Housing Government-Sponsored Enterprises
A New Oversight Structure Is Needed Gao ID: GAO-05-576T April 21, 2005Serious concerns exist regarding the risk management practices and the federal oversight of the housing government-sponsored enterprises (GSE)--Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System (FHLBank System), which had combined obligations of $4.6 trillion as of year-end 2003. In 2003, Freddie Mac disclosed significant accounting irregularities. In 2004, the Office of Federal Housing Enterprise Oversight (OFHEO) cited Fannie Mae for accounting irregularities and earnings manipulation. Fannie Mae has to restate its financial statements for 2001-2004 and OFHEO has required the GSE to develop a capital restoration plan. Also in 2004, the FHLBanks of Chicago and Seattle entered into written agreements with their regulator, the Federal Housing Finance Board (FHFB), to implement changes to enhance their risk management. To assist Congress in its housing GSE oversight, this testimony provides information on GSEs' missions and risks, the current regulatory structure, and proposed regulatory reforms.
While the GSEs provide certain public benefits, they also pose potential risks. Fannie Mae and Freddie Mac's primary activity involves purchasing mortgages from lenders and issuing mortgage-backed securities that are either sold to investors or held in the GSEs' retained portfolio. The 12 FHLBanks traditionally made loans to their members and more recently instituted programs to purchase mortgages from their members and hold such mortgages in their portfolios. While not obligated to do so, the federal government could provide financial assistance to the GSEs if one or more experienced financial difficulties that could result in significant costs to taxpayers. Due to the GSEs' large size, the potential also exists that financial problems at one or more of the GSEs could have destabilizing effects on financial markets. The current housing GSE regulatory structure is fragmented and not well-equipped to oversee their financial soundness or mission achievement. For example, although all the GSEs face increasingly similar risks (particularly potential losses in their mortgage portfolios resulting from fluctuations in interest rates), OFHEO is responsible for Fannie Mae and Freddie Mac's safety and soundness oversight while FHFB is responsible for the safety and soundness and mission oversight of the FHLBanks. OFHEO also lacks key regulatory authorities necessary to fulfill its oversight responsibilities. Moreover, the Department of Housing and Urban Development (HUD), which has housing mission oversight responsibility for Fannie Mae and Freddie Mac, faces a number of challenges in carrying out its responsibilities. In particular, HUD may not have sufficient resources and technical expertise to review sophisticated financial products and issues. Creating a single housing GSE regulator could better ensure consistency of regulation among the GSEs. With safety and soundness and mission oversight combined, a single regulator would be better positioned to consider potential trade-offs between these sometimes competing objectives. To ensure the independence and prominence of the regulator and allow it to act independently of the influence of the housing GSEs, this new GSE regulator should have a structure that consists of a board or a hybrid board and director model. To be effective, the single regulator must also have all the regulatory oversight and enforcement powers necessary to address unsafe and unsound practices, respond to financial emergencies, monitor corporate governance and compensation practices, assess the extent to which the GSEs' activities benefit home buyers and mortgage markets, and otherwise ensure that the GSEs comply with their public missions.
GAO-05-576T, Housing Government-Sponsored Enterprises: A New Oversight Structure Is Needed
This is the accessible text file for GAO report number GAO-05-576T
entitled 'Housing Government-Sponsored Enterprises: A New Oversight
Structure Is Needed' which was released on April 21, 2005.
This text file was formatted by the U.S. Government Accountability
Office (GAO) to be accessible to users with visual impairments, as part
of a longer term project to improve GAO products' accessibility. Every
attempt has been made to maintain the structural and data integrity of
the original printed product. Accessibility features, such as text
descriptions of tables, consecutively numbered footnotes placed at the
end of the file, and the text of agency comment letters, are provided
but may not exactly duplicate the presentation or format of the printed
version. The portable document format (PDF) file is an exact electronic
replica of the printed version. We welcome your feedback. Please E-mail
your comments regarding the contents or accessibility features of this
document to Webmaster@gao.gov.
This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed
in its entirety without further permission from GAO. Because this work
may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this
material separately.
Testimony:
Before the Committee on Banking, Housing, and Urban Affairs, U.S.
Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EDT:
Thursday, April 21, 2005:
Housing Government-Sponsored Enterprises:
A New Oversight Structure Is Needed:
Statement of David M. Walker, Comptroller General of the United States:
GAO-05-576T:
GAO Highlights:
Highlights of GAO-05-576T, a testimony before the Committee on Banking,
Housing, and Urban Affairs, U.S. Senate:
Why GAO Did This Study:
Serious concerns exist regarding the risk management practices and the
federal oversight of the housing government-sponsored enterprises
(GSE)”Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System
(FHLBank System), which had combined obligations of $4.6 trillion as of
year-end 2003. In 2003, Freddie Mac disclosed significant accounting
irregularities. In 2004, the Office of Federal Housing Enterprise
Oversight (OFHEO) cited Fannie Mae for accounting irregularities and
earnings manipulation. Fannie Mae has to restate its financial
statements for 2001-2004 and OFHEO has required the GSE to develop a
capital restoration plan. Also in 2004, the FHLBanks of Chicago and
Seattle entered into written agreements with their regulator, the
Federal Housing Finance Board (FHFB), to implement changes to enhance
their risk management.
To assist Congress in its housing GSE oversight, this testimony
provides information on GSEs‘ missions and risks, the current
regulatory structure, and proposed regulatory reforms.
What GAO Found:
While the GSEs provide certain public benefits, they also pose
potential risks. Fannie Mae and Freddie Mac‘s primary activity involves
purchasing mortgages from lenders and issuing mortgage-backed
securities that are either sold to investors or held in the GSEs‘
retained portfolio. The 12 FHLBanks traditionally made loans to their
members and more recently instituted programs to purchase mortgages
from their members and hold such mortgages in their portfolios. While
not obligated to do so, the federal government could provide financial
assistance to the GSEs if one or more experienced financial
difficulties that could result in significant costs to taxpayers. Due
to the GSEs‘ large size, the potential also exists that financial
problems at one or more of the GSEs could have destabilizing effects on
financial markets.
The current housing GSE regulatory structure is fragmented and not well-
equipped to oversee their financial soundness or mission achievement.
For example, although all the GSEs face increasingly similar risks
(particularly potential losses in their mortgage portfolios resulting
from fluctuations in interest rates), OFHEO is responsible for Fannie
Mae and Freddie Mac‘s safety and soundness oversight while FHFB is
responsible for the safety and soundness and mission oversight of the
FHLBanks. OFHEO also lacks key regulatory authorities necessary to
fulfill its oversight responsibilities. Moreover, the Department of
Housing and Urban Development (HUD), which has housing mission
oversight responsibility for Fannie Mae and Freddie Mac, faces a number
of challenges in carrying out its responsibilities. In particular, HUD
may not have sufficient resources and technical expertise to review
sophisticated financial products and issues.
Creating a single housing GSE regulator could better ensure consistency
of regulation among the GSEs. With safety and soundness and mission
oversight combined, a single regulator would be better positioned to
consider potential trade-offs between these sometimes competing
objectives. To ensure the independence and prominence of the regulator
and allow it to act independently of the influence of the housing GSEs,
this new GSE regulator should have a structure that consists of a board
or a hybrid board and director model. To be effective, the single
regulator must also have all the regulatory oversight and enforcement
powers necessary to address unsafe and unsound practices, respond to
financial emergencies, monitor corporate governance and compensation
practices, assess the extent to which the GSEs‘ activities benefit home
buyers and mortgage markets, and otherwise ensure that the GSEs comply
with their public missions.
What GAO Recommends:
GAO recommends that Congress establish a single regulator with a board
or hybrid board and director governance model. This single regulator
should be equipped with adequate authorities to oversee all housing GSE
activities.
www.gao.gov/cgi-bin/getrpt?GAO-05-576T.
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 Minority Member, and Members of the
Committee:
I appreciate the opportunity to participate in today's hearing to
discuss federal oversight of the housing government-sponsored
enterprises (GSE), namely Fannie Mae, Freddie Mac, and the Federal Home
Loan Bank System (FHLBank System). When I testified before this
committee in February 2004 on this same topic, it was shortly after
Freddie Mac had disclosed significant financial problems associated
with its accounting practices.[Footnote 1] Freddie Mac's regulator--the
Office of Federal Housing Enterprise Oversight (OFHEO)--did not detect
the GSE's accounting irregularities at an early stage. At that hearing,
I discussed the need for the establishment of a capable, credible,
strong, and independent regulatory structure to help ensure that the
housing GSEs operate safely and soundly. To accomplish this goal, GAO-
-and others---proposed that Congress replace the current fragmented
regulatory structure for housing GSE oversight with a single regulator
that would be responsible for safety and soundness and mission
activities. Subsequently, this committee took the lead in approving a
strong bill to create a single GSE regulator.
Over the past year, the need for fundamental regulatory reform of the
housing GSEs has become even more clear and compelling. As you well
know, Fannie Mae has been found to have engaged in the misapplication
of accounting standards and earnings manipulation, and company staff
even allegedly falsified signatures on documents. Fannie Mae will have
to restate its financial statements for the past several years and
OFHEO has required the GSE to develop a capital restoration plan. I am
encouraged that OFHEO identified these deficiencies at Fannie Mae and
has moved aggressively to correct them. I also note that the FHLBank
System's regulator--the Federal Housing Finance Board (FHFB)--has
identified risk management deficiencies at the Chicago and Seattle
FHLBanks and entered into written agreements with these institutions to
correct identified deficiencies. Nevertheless, I believe the evidence
clearly shows that the current regulatory structure is not well-
equipped to oversee the operations and effectively monitor the risks of
the large and complex housing GSEs, which had combined financial
obligations of about $4.6 trillion at year-end 2003.[Footnote 2]
To assist the committee in its oversight of the housing GSEs and their
regulation, my testimony today is divided into two sections. First, I
will provide an overview of the GSEs and their missions, identify the
risks they pose to taxpayers and the financial system, and describe the
current regulatory structure, which is divided among OFHEO, the
Department of Housing and Urban Development (HUD), and FHFB. Second, I
will identify deficiencies in the current regulatory structure and
discuss how a single regulator that is governed by a board and endowed
with adequate legal authorities is, in our view, the best potential
means to help ensure that the GSEs meet their housing-related missions
while doing so in a safe and sound manner.
To prepare for this testimony, we relied heavily on a substantial
amount of work that we had done on the housing GSEs and their
regulatory oversight in the past (see Related GAO Products), but we
also reviewed our historical positions in light of recent events. We
conducted our work in Washington, D.C., in April 2005 in accordance
with generally accepted government auditing standards.
Overview of the Housing GSEs, Their Risks, and Regulatory Structure:
I would like to begin my testimony by briefly describing the missions
and activities of each of the GSEs, and the risks they pose to
taxpayers. Then I will describe the current GSE regulatory structure.
The Housing GSEs Share Similar Missions:
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), which then use the proceeds to make additional
mortgages available to home buyers. 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 $359,650 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 mortgage-backed
securities (MBS). MBS issued by Fannie Mae or Freddie Mac 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 principal and interest on
MBS that they issue.
The 12 FHLBanks that constitute the FHLBank System traditionally made
loans--also known as advances--to their members (typically banks or
thrifts) to facilitate housing finance and community and 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.[Footnote 3]
The housing GSEs' activities have generally been credited with
enhancing the development of the U.S. housing finance market. For
example, when Fannie Mae and the FHLBank System were created during the
1930s, the housing finance market was fragmented and characterized by
regional shortages of mortgage credit.[Footnote 4] It is widely
accepted that the housing GSEs' activities helped develop a unified and
liquid mortgage finance market in this country.
Housing GSE Activities Involve Significant Risks:
While the housing GSEs have generated public benefits, their large size
and activities pose potentially significant risks to taxpayers. As a
result of their activities, the GSEs' outstanding debt and off-balance
sheet financial obligations were about $4.6 trillion as of year-end
2003. The GSEs face the risk of losses primarily from credit risk,
interest rate risk, and operational risks.[Footnote 5] Although the
federal government explicitly does not guarantee the obligations of
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
the Farm Credit System (another GSE) 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.
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. To the
extent that this risk, called systemic risk, is associated with the
housing GSEs, it is primarily based on 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 6] 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 an event were to occur, widespread
defaults could occur in derivatives markets.
Housing GSE Regulatory Structure Is Divided among OFHEO, HUD, and FHFB:
The current regulatory structure for the housing GSEs is divided among
OFHEO, HUD, and FHFB, as described below:
* OFHEO is an independent office within HUD and is responsible for
regulating Fannie Mae and Freddie Mac's safety and soundness. OFHEO
oversees the two GSEs through its authority to examine their
operations, determine capital adequacy, adopt rules, and take
enforcement actions. Although OFHEO's financial plans and forecasts are
included in the President's budget and are subject to the
appropriations process, the agency is not funded with tax dollars.
Rather, Fannie Mae and Freddie Mac pay annual assessments to cover
OFHEO's costs.
* HUD is responsible for ensuring that Fannie Mae and Freddie Mac are
accomplishing their housing missions. HUD is to accomplish this
responsibility through its authority to set housing goals, and to
review and approve new programs, and through its general regulatory
authority. HUD is funded through appropriations.
* FHFB is responsible for regulating the FHLBank System's safety and
soundness as well as its mission activities. The agency has a five-
member board, with the President of the United States appointing four
members--each of whom serves a 7-year term--subject to Senate approval.
The fifth member is the Secretary of HUD. The President also appoints
FHFB's chair subject to Senate approval. Like OFHEO, FHFB carries out
its oversight authorities through examinations, establishing capital
standards, rule making, and taking enforcement actions. FHFB is funded
through assessments of the 12 Federal Home Loan Banks and is not
subject to the appropriations process.
Housing GSE Regulatory Reform Is Necessary to Better Ensure Safety and
Soundness and Mission Achievement:
As I stated previously, OFHEO has moved aggressively over the past year
to identify and address risk management and accounting deficiencies at
Fannie Mae and Freddie Mac, and FHFB has entered into written
agreements with two FHLBanks to correct interest rate risk management
deficiencies. Nevertheless, we continue to believe that the current
fragmented regulatory structure for the housing GSEs is inadequate to
monitor these large and complex financial institutions and their
mission activities. Establishing a single housing GSE regulator with a
board structure and equipping the agency with adequate authorities
would better ensure that the GSEs operate in a safe and sound manner
and fulfill their housing missions.
Current GSE Regulatory Structure Is Fragmented, OFHEO Lacks Key
Authorities, and HUD's Mission Oversight Capacity Is Questionable:
The current fragmented structure of federal housing GSE regulation does
not provide for a comprehensive and effective approach to safety and
soundness regulation. Although the housing GSEs operate differently,
their business activities and risks are becoming increasingly similar.
As I described previously, the FHLBank System has established mortgage
purchase programs over the past several years and FHLBank System
mortgage holdings were $113 billion at year-end 2003. While still small
compared with Fannie Mae and Freddie Mac's combined retained mortgage
portfolios of $1.3 trillion for the same time period, the FHLBank
System now operates more like Fannie Mae and Freddie Mac and is
increasingly incurring interest rate risks. Management of interest rate
risk for mortgage holdings involves the application of sophisticated
risk-management techniques, including the use of financial derivatives.
Although such strategies are appropriate for risk management, they
require specialized expertise, sophisticated information systems, and
an understanding and application of sometimes complex accounting rules.
In my view, it simply does not make sense for the federal government to
entrust regulation of large and complex GSEs that are incurring similar
risks to two different regulators, which have different approaches to
examinations and setting capital standards.
Moreover, OFHEO, and FHFB to a lesser degree, lack key authorities to
fulfill their safety and soundness responsibilities, as described
below:
* Unlike with bank regulators and FHFB, (1) OFHEO's authority to issue
cease and desist orders does not specifically list an unsafe and
unsound practice as grounds for issuance and (2) OFHEO's powers do not
include the same direct removal and prohibition authorities applicable
to officers and directors.
* Bank regulators have prompt corrective action 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 7] 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 8] OFHEO
has also established regulations requiring specified supervisory
actions when unsafe conditions are identified that do not include
capital, but OFHEO's statute does not specifically mention these
authorities. FHFB's statute does not establish a prompt corrective
action scheme that requires specified actions when unsafe conditions
are identified. Although FHFB officials believe they have all the
authority necessary to carry out their safety and soundness
responsibilities, the agency has significant discretion in resolving
troubled FHLBanks. Consequently, there is limited assurance that FHFB
would act decisively to correct identified problems.
* 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 9] Thus, it is not clear that OFHEO has
sufficient authority to fully resolve a situation in which Fannie Mae
or Freddie Mac is unable to meet its financial obligations.
Finally, we have significant concerns about HUD's capacity as the
mission regulator for Fannie Mae and Freddie Mac. As I stated in my
testimony last year, HUD officials we contacted said the department
lacked sufficient staff and resources necessary to carry out its GSE
mission oversight responsibilities. HUD officials said that although
the GSEs' assets had increased nearly sixfold since 1992, HUD's
staffing had declined by 4,200 positions and GSE oversight--which
consisted of about 13 full-time positions--must compete with other
department priorities for the limited resources available. While HUD's
ability to ensure adequate resources for its GSE oversight
responsibilities is limited, its mission oversight responsibilities are
increasingly complex. For example, as we have noted in the past, it is
not clear that HUD has the expertise necessary to review sophisticated
financial products and issues, which may be associated with the
department's program review and approval and general regulatory
authorities.[Footnote 10] In addition, without the authority to impose
assessments on Fannie Mae and Freddie Mac to cover the costs associated
with their mission oversight, it would appear that HUD will always be
challenged to fulfill its GSE mission oversight responsibilities.
A Single Housing GSE Regulator with a Board or Hybrid Board/Director
Governance Model and Equipped with Sufficient Authorities Is Critical:
To address the deficiencies in the current GSE regulatory structure
that I have just described, 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.[Footnote 11] A single housing GSE regulator could be more
independent, objective, efficient, and effective than separate
regulatory bodies and could be more prominent than either one alone. 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.
New GSE Regulator Should Have a Board or Hybrid Board/Director
Governance Structure:
In determining the appropriate structure for a new GSE regulator, I
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, the Office of Thrift Supervision and
OFHEO, while boards or commissions run FHFB, the Securities and
Exchange Commission, and the Board of Governors of the Federal Reserve,
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, including the secretaries of Treasury and HUD
or their designees on the board would help ensure that GSE safety and
soundness and housing mission compliance issues are considered.
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 the hybrid board/director
governance model. Under such an approach, there would be a
presidentially appointed and Senate-confirmed agency head who would
report to a board of directors composed of secretaries from key
executive branch agencies, such as Treasury and HUD. Having board
members 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 composed of members from
the same political party, however, may 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 be
required to have some reasonable representation from different
political parties.
Adequate Regulatory Authorities Are Essential:
It is also essential that the new GSE regulator 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. These authorities include (1) cease and desist
authority related to unsound practices, (2) removal and prohibition
authority related to officers and directors, (3) prompt corrective
action authority, and (4) authority to resolve a critically
undercapitalized GSE, which may include placing it into receivership.
Additionally, the new housing GSE regulator should have the authority
to adjust as necessary the housing enterprises' minimum and risk-based
capital requirements to help ensure their continued safety and
soundness.
I would also like to comment on an area of recent debate concerning
discussions of GSE regulatory reform, i.e., restrictions on Fannie
Mae's and Freddie Mac's retained mortgage portfolios, which were
approximately $1.3 trillion as of year-end 2003. In testimony before
this committee on April 6, 2005, Federal Reserve Chairman Greenspan
stated that the GSEs' large retained mortgage portfolios do not
necessarily benefit housing finance, are primarily intended to increase
the GSEs' profitability, and increase the potential for systemic
financial risks. To address these concerns, Chairman Greenspan called
for limits on the GSEs' mortgage portfolios to be phased in over time.
Moreover, Treasury Secretary Snow also expressed concern about the
GSEs' mortgage portfolios and called for limits on their size. We also
have commented that the GSEs' housing portfolios raise potential risks,
and their benefits to housing finance markets are not clear. In my
view, providing the new regulator with strong criteria to evaluate the
costs and benefits of the GSEs' mortgage portfolios and the authority
to limit them, if necessary, is essential. The criteria could include
the extent to which the mortgage portfolios enhance the GSEs' housing
mission, increase financial risks, and raise financial stability
concerns.
Further, the new housing GSE regulatory agency should be provided with
explicit authority to oversee the GSEs' corporate governance and
management compensation practices. As I stated in my previous
testimony, while the GSEs should have been leaders with respect to
corporate governance, in many respects they were not. For example,
unlike leading organizations, the chairman of Fannie Mae's board also
served as the GSE's chief executive officer (CEO). I note that both
Fannie Mae and Freddie Mac have formally agreed with OFHEO to separate
the positions of chairperson of the board and CEO, thereby helping to
ensure that the GSE boards independently establish company policies
that their CEOs are responsible for carrying out. OFHEO also found that
Fannie Mae's compensation system provided managers with financial
incentives to take actions--such as accounting irregularities--that
increased the GSE's reported short-term profitability. Without the
authority to police such practices, the new regulator would not be able
to fully carry out its oversight responsibilities.
I also believe that the new GSE regulator should be tasked with the
responsibility to conduct research on the extent to which the housing
GSEs are fulfilling their housing and community development missions.
As I described earlier, there are already questions about the extent to
which the housing GSEs' mortgage holdings benefit housing finance
markets. Moreover, federal agencies, academics, and the GSEs have
initiated studies that have estimated the extent to which Fannie Mae's
and Freddie Mac's activities generate savings to home buyers, which
have reached differing conclusions. Additional studies may be needed to
more precisely estimate the extent to which the GSEs' activities
benefit home buyers. Further, there is virtually no empirical
information on the extent to which FHLBank advances lower mortgage
costs for home buyers or encourage lenders to expand their commitment
to housing finance. Without better information, 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 and systemic risks.
Regulatory Funding Structure:
Finally, I would now like to comment on issues surrounding the
potential funding arrangements for a new housing GSE regulator.
Exempting the new GSE regulator from the appropriations process would
provide the agency with 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.
Mr. Chairman, this completes my prepared statement. I would be happy to
respond to any questions that you or other Members of the Committee may
have.
GAO Contacts and Staff Acknowledgments:
For further information regarding this testimony, please contact Thomas
J. McCool, Managing Director, at (202) 512-8678 or mccoolt@gao.gov; or
William B. Shear, Director, at (202) 512-4325 or shearw@gao.gov.
Individuals making contributions to this testimony include Allison M.
Abrams, Marianne E. Anderson, Wesley M. Phillips, and Karen C. Tremba.
[End of section]
Related GAO Products:
Federal Home Loan Bank System: An Overview of Changes and Current
Issues Affecting the System. GAO-05-489T. Washington, D.C.: April 13,
2005.
Government-Sponsored Enterprises: A Framework for Strengthening GSE
Governance and Oversight. GAO-04-269T. Washington, D.C.: February 10,
2004.
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.
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.
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.
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] See GAO, Government Sponsored Enterprises: A Framework for
Strengthening GSE Governance and Oversight, GAO-04-269T (Washington,
D.C.: Feb. 10, 2004).
[2] The reported housing GSEs' financial data for financial obligations
and retained mortgage portfolios identified in this testimony are
subject to change. Both Fannie Mae and the FHLBank System are currently
revising previous financial statements.
[3] Securitization is the process of aggregating similar financial
instruments, such as loans or mortgages, into pools and selling
investors securities that are backed by cash flows from these pools.
[4] Freddie Mac was established in 1970.
[5] 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.
[6] Office of Federal Housing Enterprises Oversight, Systemic Risk:
Fannie Mae, Freddie Mac, and the Role of OFHEO (Washington, D.C; Feb.
4, 2003).
[7] 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.
[8] For example, bank regulators are generally 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 against an undercapitalized institution--including
restricting asset growth--while OFHEO is mandated to take only two
actions (not including restricting asset growth).
[9] 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.
[10] See GAO, Government Sponsored Enterprises: Federal Oversight
Needed for Nonmortgage Investments, GAO/GGD-98-48 (Washington, D.C.:
Mar. 11, 1998). HUD's general regulatory authority can be used to limit
or disallow activities that are determined not to support the mission
of Fannie Mae or Freddie Mac.
[11] See GAO, Government-Sponsored Enterprises: Advantages and
Disadvantages of Creating a Single Housing GSE Regulator, GAO/GGD-97-
139 (Washington, D.C.: July 9, 1997).
