, D.C.: May
22, 1991.
Government-Sponsored Enterprises: The Government's Exposure to Risks.
GAO/GGD-90-97. Washington, D.C.: August 15, 1990.
FOOTNOTES
[1] Through legislation, Congress has required the housing GSEs to
serve the credit needs of targeted borrowers, such as low-income,
urban, and rural homeowners. For example, Fannie Mae and Freddie Mac
are required to meet housing goals established by HUD for the purchase
of mortgages serving targeted groups. The FHLBanks are also required to
provide grants or below market price advances for mortgages serving
targeted groups through the Affordable Housing Program.
[2] Credit risk is the possibility of financial loss resulting from
default by homeowners on housing assets that have lost value; interest
rate risk is the risk of loss due to fluctuations in interest rates;
and operational risk includes the possibility of financial loss
resulting from inadequate or failed internal processes, people and
systems, or from external events.
[3] Office of Federal Housing Enterprises Oversight. Systemic Risk:
Fannie Mae, Freddie Mac, and the Role of OFHEO. Washington, D.C:
February 4, 2003.
[4] See U.S. General Accounting Office, Government-Sponsored
Enterprises: Advantages and Disadvantages of Creating a Single Housing
GSE Regulator, GAO/GGD-97-139 (Washington, D.C.: July 9, 1997).
[5] Office of Federal Housing Enterprises Oversight. Report of the
Special Examination of Freddie Mac. December 2003.
[6] Federal Housing Finance Board. Report of the Horizontal Review of
Board Governance of the Federal Home Loan Banks. June 2003.
[7] As specified in their charters, Fannie Mae and Freddie Mac each
have 18-member boards of directors. The President appoints 5 of the
directors at each company, while shareholders elect the other 13. Board
members are elected or appointed to 1-year terms.
[8] Testimony of Secretary John W. Snow Before the U.S. Senate
Committee on Banking, Housing and Urban Affairs. Washington, D.C.:
October 16, 2003. He stated that "—The Administration is committed to
make sure that corporate governance — remain strong and effective. That
requires that there be great clarity that the people running large
companies are there to serve the interests of the shareholders and that
their incentives and loyalties be clearly aligned in this way."
[9] U.S. General Accounting Office, Farmer Mac: Some Progress Made, but
Greater Attention to Risk Management, Mission, and Corporate Governance
Is Needed. GAO-04-116 (Washington, D.C.: Oct 16, 2003).
[10] The FHLBanks direct mortgage purchase programs expose the banks to
interest rate risk and increasingly sophisticated strategies--such as
the use of derivatives and hedging techniques--are necessary to manage
these risks.
[11] By late 2003, FHFB had a staff of 22 examination professionals,
according to FHFB officials.
[12] HUD's GSE mission oversight expenses are funded through the
appropriations process.
[13] U.S. General Accounting Office, Government Sponsored Enterprises:
Federal Oversight Needed for Nonmortgage Investments, GAO/GGD-98-48
(Washington, D.C.: March 11, 1998).
[14] See U.S. General Accounting Office, Financial Regulation: Review
of Selected Operations of the Federal Housing Finance Board, GAO-03-364
(Washington, D.C.: Feb. 28, 2003).
[15] Statement of the Honorable Armando Falcon, Jr., Director of OFHEO
before the House Financial Services Subcommittee on Capital Markets,
Insurance and Government Sponsored Enterprises Hearing on The Office of
Federal Housing Enterprise Oversight's December Report of the Special
Examination of Freddie Mac. Washington, D.C.: January 21, 2004.
[16] See U.S. General Accounting Office, Comparison of Financial
Institution Regulators' Enforcement and Prompt Corrective Action
Authorities, GAO-01-322R (Washington, D.C.: Jan. 31, 2001).
[17] Capital can be a lagging indicator of unsafe and unsound
conditions at financial institutions. Declining asset quality is an
unsafe and unsound condition that may be identified months or years
before capital declines.
[18] For example, bank regulators are required to take specified
regulatory actions at earlier stages of capital depletion than is
OFHEO. Bank regulators are also required to initiate four supervisory
actions if an institution is undercapitalized--including restricting
asset growth--while OFHEO is mandated to take only two actions (not
including restricting asset growth).
[19] According to OFHEO officials, a receivership is empowered to take
over the assets and operate an entity, assuming all of its powers and
conducting all of its business as well as removing officers and
directors. A receiver may place the failed institution into liquidation
and sell its assets. While a conservator may also remove officers and
directors of an entity, a conservator is typically appointed to
conserve rather than dispose of assets.
[20] U.S. General Accounting Office, Housing Enterprises: Potential
Impacts of Severing Government Sponsorship, GAO/GGD-96-120
(Washington, D.C.: May 13, 1996).