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REVIEW OF THE VOLUNTARY AGREEMENT BY FANNIE MAE AND FREDDIE MAC

TUESDAY, MARCH 27, 2001
U.S. House of Representatives
Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises
Committee on Financial Services
Washington, DC.

    The subcommittee met, pursuant to call, at 2:05 p.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.

    Present: Chairman Baker; Representatives Oxley, Ney, Shays, Bachus, Jones, Weldon, Biggert, Ose, Hart, Kanjorski, S. Jones, Sherman, Meeks, Ford, Hinojosa, Lucas, Shows, Crowley, Israel and Ross.

    Chairman BAKER. I'd like to call this hearing of the Capital Markets Subcommittee to order and welcome our witnesses to the table. And I would like to note that there were Members present before the Chairman, who was 5 minutes late because an unnamed airline was 3 hours late leaving my fine city this morning. But I did make it. We can take a look at that maybe later.

    I do welcome my participants to the hearing this morning. This hearing is pursuant to an agreement reached last October with the Government sponsored enterprises of Fannie Mae and Freddie Mac, both of whom had been the subject of study over the course of the last year with a series of hearings and meetings with Members concerning the accuracy of current regulatory oversight and appropriate overview of their business operations, given the relationship between their business success and the United States taxpayers.
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    Last fall, there was an important six-point plan publicly agreed to in which the CEOs of both Fannie Mae and Freddie Mac appeared and expressed support for this initiative, and second, a willingness to work with the committee this session on the construction of a new regulatory oversight body.

    The purpose of the hearing today is to receive testimony from representatives of both enterprises regarding the compliance success with the terms of that agreement since last October.

    I certainly am pleased to have read their published reports of the success of implementation to date. I'm looking forward to a more detailed discussion and feel that this is an extraordinarily important first step that we have taken to ensure the safety and soundness of these two very important business enterprises.

    For Members of the subcommittee who have not been engaged in this topic previously, these institutions are the third and the seventh largest corporations in America by SSIs, are extremely important in providing liquidity in the home ownership market, and have for many decades been the reason for facilitating access to home ownership to many individuals otherwise without such opportunity.

    So they perform excellent work. They are today, as I said in all prior meetings on this subject, well managed, highly profitable, successful enterprises. But our mission on this subcommittee must be to have the long-term view and to ensure that appropriate oversight is in place and remains in place in the unfortunate circumstance of a downturn in our economy and spiraling interest rates and a softening of loan demand, we want to ensure that the adequacy of these financial enterprises is sufficient to withstand such troubling times.
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    Hence, the reason for the agreement of last fall, the hearing today, and the work ahead of the subcommittee for the next several months with regard to the regulatory structure.

    At this time I would like to recognize Mr. Kanjorski for an opening statement.

    Mr. KANJORSKI. Mr. Chairman, before commenting further on today's proceedings, I must commend you for your continuing leadership on Government sponsored enterprise issues. In the 106th Congress, in addition to passing legislation to modernize the Federal Home Loan Bank system, we held hearings over 5 days and roundtable discussions on legislation designed to reform the regulation of housing GSEs and eliminate some of their statutory benefits. Although that bill did not become law, it did help lead to the development of six voluntary commitments by Fannie Mae and Freddie Mac, the subject of today's hearing. You deserve congratulations for playing an important role in raising public awareness about these issues.

    During our lengthy hearings last year on GSE regulation, I believe we reached consensus on several points.

    First, we agreed that we have the world's most successful housing finance system and we gained an appreciation of the important role that GSEs play in that system.

    Second, we agreed that Fannie Mae and Freddie Mac have grown significantly in recent years.
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    Finally, we agreed that we must have strong, independent regulators for the housing GSEs. These regulators must also have the resources they need to get the job done.

    As one of the few remaining committee Members who participated in the entire Congressional dialogue to resolve the savings and loan crisis, I am acutely aware of the need to protect taxpayers from risk.

    It is in the public's interest to ensure that Fannie Mae and Freddie Mac continue to operate safely and soundly. We can best achieve this goal by pursuing a three-pronged supervisory approach that includes regular Congressional oversight, continued effective Government regulation, and increased market discipline for the two GSEs.

    Through our extensive studies last year and our hearings today, we are fulfilling our obligations in Congress to conduct regular oversight of the GSEs.

    In addition, from my perspective, OFHEO operates with increasing effectivness as the safety and soundness regulator for Fannie Mae and Freddie Mac.

    The agency has, for example, developed and implemented a robust, comprehensive and continuous examination program that works. And it will soon publish its long-awaited risk-based capital standard rounding out the existing capital standards.

    The voluntary commitments recently developed by Fannie Mae and Freddie Mac promoting market discipline completes the third leg of my supervisory tripod.
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    By strengthening capital adequacy and increasing transparency, the overall package, in my view, constitutes a sound set of measures to supplement OFHEO's formal regulatory regime and augment Congressional oversight.

    The voluntary commitments are also consistent with the prevailing thinking of leading risk management specialists.

    At our October press conference on the voluntary commitments, I noted that the initiatives, when implemented, would hopefully become a complement to and not a substitute for OFHEO's already strong safety and soundness examination program and capital requirements.

    In that vein, I asked OFHEO to review the regulatory environment surrounding the voluntary measures in advance of today's hearing. In response, Director Falcon notes that these enhanced disclosures improve the public's awareness of Fannie Mae and Freddie Mac's financial condition and risk management practices.

    I agree and would ask, Mr. Chairman, unanimous consent to submit this letter for the record.

    Chairman BAKER. Without objection.

    Mr. KANJORSKI. If we once again decide to pursue legislative action affecting the GSEs in the 107th Congress, we must be sure not to diminish their ability to work efficiently.
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    In my view, we should also explore modernizing their mission. For example, the GSEs could work to improve economic development in our Nation's distressed areas or to create a secondary market for investments made pursuant to the Community Reinvestment Act. These worthy ideas merit our prudent consideration.

    Finally, throughout last year's deliberations on GSEs, I consistently noted that we must move forward cautiously in this area so as to ensure we maintain the delicate balance that has lead to more than 67 percent of all American families owning their homes.

    On at least one occasion last year, however, our committee's actions discouraged investors and raised home ownership costs. As we proceed today, we must renew our efforts to ensure that we do not repeat that mistake.

    Mr. Chairman, I therefore look forward once again to carefully, deliberately and objectively examining the many issues relating to housing GSEs in the 107th Congress.

    Chairman BAKER. Chairman Oxley.

    Mr. OXLEY. Thank you, Mr. Chairman. Many Members of our subcommittee are taking on an important issue for the first time. Government sponsored enterprises, better known as GSEs, is one of those issues, and I'm pleased that we are having this hearing today so that Members have an opportunity to learn about the vital role the GSEs play in our housing finance system and overall economy.
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    Expanded home ownership is a top priority for all of us. Congress created Fannie Mae and Freddie Mac to broaden consumer access to mortgage credit. Fannie and Freddie developed a secondary market for conventional mortgages, and then a wider market for mortgage securities.

    Fannie and Freddie have greatly advanced their housing mission and are a real success story. In order to continue benefiting America's families, Fannie Mae and Freddie Mac must operate according to the highest standards. They are two of the leading financial institutions in this country, and they occupy a central role in the mortgage and capital markets.

    Fannie and Freddie are well managed, highly sophisticated businesses. However, in light of their size and growth, a number of concerns have been raised. These include the adequacy of their supervision, the nature of their mission, and the risk they could pose to the financial system in the event of a downturn.

    The voluntary agreement reached last October addresses many of these concerns. And I congratulate you, Mr. Chairman, for your leadership, as well as Ranking Member Kanjorski, on this meaningful and timely agreement.

    The commitments to meet higher capital, risk management, and disclosure standards are impressive and commendable, and I look forward to hearing from the witnesses about the specifics of those commitments, the progress they have made in implementing them, and their future plans.

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    In addition, we should take a look at the existing framework for regulating Fannie Mae and Freddie Mac. We should consider whether the current division of regulation between OFHEO and HUD ought to be streamlined, and whether the regulators have the powers they need to be effective.

    More effective regulation, along with improved market discipline resulting from the voluntary agreement, could give Congress and the markets even greater confidence in Fannie and Freddie.

    Mr. Chairman, I look forward to this subcommittee's responsible oversight of the GSEs, and I yield back.

    Chairman BAKER. Thank you very much, Mr. Chairman, for your interest and participation today. Are there other Members with opening statements?

    Mr. Ney.

    Mr. NEY. Thank you, Mr. Chairman.

    Chairman BAKER. I'm sorry. I should go to the other side.

    Ms. Jones, did you care to make an opening statement?

    Ms. JONES. Thank you, Mr. Chairman. Good afternoon, Mr. Chairman and Ranking Member Kanjorski and Members of this subcommittee. I ask unanimous consent that my full statement be included in the record.
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    Chairman BAKER. Without objection, as will all Members' statements be included in the record.

    Ms. JONES. We are here again this afternoon to review voluntary agreements that were established to improve capitalization information disclosure and market discipline.

    Many of us on this subcommittee remember and sat through six GSE hearings and then to examine in great detail Fannie Mae and Freddie Mac.

    From those hearings, we examined their safety and soundness to an exhaustive length, and I must note, at no time did we find there to be any safety and soundness issues.

    Both Fannie Mae and Freddie Mac pledged themselves to six voluntary commitments, which we will review today and I won't go through them. I'm proud to hear of their progress made by both, and in stepping up to the challenge and demonstrating that they're both solid and sound institutions. Their success is America's success.

    I hope our review this afternoon will allow Fannie Mae and Freddie Mac to continue to fulfill their housing mission and do what they do best. Their mission is an important mission, and I am not as concerned about market share, but I am concerned about affordable housing in the 11th Congressional District, home ownership for those still seeking a piece of the American Dream, and also special housing needs of the elderly.
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    Housing is still a key public policy concern for all of us.

    GSEs were established to address many of these problems, and all I say is, let them do their job. Again, if it ain't broke, why fix it? Let Fannie Mae and Freddie Mac continue to lead the mortgage finance industry in making credit available for low- and moderate-income families.

    I want to skip on just to the closing of my opening statement, Mr. Chairman, to say that I hope that our review this afternoon serves to clear the record about GSEs' safety and soundness. I realize that there is much more to be done by these organizations.

    While home ownership rate sits at around 67 percent, and some say is close to being saturated, there is still room for improvement for those who are left out of this Nation's prosperity.

    For example, African Americans are still under 50 percent—47.8 percent in home ownership. And the Hispanic community is also under 50 percent—some 47.5 percent. That's not saturation, Mr. Chairman.

    I thank you for the opportunity to present my remarks, and I look forward to an opportunity to be heard in this hearing.

    Thank you.

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    Chairman BAKER. Thank you.

    Mr. Ney.

    Mr. NEY. Thank you, Mr. Chairman and Ranking Member Kanjorski for calling this hearing this afternoon. I didn't serve on the Capital Markets Subcommittee during the 106th, but I did take note of the good work that you did.

    You are being commended for your thorough oversight of Fannie Mae and Freddie Mac. There can be no doubt of the important role that these two companies play in helping to provide affordable housing for all Americans.

    In the 18th District that I represent, Freddie Mac has provided hundreds of millions of dollars of loans averaging $78,200 as the average loan. Fannie Mae has invested a total of $759 million over its lifespan. This has made home ownership dream a reality for many of my constituents in Appalachia.

    In light of these questions, however, that were raised in the 1992 GSE reforms that were passed following the savings and loan disaster, Fannie and Freddie made six voluntary agreements with Congressman Baker, our Chairman, last year designed to strengthen safety and soundness of GSEs by increasing the market transparency.

    These agreements brought new levels of transparency to the operations of these companies and exceed standards to which almost all the private companies are held.

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    This hearing, of course, is designed to follow up on these agreements and see if they have served the purpose of showing that market disclosure can give us the assurances we need to trust that Fannie Mae and Freddie Mac continue to fulfill their role of providing affordable housing to all Americans while remaining the Nation's stable institutions in which we place our trust and faith.

    So far, both Fannie and Freddie have been diligent in following both the spirit and tenor of the voluntary agreements. The lengths to which they have gone to meet these six voluntary agreements is commendable, and I look forward to hearing the details of the implementation of the six voluntary agreements.

    I also look forward to the discussion on the impact of market discipline on safety and soundness.

    Again, thank you, Mr. Chairman and Ranking Member for this hearing.

    Chairman BAKER. Thank you very much, Mr. Ney. Are there are other opening statements?

    Mr. Meeks.

    Mr. MEEKS. Thank you, Mr. Chairman and Ranking Member Kanjorski.

    Home ownership is a key factor in asset and wealth creation for individuals all over the world. For many Americans, a home is the most significant purchase and/or investment they will ever make. Increasing home ownership opportunities for my constituents is a major component to my economic development initiatives.
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    In fact, we go around the district urging the constituency to rent the car, but own the house, and we teach them that owning the house is an appreciating asset, while owning the car is just a depreciating asset.

    This is one of the reasons why I'm organizing a Congressional Black Caucus housing summit in my district in May.

    Of all the bills and all of the questionable legislation that Congress has passed, the creation of GSEs—Fannie Mae, Freddie Mac and the Federal Home Loan Bank—was one of its wisest and most effective laws. By creating a secondary market for the mortgage industry, they have increased the supply of cash available to their banking partners while at the same time decreasing the credit risk to banks, making them more willing to extend credit to many individuals and families seeking inclusion in the American Dream.

    The creation and work of the GSEs are critical factors in American's nearly reaching a 70 percent rate of home ownership. Fannie Mae and Freddie Mac have also had a significant impact on ownership in minority communities.

    In the year 2000, Fannie Mae and Freddie Mac assisted over 500,000 minority families with nearly $60 billion in financing. Yet for all the good that has been done, including a nearly 5 percent increase in minority home ownership since 1994, minority home ownership is still lagging the national rate by some 20 percent.

    I expect the GSEs, their lending partners and the Members of this subcommittee to work together on rectifying this inequity.
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    I have reviewed the voluntary initiatives that Freddie and Fannie Mae agreed to last year as well as the progress they have made toward implementing them. By meeting each of the six initiatives, Fannie and Freddie will provide increased public confidence in their already well managed and financially profitable companies and hopefully allay most of the concerns some of my colleagues have about their role in the home mortgage industry.

    Many of these initiatives exceed the best practices of any of the Nation's most successful financial institutions. Perhaps these initiatives will set a new national and international standard for risk management and disclosure to help us to avoid any future S&L-type debacles.

    I look forward to learning more about Fannie Mae and Freddie Mac's progress in achieving the initiatives and working with them to maximize the success of their mission.

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Meeks.

    Mr. Bachus.

    Mr. BACHUS. Thank you, Mr. Chairman. First of all, I want to commend you, not so much for having this hearing, but for fashioning the voluntary agreement last year, which—we're here to look at the progress of that agreement.
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    So had it not been for your leadership, we wouldn't be here today talking about the progress that's been made.

    Chairman BAKER. You're kind in describing it in those terms. Others have different opinions.

    Mr. BACHUS. And I think all our goal, oversight goal, is to see that Fannie and Freddie and the other GSEs are properly, adequately capitalized; that there is market discipline and there is transparency in disclosure. That helps the consumer. It helps the taxpayer. It helps the GSE, and it is good for the country.

    I would add that over the last several decades, Fannie Mae and Freddie Mac have really shaped the secondary mortgage market by providing adequate liquidity. They have done a great job in improving the distribution of investment capital for residential mortgage financing, and we really have the best financing system in the world for residential mortgages.

    If you went to Europe, you couldn't even get a 30-year mortgage. They are not available. So they have done a commendable job.

    We've got the highest rate of home ownership in the world, the highest rate ever in this country. And individual consumers I believe saved several thousand dollars a year because of what was initially a Congressionally chartered effort.

    I do know that there has been some criticism of the GSEs because of their Government sponsorship. But I would think to a great extent, these advantages are offset with serious regulatory restrictions and affordable housing mandates that we have put on these GSEs that other ''private sector'' entities don't have. And I think we ought to keep that in mind.
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    Although Freddie and Fannie did have a 30-year record of managing the secondary mortgage activity successfully, as I said, we all welcome any additional efforts by the two GSEs working with Congress and the oversight agencies to ensure that the safety and soundness of their institutions are maintained and improved.

    And I think the voluntary initiatives announced last year were a good approach to take. I look forward to hearing the testimony of our two witnesses.

    I once again commend the Chairman and would note that both the GSEs represented today have taken the initial steps in complying with certain of the agreements made last year, so I commend you for that.

    Chairman BAKER. Thank you, Mr. Bachus. Your time has expired.

    Mr. Hinojosa.

    Mr. HINOJOSA. Thank you, Mr. Chairman and Ranking Member Kanjorski.

    As a new Member of this committee and subcommittee, I am looking forward to learning more about the issues related to Government sponsored enterprises and their work in providing affordable housing in the United States.

    I hope to hear from Fannie Mae and Freddie Mac on their implementation of the voluntary initiatives announced last October on which this hearing is focused.
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    I'll just tell you at the start that these companies are doing an admirable job providing affordable housing in South Texas, and particularly in the Texas border region I represent from McAllen, Texas to San Antonio.

    The need for affordable housing along the border is great, and the barriers of home ownership are unique. Fannie Mae has shown flexibility and creativity in addressing the needs of our immigrant population and low-income families who may not have the long employment history nor the credit credentials often required to get competitive mortgage rates.

    Without these secondary lenders in the marketplace and the specific HUD mandates to house minorities and the historically underserved populations, I am fearful of the rates and requirements that would be imposed upon the most economically vulnerable members of our society.

    Mr. Chairman, I think that we all should have an equal chance at the American Dream. By partnering with commercial banks, Fannie Mae and Freddie Mac, bringing consumers affordable rates and flexible downpayment amounts, the system appears to be working the way Congress intended in chartering these GSEs. They bring competitive rates, creative programs and opportunities for increased home ownership to our communities, especially the minority communities I represent.

    Some believe that home ownership in the United States has reached its saturation point and that Fannie and Freddie may no longer be needed. Mr. Chairman, as I look around my district and talk to my constituents, I cannot agree with that assessment.
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    The rate of home ownership for Hispanic Americans in the United States lags an estimated 26.4 percent behind the larger Anglo home ownership rate. We need to close that gap. If these companies can help, then their job and usefulness is far from complete.

    In closing, I'll just say I congratulate this subcommittee for its vigilance in overseeing the GSEs. I think this hearing will be useful in reviewing the steps taken by the GSEs to guarantee their financial soundness.
    At the same time, I trust we will be careful not to cause unintended adverse consequences in addressing GSEs that would have a negative effect on our Nation's housing nor on the interest rates paid by consumers.

    I look forward to hearing the testimony of the witnesses, Mr. Brendsel from Freddie and Mr. Howard from Fannie Mae.

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you very much.

    Mr. Israel.

    Mr. ISRAEL. Thank you, Mr. Chairman and Ranking Member Kanjorski.

    I am also a brand new Member of this subcommittee and learned early of the Chairman's concern for enhancing the safety and soundness of the GSEs. And I am sure that, principally as a result of that concern, both Fannie and Freddie embarked on its voluntary commitments that today make them better and stronger companies.
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    I think we can all agree that the creation of Fannie Mae and Freddie Mac is one of those instances where Congress really got it right. They are an enormous public policy success. Their creation has ensured that our housing system is better than any other in the world, but it can be even better.

    Their existence ensures that Americans have ready access to mortgage funds at the same rate, no matter where they live in the country, no matter what the financial state of the Nation or the world.

    The voluntary commitments that Fannie and Freddie agreed to last fall are added measures to ensure that they will always conduct their business safely and soundly. These commitments not only demonstrate their financial strength, but they provide not available previously windows to that safety and soundness.

    This Nation is fortunate since no other country has a secondary mortgage market created by Fannie Mae and Freddie Mac that ensures we have mortgage credit available all the time, no matter what happens in other credit sectors.

    These are well run, safe companies that bring down the cost of mortgage credit. Our work should strengthen this model, and I thank the Chair.

    Chairman BAKER. Thank you very much, Mr. Israel.

    There being no further Democrats, I'll go back to Mr. Sherman.
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    Mr. SHERMAN. Well, Mr. Chairman, I was going to deliver this really eloquent opening statement, but the gentleman from New York just delivered it. So I thank him for his remarks and the other remarks that preceded his.

    I think that this voluntary agreement does a lot to strengthen these two entities and that they do a lot to provide for home ownership.

    We obviously have not achieved the home ownership percentages that I'd like to see, but we are certainly doing better in every sector and with every community than we had even 10 years ago. Thank you.

    Chairman BAKER. Thank you, Mr. Sherman. If there are no further opening statements, at this time I would like to introduce our two witnesses for the hearing today. I certainly think they are no stranger to the subcommittee.

    I wish to welcome the CEO of Freddie Mac, Mr. Leland Brendsel, as well as the Vice President and Chief Financial Officer, Mr. Timothy Howard.

    Gentlemen, we will certainly make your complete testimony as part of the record. Please feel free to proceed as your pleasure. Mr. Brendsel, if you would please, sir. Welcome.

STATEMENT OF LELAND C. BRENDSEL, CHAIRMAN AND CHIEF EXECUTIVE OFFICER, FREDDIE MAC
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    Mr. BRENDSEL. Thank you, Chairman Baker. And good afternoon. Indeed, I'm pleased to be here and to appear before this subcommittee.

    I am the Chairman and Chief Executive Officer of Freddie Mac. And I'm certainly pleased that Chairman Oxley could be here earlier and look forward to working with him as well as Members of this subcommittee as we move forward.

    As you have already said, Chairman Baker, last October Congressman Kanjorski, you, Members of the subcommittee, Freddie Mac and Fannie Mae joined together in a landmark announcement, one that provides, I believe, a model of financial management for the new century.

    Freddie Mac committed to a six-point plan that keeps us at the vanguard of world financial practices. We did this to put to rest any concerns about any future safety or soundness of Freddie Mac, since indeed, as has already been said here today, there are no concerns currently. Indeed, we are rock solid.

    Freddie Mac plays a vital role in financing home ownership and rental housing. It is something we are strongly committed to. And we are determined to maintain the confidence of Congress, of investors and of the public in our ability to keep meeting our mission.

    The commitments that we made last fall and announced with you are real, they are significant, and I believe they completely outpace the practices of other financial institutions, with the single exception of Fannie Mae.
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    Even before we made these commitments, Freddie Mac already had outstanding risk management and information disclosures for investors and the public. But we are now providing more relevant information about our condition than any other financial company, I believe, in the world.

    Our commitments meet or exceed recommendations of international experts in financial regulation. The national rating agency, Moody's, said last fall that they set new standards not only for us, but also for the global financial market.

    We also asked former FDIC Chairman William Seidman for his assessment of these commitments. And he concluded, and I quote, ''This package of disclosures and standards puts you in a position of providing more and better public information than any other financial institution, both regulated and non-regulated.''

    Now with your permission, Mr. Chairman, I would like to enter his full comments for the record.

    Chairman BAKER. Absolutely. Without objection.

    Mr. BRENDSEL. Thank you. Now let me walk through each commitment and report on their status of implementation at Freddie Mac.

    I'm pleased to report that Freddie Mac's implementation is nearly complete.
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    Briefly, the first commitment is public disclosure of our independent rating. We announced our AA-minus risk-to-the-Government rating from Standard & Poor's on February 27th.

    To put this in perspective, of the ten largest bank holding companies, only two have a rating this high on their senior debt.

    Originally we planned to obtain a rating once a year, but now Freddie Mac has gone beyond that. We asked Standard & Poor's for a continuous surveillance rating, which means that S&P will notify the public if there is ever a change in our financial position that affects our rating.

    Our second commitment ensures that we maintain a high level of liquidity. We announced that we met that commitment on March 8th. Freddie Mac has enough liquid high quality assets so that we can meet all our financial obligations even if we are unable to issue debt for 3 months. That's a high standard.

    The Basel Committee on Banking Supervision suggested that institutions maintain a liquidity reserve of between 1 and 3 months. We chose the more stringent 3 months. This sets a new best practice for industry.

    Our third commitment is semi-annual issuance of subordinated debt. We completed our first $2 billion issue on March 21st. It will be the first of many issues, of course.
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    The benefit of this commitment is twofold. The issuance of subordinated debt enhances our already strong financial base. In addition, it provides real-time information to the market about our financial condition.

    After 3 years, the sum of our core capital and subordinated debt will equal at least 4 percent of our assets.

    We expect that there will be an additional $8 to $10 billion of investor funds standing in front of our senior debt holders.

    A recent report by the Federal Reserve and the Treasury views subordinated debt as a tool to enhance market discipline. No bank has committed to a regular program of subordinated debt, however. But Freddie Mac, along with Fannie Mae, stepped up to the challenge.

    Our fourth commitment is to implement a risk-based capital stress test on an interim basis until our regulator, OFHEO, completes the final rule. Yesterday, we announced that we passed this test. Freddie Mac holds enough capital to survive a 10-year downturn much like the Great Depression. This is the most rigorous test in the financial services industry.

    And again, to put this in perspective, for the thrift industry to pass this test, it would have to triple its capital today.

    Our fifth commitment is new quarterly disclosure about credit risk. Going beyond our already extensive credit risk disclosures that we currently provide to investors, Freddie Mac has added a new forward-looking disclosure.
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    Most credit disclosure, in fact, is backward-looking, focusing on charge-offs, loans that were already delinquent. Our new measure predicts the impact of a 5 percent decline in housing prices nationwide and the impact that would have on losses of Freddie Mac.

    We made this disclosure for the first time yesterday and will include it for the record. It demonstrates Freddie Mac's financial strength and the many layers of protection that we have for our mortgage purchases.

    Finally, our sixth commitment is new monthly disclosure of interest-rate risk. We will meet this sixth and final commitment with our regular monthly disclosure to investors in the middle of April.

    This commitment exceeds supervisory guidance made just last week by the Federal Reserve and the OCC, I would point out. These agencies encouraged large financial institutions to adopt the recommendations of the commission headed by former Chase Chairman Walter Shipley. They called on banks to move from annual to quarterly disclosure of interest risk. Our move is to monthly disclosure, which keeps us, I think, a step ahead.

    Taken together, our six commitments represent a watershed in financial practices. I think this is important. Because over the next 10 years, America's families will need an additional $6 trillion to fund their mortgage loans, a net increase, reflecting anticipated growth in home ownership as well as the growth in this Nation and the strength of its economy.

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    Freddie Mac will open doors of opportunity for the home buyer of the future who is more likely to be a low-income, minority or immigrant family eager to realize the American Dream.

    To meet our mission, Freddie Mac is wringing out every unnecessary cost and barrier to home ownership. We're pushing the limits of technology. We're searching the globe to find the lowest cost funds for housing. Indeed, housing is one of the few bright spots on today's economic horizon. More than ever, the country needs Freddie Mac's strength and vitality, and the six commitments demonstrate our determination to remain safe and sound and to finance housing for generations to come.

    So, Mr. Chairman and Members of the subcommittee, I appreciate your support when we announced these commitments, and I look forward to working with you in the future to secure the future of America's housing finance system and with it the dreams of millions of families.

    Thank you very much.

    Chairman BAKER. Thank you, Mr. Brendsel.

    Mr. Tim Howard.

STATEMENT OF J. TIMOTHY HOWARD, EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, FANNIE MAE

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    Mr. HOWARD. Mr. Chairman, Congressman Kanjorski, Members of the subcommittee, I'd like to thank you for the opportunity to come before you today.

    My name is Timothy Howard and I am Chief Financial Officer and a member of the Office of the Chairman of Fannie Mae.

    Mr. Chairman, last October Fannie Mae's Chairman and Chief Executive Officer, Frank Raines, was pleased to join you, Congressman Kanjorski and others in Congress to announce that Fannie Mae would adopt a series of six voluntary initiatives to further strengthen our liquidity, transparency, market discipline and capital.

    Under your leadership, this was a signal achievement for the safety and soundness of the financial system.

    Consolidation and globalization in the financial services industry is a reality today. In the last decade, the total number of banks in America has fallen by 40 percent, and the share of assets in the eight largest banks has almost doubled, from 21 percent to 41 percent.

    America's two largest banks now hold 19 percent of all bank assets, nearly double the concentration of 8 years ago.

    As financial institutions become larger, more global, more complex and more interconnected, financial supervisors and policymakers worldwide are proposing new strategies to strengthen their safety and soundness and reduce the potential for systemic risk.
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    Every large financial institution has the potential to affect the fundamental safety and soundness of the financial system. Fannie Mae is no exception.

    With that in mind, over the last year, we engaged in a series of discussions with key policymakers, including people at Treasury, the Federal Reserve, and our own regulator, the Office of Federal Housing Enterprises Oversight, to determine how best to ensure that Fannie Mae's safety and soundness protections are at the vanguard of evolving world practices.

    And I would add, Mr. Chairman, that the hearings and oversight by this subcommittee under your leadership has played a critical role in our review.

    We learned much that was useful. For example, the Basel Committee on Banking Supervision supports the use of risk-based capital standards with an economic stress test. The Working Group on Public Disclosure chaired by Walter Shipley recommends increased transparency as a means to enhance market discipline. And a recent study by the U.S. Treasury and the Federal Reserve suggests that issuing subordinated debt can strengthen market discipline in a powerful way.

    In the end, I believe the discussions we engaged in greatly raise the level of understanding of Fannie Mae's role in the housing finance system and our risk management strategies. They also reaffirmed the fundamental wisdom of the changes to our charter made by Congress in 1992.

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    Through these charter revisions, Congress provided for a dedicated financial regulator, continuous on-site examination with results disclosed to the public, and most far-reaching of all, a risk-based capital standard with a severe economic stress test long before the Basel Committee proposed this model for others.

    These measures in 1992 put Fannie Mae at the cutting edge of regulatory discipline. But our discussions last year with policymakers made it clear that Fannie Mae had the opportunity to build on this cutting edge regulatory discipline by adopting measures to enhance our market discipline.

    That led to the joint announcement by Fannie Mae and Freddie Mac last October 19th committing to the six voluntary initiatives.

    Mr. Chairman, Congressman Kanjorski, I am pleased to report to you today that Fannie Mae now has implemented all six of these voluntary initiatives during the first quarter of this year, and in some cases, we have gone beyond our commitment.

    In January we did our first issuance of subordinated debt. This $1.5 billion, 10-year issue was rated AA–2 by Moody's and AA-minus by Standard & Poor's. We priced it at a spread of 22 basis points over our senior debt. And since that time, it has traded in a range of 18 to 28 basis points over our senior debt.

    That is a higher spread to senior debt than the subordinated debt of many high quality commercial banks, and it shows that investors do believe that our subordinated debt is in a different risk category from our senior debt.
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    In late January we obtained and disclosed ''a risk to the Government'' rating of AA-minus from Standard & Poor's. This rating measures our inherent credit quality without assuming Government support. No U.S. commercial bank holding company or thrift institution has an S&P rating higher than AA-minus.

    And we went beyond the October 19th commitment by seeking this rating on a surveillance basis, which means that S&P will change its rating during the year if our financial condition changes.

    We announced earlier this month that we have built enough liquidity into our portfolio to allow us to continue to operate smoothly and meet our obligations even if we had no access to the agency bond market for 3 months. This is a statement very few financial institutions could make.

    We also said that we would disclose each quarter the percentage of our on-balance sheet assets we hold as liquid assets, again, going beyond the terms of the voluntary initiatives.

    And yesterday we announced that we had made the initial disclosures of our interest rate risk and credit risk sensitivities, as well as disclosures from our interim risk-based capital stress test.

    For our interest rate disclosure, we followed the directives of the new Basel Accord and released the two measures of interest rate risk we used to manage our business internally: net interest income at risk, and our effective duration gap. We are going beyond our commitment by releasing our duration gap on a monthly basis.
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    We also made our first quarterly disclosure of the impact on our credit losses of an immediate 5 percent drop in home values. We are showing our credit loss sensitivities both with and without the effect of credit enhancements to highlight the role that loss-sharing arrangements play in our credit risk management.

    And finally, we carried out our first interim risk-based capital stress test. We passed this test with a capital cushion of between 10 and 30 percent of our total capital as of December 31st, 2000.

    Combined with our charter revisions in 1992, the six voluntary measures we have just implemented place Fannie Mae at the vanguard of risk management and disclosure practices worldwide with cutting edge regulatory discipline bolstered by cutting edge market discipline.

    If there is any question or concern about how Fannie Mae is doing, there are now several ways to find out. You can look at the results of our supervision exams. You can look at our capital levels, our regular stress test results, our external rating reports, our monthly and quarterly reports on how the economy is affecting our business, or changes in the value of our subordinated debt.

    No financial company in the world will tell you more about its financial condition than Fannie Mae does.

    Our new disclosures reinforce the fact that Fannie Mae is one of the safest, soundest financial institutions in the world. Our subordinated debt and risk-to-the-Government ratings are among the strongest in the industry.
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    We have more than adequate liquidity to survive for 3 months without access to the credit markets, and we could endure the worst economic shocks in history, shocks few other financial institutions could survive, with significant capital left over.

    Mr. Chairman, Congressman Kanjorski, thanks to your leadership and partnership, our safety and soundness regime is now consistent with the best thinking in the world, and it goes well beyond any federally-chartered bank or financial institution today.

    Together, we have produced an even safer, sounder Fannie Mae, a stronger U.S. housing finance system, and a better chance for more Americans to own a home. And we have done more than that. Together, we have created in Fannie Mae nothing less than a model for financial institutions in America and around the world.

    Mr. Chairman, we applaud you for your leadership and look forward to continuing to work with you.

    Chairman BAKER. Thank you very much, Mr. Howard. Thank both of you gentlemen.

    My first question relates to the comment about the stand-alone measure of the S&P rating, Mr. Howard. In your testimony, the rating agencies rated your subordinated debt separate and apart from Fannie's relationship with the Federal Government.

    I visited with a representative of S&P not long ago trying to understand the mechanisms by which ratings were established. And there's a fine line that I think has been drawn, but that I need to clarify from your perspective.
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    As I understand it, they set aside the value of a governmental intervention by exercising the line at the Treasury. But at the same time, they did calculate the value of the ratings.

    The fact that the market perceives that you have an implicit guarantee, therefore, even in illiquid markets, you have the ability to market your securities and debt instruments in a manner which others may not, so that there is a buy-side bias, as I would describe it, in the market toward the rate, although it does take into consideration prohibiting the exercise of a line of credit. Do you see that differently? That's the way it was explained to me.

    Mr. HOWARD. Let me go into my understanding of both the rating Standard & Poor's did of our subordinated debt as well as the risk-to-the-Government rating, because they are rating somewhat different things, but from a common perspective.

    In each case, Standard & Poor's assumes that our fundamental operating practices, whatever causes them to be what they are, whether it's a view by investors that the Government would in some form support our senior debt or not, they take no position on that. They simply say that whatever your current operating practices are—''your'' being Fannie Mae's—we assume those will continue in times of duress.

    For our subordinated debt——

    Chairman BAKER. Excuse me. I'm sorry. But on that point, whatever your existing business practices are will continue during times of duress?
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    Mr. HOWARD. Yes.

    Chairman BAKER. That is, despite the fact that the securities may say not guaranteed by the full faith and credit of the United States, you could buy it with that assumption anyway? That that's sort of the market practice today.

    Mr. HOWARD. The investors with whom I speak, and Mr. Baker, Chairman Frank Raines and I returned from Europe a month ago, doing our annual visit with European investors. For 17 years, Fannie Mae has been doing a visit with European investors in the spring and a visit with Asian investors in the fall.

    We talk to investors continually. The investors, including the most sophisticated, fully understand that our debt is not guaranteed by the U.S. Government. There is no ambiguity in their minds on that point.

    What Standard & Poor's does in rating our subordinated debt, they have said explicitly they do not assume that in the unlikely event that Fannie Mae were to encounter financial difficulty, that the U.S. Government would guarantee or support that debt. That's an explicit statement they make.

    So the subordinated debt rating is a very pure credit quality rating of our obligations, assuming no Federal support. And that distinguishes it from the senior debt.

    The risk-to-the-Government rating, in my understanding from talking to Standard & Poor's, attempts to view the U.S. Government as a potential creditor of Fannie Mae, and in effect ranks the probability of the Federal Government ever being put in a position where it has to make a decision whether to support or not support the senior debt.
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    And in both cases, whether it's viewing the exposure that a subordinated debtholder has to Fannie Mae's credit condition, or viewing the Government's role as an entity that has chartered Fannie Mae and may at some point face a decision about whether or not to support senior debtholders, in each case we have been accorded a AA-minus rating, which is extraordinarily high. And that represents, in my view, the fundamentally sound risk management practices that we have put in place.

    Chairman BAKER. Let me follow up with the second part, Mr. Brendsel, of the stated agreement of October. And first let me congratulate both Fannie and Freddie for your success in the implementation of the proposal to date. I want to acknowledge that and that you have in my judgment made a good faith effort to comply with the tenor and tone of the agreement.

    However, that meeting of that morning, I announced the intent to introduce legislation this year with regard to a regulatory structure. I don't want to open a discussion as to the details of the regulatory structure.

    All I want is to confirm, since this is the first opportunity you've had to visit in this forum since last October, that you, both from a corporate perspective, view the creation of a strong regulatory structure not only as protection for the taxpayer, but an asset in the markets, because it gives them confidence and you do have oversight that is appropriate and sufficient.

    Mr. Brendsel.
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    Mr. BRENDSEL. Absolutely.

    Chairman BAKER. Mr. Howard.

    Mr. HOWARD. Yes. We believe that the existence of a strong regulatory structure is very much in our interests, the interests of our investors, policymakers, and anyone who has a strong interest in the continued smooth workings of the U.S. housing finance system.

    Chairman BAKER. Let me do this quickly. I really wish I had a whole lot more time. But since we have a fair number of Members, I'll try to stick to 5 minutes. I would just like to have a little more in-depth analysis if I might, Mr. Howard, or from both operations with regard to the spreads on the sale of subordinated debt. It appears that the spreads have widened instead of narrowed from the first offering at 22 basis points. I've seen different reports where it's vacillated. But it seems of late to have been significantly higher than it was at the outset, and I wish to understand better whether that's a liquidity issue in the market or other reasons. And I'll just get that in writing at a later time.

    Mr. Kanjorski.

    Mr. KANJORSKI. Thank you, Mr. Chairman.

    As I understand it, in developing the voluntary commitments, you studied worldwide the best practices of regulators for safety and soundness of financial institutions, particularly those of your own regulator, OFHEO. How do your commitments stand up in comparison with other financial regulators, both inside and outside of the country?
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    Mr. BRENDSEL. Well, Mr. Kanjorski, as I commented in my oral statement, our disclosures really stand up extremely well. In fact I would call them world class in terms of the kind of information they provide to investors.

    Justice Brandeis once said ''sunshine is the best disinfectant.'' And that's really what has occurred here. We are providing the kind of information to the marketplace, to investors that really exposes us to the sunshine, to the scrutiny of our investors, and whether it is our practice to issue additional subordinated debt, disclosure of our independent rating, disclosure of our interest rate risk or credit risk, they put us at the head of the pack.

    And it really is reflecting the recommendations made by the Basel Committee on Banking Supervision as well as the Shipley Commission as well as recommendations by the Fed and Treasury for commercial banks in this country.

    Mr. HOWARD. The recommendations of both the Basel Committee as well as the Shipley Commission were targeted primarily on disclosure practices of institutions as a supplement to regulation.

    Although in the case of Basel, Basel did support quite strongly the use of specific stress tests and internal models in gauging the true risk of complex financial institutions. And in that regard, the legislation in 1992 was quite far-sighted in enshrining in statute the need to do just such a test, using the actual data from businesses practices in determining the amount of capital that the entity should hold in light of the specific risks that it takes and the way in which it manages them.
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    So in that regard, I believe OFHEO's regulatory structure is indeed at the cutting edge of regulatory practice.

    Mr. KANJORSKI. Some have suggested that the recent GAO report on OFHEO regulatory authority concludes the agency lacks sufficient enforcement power to ensure that Fannie Mae and Freddie Mac do not pose a threat to the economic stability of our country.

    The report, however, also notes that it appears each regulator has the statutory tools available to address significant safety and soundness concerns. These views seem to be in conflict. I was just wondering if you would give us your perspective on these two conflicting views.

    Mr. BRENDSEL. My reading of the GAO report—and indeed, it's my reading—is that it concludes that OFHEO does have adequate regulatory authority that they need for regulating the two institutions, albeit in some cases it is slightly different than the authorities that banking regulators have.

    But that is also appropriate, given that we are different kinds of institutions. We're only two. We're only focused on one line of business—residential mortgage loans. We're not engaged in a myriad of activities like banks are. And indeed, our regulator only has two institutions to focus on rather than the thousands of banking institutions.

    So overall, my conclusion on reading the report is although different in some cases, they conclude that the authorities are adequate and appropriate.
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    Mr. HOWARD. Congressman Kanjorski, I would echo that. I would also add that the principal conclusion of the GAO report, and I'll quote this, is that ''based on each regulator's powers and authorities, it appears that each regulator has statutory tools available to address significant safety and soundness concerns.''

    The GAO report did highlight areas where the powers were different. But as Mr. Brendsel said, that seems to reflect largely the different circumstances of banks and other financial institutions versus Fannie Mae and Freddie Mac.

    Mr. KANJORSKI. I guess it is not proper to ask the hen whether we should empower the fox, but do you feel that Congress should give greater powers to your regulators? Is this something we should presently investigate or potentially legislate?

    Mr. BRENDSEL. I think that overall, I would say first and foremost, we support a strong and credible effective regulator. Whatever the structure, whatever the particular authorities that are necessary to carry out that objective that you give to the regulator, we certainly want the regulator to be professional, knowledgeable, have the appropriate authorities. And ultimately, it's a decision for Congress to make.

    And from my standpoint today, at least from what I understand their authorities to be in my reading of the GAO report, I would not recommend to Members of Congress that any changes be made.

    But first and foremost, we want a regulator that has credibility and the confidence of you and of investors worldwide.
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    Mr. HOWARD. Our view is quite similar.

    Mr. KANJORSKI. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    Mr. Ney.

    Mr. NEY. Thank you, Mr. Chairman. I have a question for both witnesses.

    Freddie Mac and Fannie Mae operate with less equity capital per dollar of debt than banks risk. Given your size, what would you want to comment on the suggestions made that there's undercapitalization and perhaps the capital adequacy needs to be increased? Do you want to comment on that?

    Mr. HOWARD. I'd be happy to. One of the principles of the Basel Commission is that capital needs to be appropriate for the risk undertaken. In Fannie Mae's case, and also in Freddie Mac's case, we are doing business in a single asset class. U.S. residential mortgages.

    We do two things with that asset class. We guarantee the credit and we take the interest rate risk for the mortgages that we hold in portfolio. On the credit risk side, the fundamental credit quality of residential mortgages is extremely high compared with other asset classes—consumer loans, loans to small businesses, loans to international borrowers.
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    There's a wealth of data on that. And under the principle that capital needs to relate to risk, if an entity is limited to a single business which has a low embedded default rate, less capital on an absolute basis can still mean a much stronger institution if the entity holding that small amount of capital is limited to mortgages.

    Fannie Mae's risk-based capital test is designed to measure exactly that, and it goes beyond that. Because by explicitly relating capital to risk, it gives us the financial incentive to hedge our risks and limit our risks in a fashion that we can keep our required risk-based capital under our statutory minimums.

    One of the fundamental flaws recognized by international regulators of the current ratio-based system that covers most institutions including commercial banks is it requires a large amount of capital as a buffer against what could go wrong, equivalent to what you could as capital against the 100-year flood. The only problem with that is entities that have to hold that capital then have to go out and attempt to earn a return on that excess capital, which gives them the incentive to take more risk.

    So the incentives under the additional capital system are in my view precisely the wrong ones. A company that takes modest risk and hedges it well can actually be considerably safer, sounder and stronger than the one that has a higher nominal amount of capital, but is taking more risks, because it has a broader range of businesses and doesn't hedge as well.

    Mr. NEY. Mr. Brendsel.

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    Mr. BRENDSEL. I'm not certain I can add to Mr. Howard's dissertation, an excellent dissertation on risk-based capital, other than to say ditto.

    If we can survive, which is basically what is contemplated in the 1992 legislation and essentially how Freddie Mac operates today, if we can survive an economic calamity that is basically equivalent to the Great Depression, that clearly indicates we are extraordinarily strong and well capitalized, even though you can't measure it by the typical kinds of accounting ratios that many use. But that's not the appropriate measure of capital adequacy and capital strength, as Mr. Howard has pointed out.

    Mr. NEY. Everybody talks about the crisis in affordable housing. How do you feel that the six voluntary commitments that have been made and are being undertaken in fact would help with the mission of home ownership?

    Mr. BRENDSEL. I think they're extremely positive, because they will serve to maintain the confidence of investors in the world's capital markets, the confidence of the public policymakers, and indeed, the confidence of our customers, the Nation's mortgage lenders, that we are there and will be able to meet our obligations as well as provide the kind of liquidity and stability to the mortgage market.

    Ultimately that means there will be more mortgage money available at lower rates, which is in essence the core of what we're doing in terms of providing money to finance affordable housing as well as housing for middle income Americans.

    Mr. HOWARD. There is a very fundamental connection between our safety and soundness and our ability to carry out our mission.
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    As Fannie Mae continues to do its part to meet the large number of unmet housing needs that still exist, we will by definition get a larger profile. Our mortgage portfolio will continue to grow. We will issue more debt. Our credit needs will continue to grow.

    A growing Fannie Mae is evidence that we are being more effective carrying out our mission of making housing credit more available and more affordable.

    As we grow, this concern that exists legitimately among policymakers over whether or not size equates to risk goes fundamentally to the heart of these voluntary disclosures and a strong regulatory system.

    We feel that if we can be as transparent as any financial entity in the world, we can continue to be innovative, be aggressive in achieving our mission and reaching the pockets of unserved areas and not have concerns be raised about whether or not this should cause Congress to worry about our fundamental safety and soundness and risk to the taxpayer.

    Chairman BAKER. Thank you, Mr. Ney.

    Mr. Meeks.

    Mr. MEEKS. Thank you, Mr. Chairman.

    Mr. Howard, can you—as you know, predatory lending is a scourge in the minority community. Can you tell us about the specific steps your company is taking to combat predatory lending?
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    Mr. HOWARD. Yes. I would be happy to do that. Several months ago we announced a series of guidelines to which we requested that our lenders adhere in showing us credit-impaired loans that might conceivably be eligible for purchase by us.

    The areas that we specifically looked at included a number of—the interest rate that could be charged on those loans, whether or not there were prepayment penalties that were unreasonably imposed on the loan, and the existence of prepaid credit life policies that might result in an erosion of equity in the property, making it harder for the borrower to stay in the home.

    We came out with a series of guidelines that were quite explicit. We shared those with our lending partners, came to an agreement that these were the right set to use, and have implemented them. And we found that many originators have in fact confirmed their origination practices to those standards.

    So we think that even though our presence in the market as far as guaranteeing or purchasing of those loans has not increased as much as ultimately we believe it could, we think we've already had an impact on lending practices which is highly positive.

    Mr. MEEKS. Mr. Brendsel, Freddie Mac has bought billions of dollars of subprime mortgages. In the same vein, how can you ensure that these mortgages are not predatory?

    Mr. BRENDSEL. First of all, we only deal with the good guys. And there are some, as you've already pointed out, Congressman, that are not the good guys. They're engaged in abusive practice and so forth.
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    So what do we do? We have a combination of certainly guidelines and requirements for any mortgage loan that we will purchase that includes no high cost loans, no single-premium credit life, no prepayment penalty in excess of 5 years, required monthly reporting by all of our services, prompt reporting of prompt payments. And so we begin with that.

    Second, we have an audit program that on a regular basis audits the customers that we do business with around adherence to our policies and guidelines.

    And finally, we engage in a fairly significant education campaign overall, not only with lenders, but also increasingly with consumers in communities.

    We've been involved in something called the ''Don't Borrow Trouble'' education campaign that we've now taken to 12 cities that really is a public education campaign around, again, alerting consumers to what to look out for when they go to get a mortgage loan or any loan.

    Mr. MEEKS. And finally, let me just ask both of you I guess, there's a new problem, or maybe it's an old problem, that I have found in my district. While understanding that we need the subprime market, I'm becoming concerned that we've been finding individuals who had Class A credit, but they are led into the subprime market.

    And as a result of being classified improperly, they are being robbed in essence of their individual buying power, buying power that they would have, if not the money for the mortgage, because of the incorrect classification.
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    And then I've heard this phrase, ''mission creep,'' that is leading you into the subprime market. Can you tell me how do you respond to that? Mission creep and the misclassification of borrowers.

    Mr. BRENDSEL. If ''mission creep'' means trying to clean up practices in the subprime market, trying to find ways to qualify more borrowers for low cost loans that can be purchased by Freddie Mac, we plead guilty, absolutely. But in fact, we're not going beyond our charter there. That's foursquare in keeping with the purpose and mission for which Freddie Mac is chartered.

    Indeed, yesterday there was an article in The American Banker that talked about some subprime lenders who were complaining that we were engaging in some business, trying to buy some business and purchase subprime loans, and it's going to drive down their profit margins, drive down what I would say is their excessive fees and returns that they are getting today.

    So, great article, great compliment, I think, to what Freddie Mac is doing. I submitted it for the record actually. Beyond that, though, I think what we've also discovered is that there frankly are just many families that are in the subprime market that really can qualify for a prime loan if only they are reached by the right lender.

    That's why we want to partner and team up with the right lender with our tools, many of our automated underwriting tools, so that they can qualify those families for a prime loan at the lowest possible rate.

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    Chairman BAKER. Your time has expired, Mr. Meeks.

    Mr. Shays.

    Mr. SHAYS. Thank you, Mr. Chairman. I want to compliment both gentlemen for their efforts to comply or conform to the voluntary agreement. You're satisfied, so I'm satisfied.

    I also say if you told me a year ago that I'd be reading The American Banker, I'd say ''fat chance.''

    [Laughter.]

    Mr. SHAYS. But I want to continue what Mr. Meeks went on, and I want to know, what is the lowest acceptable score that you would have?

    Mr. HOWARD. We have no automatic cutoff. We have programs that will evaluate all borrower characteristics, credit score, the property the person is borrowing.

    Mr. SHAYS. So you have no score?

    Mr. HOWARD. We have no bright line below which one cannot get a loan.

    Mr. BRENDSEL. We do not either.
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    Mr. SHAYS. And how are you pricing these borrowers' risks? How do you determine that?

    Mr. HOWARD. We look at the characteristics, and based on a review of the characteristics compared with how loans with similar characteristics have behaved in the past, we pick prices that we believe adequately compensate us for bearing that risk.

    Remember, we have two objectives whenever we're underwriting a loan. We want to make sure that the consumer gets the lowest rate possible, but we also have to grade it and price it so that we meet our safety and soundness objectives on the other side. It's a constant balancing act.

    Mr. SHAYS. Mr. Brendsel.

    Mr. BRENDSEL. Same answer.

    Mr. SHAYS. Same answer as his? Thank you. How are you disclosing your activities to your shareholders? Should we have been surprised this was happening?

    Mr. HOWARD. What's the ''this''? I'm sorry.

    Mr. SHAYS. How would you disclose your activities to your shareholders? You know, you're getting into a new market it seems to me.

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    Mr. HOWARD. We have been very open with our investors as well as the Congress about our intent to be active in this market.

    I'll echo what Mr. Brendsel said in that this is in no way mission creep. Mission creep has a connotation of doing something you shouldn't be doing. And making loans to people with less-than-perfect credit is not only totally within our charter, it's something that we should do and it's something that's right to do.

    And as we can take more advantage of the benefits of automated underwriting that allow us to more effectively grade credit risk, we can and will be moving further into this area.

    I will say that last year we have done an amount of this business that's significant to the market.

    Mr. SHAYS. I don't mean to be rude and interrupt, but I only have 5 minutes.

    How do you respond to the allegations that the GSEs are using their ability to allocate business to the detriment of the institutions that are outspoken critics of them, such as moving up to the list of approved bidders for Fannie?

    I'm going to give you a chance to—this is today's edition of The American Banker. So don't give me as long an answer as they have here.

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    Mr. HOWARD. It actually deserves a longer answer. I will give you a short answer. The allegations are completely baseless.

    Mr. SHAYS. Let me just ask you, though. They're baseless that you haven't done it, but how can you be assured that others in your organization haven't made that—if someone said my staff did something, I could say ''they're baseless,'' but I would check it out. I would know they were baseless. You don't——

    Mr. HOWARD. Congressman, I have checked it out. The only specific cite made in the article alleging threats was that we removed Wells Fargo Bank from a list of approved or eligible bidders for our debt. We did not do that. We have no such list.

    Wells Fargo, as any other bank, can bring us debt transactions anytime it wants to.

    Mr. SHAYS. Fair enough.

    Mr. Brendsel.

    Mr. BRENDSEL. As I was reported in The American Banker, I made a statement, wrote a letter indicating that Freddie Mac has not, does not, will not engage in bullying or abusive tactics. We have a clear corporate ethic against that kind of thing. Second——

    Mr. SHAYS. If any of your employees were implying that might be the case, what would be your response to those employees?
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    Mr. BRENDSEL. Depending upon the seriousness, clearly I would do a review of that particular statement and obviously it could result in an employee being fired.

    Mr. SHAYS. You would consider that a very inappropriate action?

    Mr. BRENDSEL. Absolutely.

    Mr. HOWARD. As would I.

    Mr. SHAYS. Thank you very much.

    Chairman BAKER. Thank you, Mr. Shays.

    Ms. Jones.

    Ms. JONES. I'll pass. I'll pick up later on.

    Chairman BAKER. Mr. Ford.

    Mr. FORD. Thank you, Mr. Chairman. Thank you both Fannie Mae and Freddie Mac for being here. I want to follow up my colleague, Mr. Shays, with a line of questioning he was sort of following through.

    I guess in the article from yesterday's American Banker reads that ''The idea that Fannie and Freddie would dip their toes''—it's sounding something like ''The Sopranos'', I might add—but, ''would dip their toes further into subprime lending has lenders concerned that their margins will shrink and their profits erode. They also figure they will lose business as prime lenders snap up their loans by offering better rates.''
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    I applaud you, both of you, for working to make housing more affordable. It would seem to me, Mr. Chairman, that on this subcommittee we would be applauding that and encouraging that as well.

    Would you mind—I know that you've had questions asked by my colleague, Mr. Meeks and certainly by others on the subcommittee—would you mind elaborating just briefly if you could on some of your other efforts in the subprime market? I know you started, Mr. Brendsel of Freddie Mac. I can't pronounce your last name correctly.

    Mr. BRENDSEL. Brendsel.

    Mr. FORD. Mr. Brendsel. I'm sorry. Mr. Brendsel, if you could elaborate for 30 seconds and perhaps, Mr. Howard, you could as well, just summarize very quickly some of your activities in the subprime market.

    And why have you made these people so mad at you is what I want to know. Is it you're providing more housing for people? Is that essentially what it is?

    Mr. BRENDSEL. Yes. Basically, it's all about competition if you want to look at it that way. It is providing additional consumer choice through other lenders.

    After all, one of the reasons why someone finds themself in a situation of having to take out a subprime loan is that that's the only source of credit that they may be aware of.
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    And indeed, by working with a number of lenders, small as well as large, providing them with the kinds of tools so that they can originate those loans, it means that, you know, that family can get a better mortgage loan.

    Well, the subprime lender that was charging very high fees and very high costs is going to be unhappy, and that's what you see reflected in the article of yesterday.

    Mr. FORD. Mr. Howard.

    Mr. HOWARD. We are very much aware that there are many, many borrowers who are not getting the best mortgage for which they are qualified.

    We have developed products, including our expanded approval and timely payment reward mortgages that are designed to address that. But we're also working very intensely with our lender partners on figuring out how to get those products in front of you.

    We are surprised, frankly, that even with the products, we're not getting the demand that we would hope we could. So we think we have to come up with new ways for making those products available and accessible to people who could benefit from them.

    And we are going to work very hard and very diligently until we figure out how to do that. We think we have a service to offer this underserved area, and we intend to do that.

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    And I think that's one reason why subprime lenders are currently kicking up some dust around this.

    Mr. FORD. Is it true that over the life of an average subprime loan that a consumer will pay nearly $209,000 more than a conventional loan?

    Mr. HOWARD. It's certainly possible given the rates that I've heard are being charged in that market.

    Mr. FORD. I know we are discussing a potential tax cut here, which I support, I might add, here in Congress, but I cannot think of a better tax cut for working people than helping them to save that amount of money over the life of a loan.

    To put some of these voluntary initiatives in perspective, both of you, could you please comment as briefly—my time is running out—on how safeguards like these compare to the norms of industry? Have other companies, particularly those that are part of FM Watch, taken similar steps or they simply mirror what you all are doing?

    Mr. BRENDSEL. I can't say how particular companies that are members of FM Watch match up against these particular disclosure commitments.

    However, in general, I can say that based on my knowledge of what financial institutions disclose, our commitments, our disclosures put us clearly up ahead of the pack.

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    Indeed, last year, we retained PriceWaterhouseCoopers to review our disclosure practices before we made these additional commitments. At that time, they said our disclosures to investors placed us among the best of the best in terms of banking and financial institutions.

    These additional commitments take us beyond the best.

    Mr. FORD. Mr. Howard.

    Mr. HOWARD. Our commitment is to remain at the forefront of disclosure practices. We think we have now moved beyond that to being best practice. If and as disclosure practices improve, we will revisit what we're doing, and our commitment is to stay ahead.

    Mr. FORD. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Ford.

    Mr. Bachus.

    Mr. BACHUS. Thank you, Mr. Chairman. I'd like to yield 15 seconds.

    Mr. SHAYS. Just very quickly. My concern and my questions are, it's not a level playing field. We give you a charter because of that. We cannot go into our business if we put everyone out of business. And the question is, what's appropriate for you to be in? And I'm not asking for a response now, but I'm eager to have a second round of questions just to pursue what is your legitimate business.
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    Thank you.

    Mr. BACHUS. Thank you. Gentlemen, you all make projections on your debt in future years, and I've noticed that Treasury, they make projections on what their debt is. And I'm told that the debt of Fannie Mae and Freddie Mac will exceed that of the U.S. Treasury by 2005.

    Is that accurate? Are you aware of that?

    Mr. BRENDSEL. I can't say whether or not those particular projections are accurate. I can say that those types of comparisons that you read are kind of comparing apples to oranges, or I'd put it this way.

    Declining U.S. Treasury securities outstanding is clearly good news for the U.S. taxpayer.

    Increasing Freddie Mac securities outstanding really reflects good news for America's home buyers. And after all, it is securities that are backed by mortgages on people's homes.

    So our growth is in line with the growth of the U.S. mortgage market. Indeed, for example, over the last 5 years, residential mortgage debt outstanding has grown roughly 8 percent a year. We've grown roughly 9 percent a year. But that reflects the strength of the economy, increasing home ownership rates, the exploding home ownership rates that have occurred over the last several years.
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    And so, clearly, that is good news for America's home buyers as reflected in the strength of Freddie Mac, not any risk to the U.S. Treasury or taxpayer.

    Mr. HOWARD. I'd make a couple of points to that. First of all, this is what we would call a high quality problem, having Treasury debt disappear by the year 2010. When Treasury debt totally disappears, my teenaged daughter will have more debt outstanding than the U.S. Treasury.

    Fannie Mae currently has about $640 billion in debt outstanding, all of which is funneling capital into housing. A very important point in comparing Fannie Mae debt with Treasury debt is the fact that, because we deal exclusively in the secondary market, we do not create debt except insofar as we cause more mortgages to be made.

    Whenever Fannie Mae buys a mortgage in the secondary market by issuing debt, the proceeds of that debt are given to the seller who then pays off their debt. So what's happening in the aggregate is debt is shifting from that of the seller of the mortgage to Fannie Mae.

    We talked earlier that Fannie Mae debt has a stand-alone rating of AA-minus. It's very high quality debt. So this is a good problem to have in my view.

    Mr. BACHUS. Thank you. Mr. Howard, Moody's, in rating your subdebt, stated ''It is Fannie Mae's intent to create a class of securities that would reflect the market's views on the firm's credit profile via the price at which it trades.'' Would you explain?
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    Mr. HOWARD. Yes. What we're hoping to do is create a class of security where investors know they have an economic interest in the risk management practices of Fannie Mae.

    And that's because we built into the subordinated debt a feature that would cause the holders of that subordinated debt to have their interest payments deferred for up to 5 years if our capital falls below a threshold amount. And that threshold amount is 125 percent of our so-called critical capital level.

    With that financial incentive, we believe subordinated debtholders will pay attention to our disclosures, monitor our credit quality, and the reflection of their view will be in the price at which that subordinated debt trades relative to our senior debt.

    Mr. BACHUS. You just mentioned that you would defer interest payments. A lot of times on subordinated debt, that debt converts to equity. Is that right?

    Mr. HOWARD. Subordinated debt can be structured that way. We have deliberately chosen not to do that, because we want to ensure that a holder of subordinated debt has the same interest as the U.S. taxpayer.

    The subordinated debt that converts to equity gives the holder an interest in the company doing whatever it can to make that subordinated debt principal pay off, even if the risk the company takes are very high, the equity holders, if a company is in trouble, basically want the company to go for broke, shoot for the moon, on the hope they'll get paid off. Debtholders want exactly the opposite.
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    So subordinated debtholders in that circumstance, if the debt is not converted to equity, have exactly the same interest as the Congress and the U.S. taxpayer, and that's what we wanted to create.

    Mr. BACHUS. But of course, it might not bring you up to the minimum capital standards, which you are intending to do by deferring those interest payments.

    Mr. HOWARD. No. But remember, the suspension of interest is only triggered if we fall below those critical capital thresholds which, given our risk management incentives and practices, is a highly unlikely event. And again, that's reflected in our stand-alone credit rating.

    Mr. BACHUS. Who is going to verify the commitments you've make whether they're being acted upon?

    Mr. BRENDSEL. Certainly it starts internally with our own board of directors and our internal audit function. Externally, of course, it will be verified by our regulators through their examination function at OFHEO.

    Mr. BACHUS. So you do see part of their role is to verify that the commitments you made to this subcommittee are realized?

    Mr. BRENDSEL. Yes.

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    Chairman BAKER. You've expired your time, Mr. Bachus. We'll come back to you.

    Ms. Jones.

    Ms. JONES. Thank you, Mr. Chairman. I want to commend you for holding these hearings once again. It's kind of like deja vu, though. Remember last year when you were holding these hearings, Mr. Brendsel, Mr. Howard, and all the articles that came out about Fannie Mae and Freddie Mac on the issues of mission creep?

    I want to quote specifically from an article in The Washington Post that said, ''Today a hearing before Representative Richard Baker, Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, was not scheduled to question the company's lending guidelines, rather aimed at assessing their progress toward a number of goals laid out last year.'' And on and on and on.

    That was the intent of this hearing, was it not, gentlemen? Is that why you came prepared to testify today, Mr. Brendsel?

    Mr. BRENDSEL. Yes.

    Ms. JONES. Mr. Howard?

    Mr. HOWARD. Yes it is.

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    Ms. JONES. And I really didn't intend to question the issue of mission creep, but seeing how everybody else decided they'd go down the line on mission creep, I thought I'd go that route myself.

    It's true that the mission of both of your Government sponsored enterprises allows you to go into the secondary market? I'm kind of cross-examining like a prosecutor. Forgive me. Give me short answers. Correct?

    Mr. HOWARD. Yes.

    Ms. JONES. And in that effort, Mr. Howard, you've been with Fannie Mae maybe—in this position for the past 10 years. Is that correct?

    Mr. HOWARD. Eleven, yes.

    Ms. JONES. Eleven. Excuse me. And in those 11 years as the CFO of Fannie Mae, can you talk about why you chose to go down the route that you've gone to look at your charter and make some specific changes and what you thought you were permitted to do under the law?

    Mr. HOWARD. We last took a look at our charter in 1992 in conjunction with Congress. At that time, Congress made some changes, including giving us specific housing goals that we have met every year since they've been in effect. It created a new regulatory capital standard, which we're now discussing.

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    Subsequent to the 1992 law, we have made no request for further charter expansion. We believe our charter as adopted by Congress in 1992 is exactly the right charter for us to have to carry out the mission that Congress has given us.

    We have been operating within that charter, which is why on the topic of mission creep, I have yet to hear a credible description of what it is we are doing that exceeds the charter that this Congress passed in 1992.

    Ms. JONES. Mr. Brendsel, would you like to answer that question as well?

    Mr. BRENDSEL. Having been in Freddie Mac since 1982, now 18 years, I have a long history in the evolution of Freddie Mac.

    First I'd say our charter is very clear as to our purpose, our authorities, what we can do and what we cannot do. And over time, while the regulatory structure has been changed and enhanced certainly for Freddie Mac, we have not sought really to change our charter in terms of our authorities with one exception that I can remember, and that is in fact we proposed, attempted to get a change to the charter requirement that we have private mortgage insurance on every low downpayment mortgage that we purchase.

    We proposed making it more flexible so there would be alternative forms of credit enhancement that we could use on low downpayment mortgages. We saw that the evolution of the capital markets meant that there were many other alternatives other than private mortgage insurance to give us that protection.
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    That particular proposal failed, but I still think it's a good idea.

    Ms. JONES. Do you know who Beneva Scholte is?

    Mr. HOWARD. I've heard the name.

    Ms. JONES. She's the contact person for the FM Watch report that outlines how GSE mission creep threatens American consumers, the report that came out about a week ago, just in time for our wonderful hearing. Have you ever been in contact with her?

    Mr. HOWARD. I have not been personally.

    Ms. JONES. Let me finally say that you've had an opportunity since last year to comply with these six voluntary agreements to put your ships in better shape than they already were in, correct?

    Mr. BRENDSEL. Correct.

    Ms. JONES. You don't have any issue about entering into voluntary compliance, do you?

    Mr. BRENDSEL. No.

    Ms. JONES. Did you welcome the opportunity to continue to make these two companies the leading companies here in the United States in pushing or providing for affordable housing in the United States?
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    Mr. BRENDSEL. Absolutely. I couldn't have said it better myself.

    Ms. JONES. Thank you very much, Mr. Chairman. I yield the balance of my time.

    Chairman BAKER. Thank you.

    Mr. Weldon.

    Mr. WELDON. Thank you, Mr. Chairman.

    Mr. Brendsel, you stated regardless of disruptions in the capital markets that that may make it impossible to borrow, Freddie Mac has the means to meet our financial obligations for at least 3 months.

    Mr. BRENDSEL. That's true.

    Mr. WELDON. I think, Mr. Howard, you said the same thing?

    Mr. HOWARD. Yes.

    Mr. WELDON. Could you give me a little more detail on how you'd go about doing that?
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    Mr. HOWARD. I think we would both do it in a similar way. First of all, we maintain a fairly sizable liquidity portfolio. As of the end of last year, it was 8 percent of total assets.

    That liquidity can be run off. They're high quality securities that can be sold to allow us to pay down debt if we don't have access to capital markets.

    Mr. WELDON. What kind of securities are they?

    Mr. HOWARD. Many of them, we made short-term loans to banks, in the Fed funds market. We have AAA-rated securities that can be sold readily for prices very close to what we paid for them.

    We also have over $300 billion in high quality Fannie Mae mortgage-backed securities that can be pledged as security for repurchase agreements that can then be used for borrowing. This is very standard practice in the financial services industry. And the use of those securities as collateral for repurchase agreements would give us many months of access to borrowing without having to issue debt.

    Mr. WELDON. Mr. Brendsel.

    Mr. BRENDSEL. My answer would be very similar. Clearly, we start out with a schedule of what are all the outstanding commitments and obligations that the company will have coming due over the next 3 months, so we can have a clear idea on that.
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    And then second, we make certain we have the kind of liquidity that Mr. Howard was referring to, whether it was in the form of very high grade, high quality corporate securities and banking securities or our own mortgage-backed securities.

    Mr. WELDON. Correct me if I'm wrong. It's very easy for you to raise capital by just issuing debt, and that in itself gives you a lot of liquidity in terms of giving you the ability to expand your business. Would you say that that enhances safety and soundness for your institutions?

    Mr. HOWARD. Not just for our institution, but for the financial system as a whole. So in times such as the fall of 1998 when credit was not readily available, we were able to issue Fannie Mae debt that investors valued and would invest in, take those proceeds and channel them into the housing market.

    So we can serve as a stabilizing force for the entire system.

    Mr. WELDON. Do you want to add to that at all?

    Mr. BRENDSEL. This may be just a point of clarification. This liquidity and contingency commitment would assume that we would not be able to issue any debt at all for that 3-month period.

    Mr. WELDON. Right. I realize that. You have been conducting the internal risk-based capital test, the so-called ''stress test.'' In the agreement you committed to disclosing the parameters of your testing models and the outcomes of the testing. What level of detail are you going to be providing on that? Or have you made that decision yet or not?
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    Mr. HOWARD. Yes. In implementing the interim risk-based capital test associated with the voluntary agreements, we have moved from using a model based on Fannie Mae's own specification that we have been running since 1993 to one that uses as its basis the notice of proposed rulemaking that OFHEO put out in 1999.

    So we use that as the basis plus amendments OFHEO has made subsequent to that.

    In addition, we added elements in our comment letter of March 10th of 2000, which is publicly available, and made some additional adjustments to approximate as closely as we could what we think a final official standard might look like. And those changes are available on our website as part of our disclosure package.

    So by going to OFHEO's website, looking at our comment letter on our website, an observer can look at all of the elements that we used in running our risk-based capital test on an interim basis that we just announced.

    Mr. WELDON. The same for you as well?

    Mr. BRENDSEL. Similar. We've attempted to coordinate wherever possible types of disclosures with Fannie Mae to assure that investors wouldn't be confused.

    Mr. WELDON. Have two standards.

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    Mr. BRENDSEL. Yes, two standards and so forth. And I wouldn't say that in all cases we have adopted the identical approach.

    But I'd like to add one additional point about Freddie Mac. We really began managing the company under a kind of a stress test approach to assess capital adequacy and to maintain assurances that we were appropriately capitalized beginning in the late 1980s.

    Indeed, we were an advocate of the legislation that was crafted in 1992 establishing this very dynamic and forward-looking, at the time an avant garde risk-based capital approach, and we've been managing according to that at Freddie Mac ever since.

    Indeed, we were disclosing a lot about how we assessed capital even before we made this final commitment. And now of course, we're going to provide additional information including general information around the kind of parameters in this stress test that we use for this disclosure.

    Mr. WELDON. Thank you, Mr. Chairman. I think my time has expired.

    Chairman BAKER. Thank you very much, Mr. Weldon.

    Mr. Hinojosa.

    Mr. HINOJOSA. Thank you, Mr. Chairman. I want to yield my first 2 minutes to my good friend and colleague, Congressman Israel.
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    Mr. ISRAEL. Thank you. I thank the gentleman for yielding.

    There seems to be near-unanimous praise on both sides of the aisle for the voluntary initiatives that you are conforming to, and you've already stated that those voluntary initiatives help you meet your core competency, which is to provide affordable housing.

    I'm just wondering whether you can estimate the approximate cost of conformance with the voluntary issues in terms of personnel or hard dollars. Mr. Howard?

    Mr. HOWARD. Most of the voluntary commitments codify or make public practices that we have already undertaken. Those practices do have costs, because we need to have high quality staff to do risk assessment. We need to do lots of modeling to help us get a sense for how best to measure and manage our risk.

    The one specific cost that's easy to track is the additional cost we pay to issue subordinated debt. Because if we didn't have a subordinated debt, we would issue senior debt at a lower cost.

    So for the first issue we did, $1.5 billion, we paid 22 basis points more. That's a pure additional cost.

    We have committed to build our subordinated debt up to roughly 1.5 percent of total assets, which over the next 3 years will be between $12 and $15 billion of subordinated debt. And if we pay 22 basis points on all of that, that will be a real incremental cost over and above the others that I've mentioned.
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    Mr. ISRAEL. Mr. Brendsel, if you answer briefly please.

    Mr. BRENDSEL. Yes. The additional incremental cost on subordinated debt would be similar. I think our first issue, we had 22 basis points, which would amount to, on a $2 billion issue, that we did about $4.4 million annually in additional cost.

    If, however, these commitments, including the subordinated debt, provide greater assurance and confidence to the investors in the stability of the company, really the confidence of Congress and the public, that will be more than offset in terms of overall cost on our senior debt.

    Mr. ISRAEL. I thank the gentleman for yielding.

    Mr. HINOJOSA. Thank you. I was looking at the closing statement that Mr. Brendsel used, and he said that he looks forward to working together with us to secure the future of our housing finance system and with it the dreams of millions of families.

    So that brings me to one of the points that I made earlier in my opening remarks, and that was my concern about the wide gap that exists between the standard families owning a home, Anglo-Saxon families, I think that there's a lag of 26 percent behind Anglo-Saxon home ownership.

    So can you tell me what your company is doing to close this wide gap?

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    Mr. BRENDSEL. Yes. I can tell you what our company is trying to do with all its energy and all the commitment of the 4,000 employees at Freddie Mac and their creativity.

    First of all, I'd emphasize that we are committed to closing that gap, finding every avenue that we can within our charter.

    Certainly, it includes developing new flexible mortgage products that make it easier for a low-income or minority family to afford their first home. It includes partnering with organizations that know the Hispanic community well, like the National Council of La Raza and the National Association of Hispanic Real Estate Professionals.

    Indeed, we recently entered into an agreement, a partnership really, with those two organizations, $2 million to develop web-based technology to increase home ownership counseling for Hispanic families.

    In addition, we're constantly trying to improve our underwriting systems, use technology to drive down origination costs, increasing the ability of a low-income family or a minority family to get a mortgage loan. And, of course, we are constantly exploring new ways to attract capital from throughout the world at a lower cost, making it again more possible to afford a home.

    I think it's a journey. It's a journey that we've been on for decades now. Clearly, there's a long way to go. Yes, the average home ownership rate nationally approaches 70 percent, 67 percent. But as you have clearly indicated, the home ownership rate for Hispanics as well as African American families in this Nation falls well below and indicates that there is still a lot more work to be done.
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    Mr. HINOJOSA. Mr. Howard, your group has done a great deal of effort in San Antonio to Brownsville, to McAllen, to Laredo and that area, because I've seen some of the programs that were introduced in these last 4 years as we were moving many families from welfare to jobs, and in some cases not letting them stay more than 2 years in Section 8 housing.

    Do you have a way of monitoring and assessing the success or failure of your new programs as they relate to get Hispanics to own their own homes?

    Mr. HOWARD. Yes we do. Last year, Fannie Mae announced our $2 trillion American Dream commitment. That was the successor to our $1 trillion initiative that we announced back in 1994.

    In both cases, we established a very rigorous pattern of announcing specific goals and then tracking and reporting on how we were doing against those goals.

    One of the subgoals of the American Dream commitment is a specific minority lending initiative where we are setting targets to help close the home ownership gap between minorities, including Hispanics, and majority Americans.

    But I've noticed in recent publications by FM Watch and others, they're claiming that we have solved the home ownership problem and that we should stop. That totally ignores the very wide gap between minority home ownership and majority home ownership that we are committed to working on to close.

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    And through the American Dream commitment and specific target initiatives that we are working on with interest groups as well as lenders and others, we will follow up on those initiatives, track and report on them, and hopefully be a positive force in achieving a good outcome.

    Mr. HINOJOSA. Would you repeat the name of the organization that felt that you should stop?

    Mr. HOWARD. FM Watch.

    Chairman BAKER. You'll be hearing more from those folks, Mr. Hinojosa, I'm sure.

    [Laughter.]

    Chairman BAKER. The gentleman's time has expired. I'll start back on a second round. There being no further Republican Members.

    Just one comment again on the specifics of the arrangement of last fall. The requirement to issue subordinated debt equal to 4 percent as subtracted from the core capital, whatever that difference turns out to be, an annual rating which now has turned into a surveillance rating, new liquidity standard for a 3-month operating window, an interest rate risk disclosure and credit risk disclosure that is new and heretofore not engaged in, and each of you commented that you feel that that package represents a substantive structural change in the level of transparency and disclosure to the markets. Is that correct?
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    Mr. HOWARD. Yes it is, sir.

    Chairman BAKER. And to your knowledge, has it had an adverse impact on your operations since you complied with these activities?

    Mr. HOWARD. None whatsoever.

    Mr. BRENDSEL. No.

    Chairman BAKER. Well, I just want to make the point, and this is coming from a little different perspective, that it is possible to manage the affairs of Government sponsored enterprises without necessarily legislation, but with regulatory changes that do not result in adverse circumstances, like throwing hundreds of thousands of people out of home ownership. I feel that's a pretty substantive point to make.

    Second, that with regard to the discussion of the regulator piece that is yet to come, these are elements that a—I don't want to say a well-run shop, because you all are extraordinarily well run—would want to have in the marketplace, coupled with a competent regulator so there's no question about the stability of your debt issuances.

    And the reason for bringing that up is I am concerned about the consolidation of the counterparties because of mergers and acquisitions internationally and domestically and your ability to hedge risk appropriately.

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    I am concerned about the difficulty we may engage in if we have a short-term 1998 liquidity problems and whether or not—I'm not suggesting we haven't gone far enough, but what I'm asking you is, what is your level of confidence, knowing now that these new standards are operative, that the markets are now expecting this, and you can't back off of it. It's a requirement that you must go forward with. Am I reading anything into the spreads on the subdebt as being any indicator of any concern, particularly with the consolidation of counterparties' potential liquidity problems in the broader market, not within your shop?

    How good do you feel about the deal we put together here and its effect on being able to insulate taxpayers from any adverse circumstances that could develop? Keep in mind we're talking the 1980s and Louisiana/Texas oil and gas patch circumstances that are in pretty dire consequences.

    Mr. BRENDSEL. Mr. Chairman, I think I would answer the question this way. We started from a point at the time that we announced the commitments that we were already extraordinarily well capitalized for the risks we take and face, because we're only in the home ownership business and rental housing.

    And we only added to that by the additional commitments. Obviously, spreads on securities fluctuate from day to day for a variety of reasons, many of which have nothing to do with any one institution. So I don't know what you're reading into a spread moving from 22 basis points to 28 basis points, but in the scheme of things, that is just a random fluctuation.

    I used to be the chief financial officer at Freddie Mac years ago and I've lost my edge a little bit, so I'll let Mr. Howard comment as well.
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    Mr. HOWARD. I put the movement in our subordinated debt in this perspective. As Mr. Brendsel mentioned, each of us priced subordinated debt around 22 basis points off our senior debt.

    In our case, we traded as tight as about 18 and as wide as 28. That's a minus 4 plus 6 move. That is a range that is well within what other issuers of subordinated debt have experienced over the same time period. These are the high quality commercial banks that have subordinated debt outstanding that is quoted publicly in the market.

    I would also say that over the last year, our 10-year senior debt spreads to Treasuries have moved within a swing of about 45 basis points, reflecting a host of factors, none of them specifically being credit quality-related.

    Chairman BAKER. Well, the overall interest market since the date of introduction of the legislation year til now has been nothing but a continuous, steady downhill trend, and we're enjoying a very low interest market at the moment, which certainly has to have a much larger effect on the cost of selling than anything else I can imagine. I'm again exceeding my time.

    Mr. Kanjorski.

    Mr. KANJORSKI. Mr. Chairman, I think I have asked all my questions and heard all the answers. I suggest this has been a very successful hearing.

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    Chairman BAKER. Does any other Member wish to be heard?

    Ms. JONES. Just very briefly. Some would say that the current interest market has been influenced by conversations by our chief officer of Government and other elected officials or appointed officials in his Administration. Some would say that, wouldn't they, Mr. Brendsel, Mr. Howard?

    I'm not asking you to say it, because you can't say it, but I can say it. That some of the articles would say that the interest or the economy is in the position that it was—I think it was the New York Times in fact that said that some in our Administration have talked the economy down. You read that, didn't you, Mr. Brendsel? You don't have to admit to it. But I know you read it. Well, let me go on.

    [Laughter.]

    Ms. JONES. Standard & Poor's and Moody's, those are the organizations that evaluated your economic status and debt ratio, right? Correct?

    Mr. HOWARD. Yes, that's correct.

    Mr. BRENDSEL. That is correct.

    Ms. JONES. And in fact, they're kind of like Alan Greenspan. When he speaks, people listen. When Standard & Poor's and Moody's give you a rating, people listen to that, right?
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    Mr. HOWARD. Yes they do.

    Ms. JONES. And in fact, in order to judge your soundness, and what's the other word I want?

    Mr. HOWARD. Safety.

    Ms. JONES. And safety. Thank you very much. You went to these institutions to have them evaluate you and even passed what was part of the voluntary agreement.

    Mr. HOWARD. Correct.

    Ms. JONES. And so if I were sitting in your shoes, I would feel pretty darn good about the—I wish my son would get A and double AA and what are those other ratings?

    [Laughter.]

    Ms. JONES. But he says, Mom, give him time. But you're at that status right now. Is that correct?

    Mr. HOWARD. Yes we are.

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    Ms. JONES. I wondered if you might briefly elaborate for me. One of my colleagues said something about when you can raise capital by issuing debt. I can't think of his name. He's seated four down on the side. He said that the way you can raise capital for your company is by issuing debt. Is that correct?

    Mr. HOWARD. He may have said that.

    Ms. JONES. Anyway, he raised the question. My question is—and I'm not a business expert or anything—but most corporations raise capital by issuing debt. You're not doing anything unlike other corporations. Is that a fair statement?

    Mr. HOWARD. I don't believe we are.

    Ms. JONES. OK. And wouldn't it be fair to say that because of the lack of affordable housing in the United States and because there are so many people in need of housing, there's room at the table for many, many financial institutions who want to engage in mortgage lending in communities, regardless of their color, economic interest, to get involved?

    Mr. HOWARD. Very much so.

    Ms. JONES. And that even though this is a competitive market, Fannie Mae does not have to engage in threatening tactics in order to be successful?

    Mr. HOWARD. We do not and have not.

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    Ms. JONES. What about you, Freddie Mac? Do you have to engage in threatening tactics in order to be successful?

    Mr. BRENDSEL. No. We never have and we never will.

    Ms. JONES. I'll yield, Mr. Chairman.

    Chairman BAKER. Thank you.

    Mr. Shays.

    Mr. SHAYS. Thank you, Mr. Chairman. I just want to say that both your organizations have been very helpful to me. Both organizations are very responsive.

    But I found the hair on my back rising when you talked about going to any market where you see an opportunity, where there's an overpricing and so on. It almost sounded a little sanctimonious to me, with all due respect.

    You all are given opportunities to compete that your competition in a sense doesn't have. Is that correct?

    Mr. HOWARD. This is a longer discussion, but I think that's a complicated subject.

    Mr. SHAYS. It is a complicated subject. And that's almost an arrogant answer. I realize it's a complicated subject. But the bottom line is, you are given certain opportunities that your competition doesn't have.
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    Mr. HOWARD. We are given different opportunities from those which our competition's been given.

    Mr. SHAYS. Your cost of capital is less, correct?

    Mr. HOWARD. In the long-term end of the market, yes. In the short term, it is higher than our competition.

    Mr. SHAYS. You don't have to file certain reports, correct?

    Mr. HOWARD. That's correct.

    Mr. SHAYS. You don't have to pay State and local taxes?

    Mr. HOWARD. Through Congressional design.

    Mr. SHAYS. I know that. I'm not saying that you have these powers illegally. You have them. We've given them to you. And doesn't that apply to you as well? It applies to both organizations.

    Mr. BRENDSEL. That's correct.

    Mr. SHAYS. So you don't have to pay State and local taxes. You can get capital, at least in the long-term, cheaper. There are certain advantages you have.
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    And so what obligations do I have up here to make sure that you don't use those advantages to basically put everyone out of business?

    Mr. HOWARD. We have a charter that precisely limits us to channeling whatever those advantages may be into housing.

    Mr. SHAYS. So the charter basically sometimes is going to tell you that you can't go into a marketplace even if you happen to think that the market is overpriced and you have opportunities?

    Mr. HOWARD. Yes, that's correct.

    Mr. BRENDSEL. I think I would agree with many of the points that you were making, Congressman. We compete with certain tools, advantages, that come as a result of our charter. And indeed, with those tools come special or different responsibilities. We're limited obviously to only the residential mortgage market.

    Indeed, we're also limited. We can't originate a mortgage loan. In addition, of course, we can't buy mortgage loans on expensive housing, so-called jumbo loans.

    Our charter is very clear. We can't go off into doing credit cards. We can't go off into any number of different other things.

    Mr. SHAYS. The bottom line, the purpose for which you exist is to enable Americans to buy more homes. That's the basic purpose for why you exist. And you've done a pretty good job of that. Am I wrong? Isn't that the basic purpose? If we want more residential housing, we want more homeowner properties.
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    Mr. HOWARD. But beyond that, it's targeted residential investment. That's why we have housing goals that guide us as to where we should focus whatever benefits Congress gave us. There are limits that come with the benefits.

    Mr. SHAYS. So you could make a determination in your charter allowed it that there's great opportunities in the jumbo loan market?

    Mr. HOWARD. No. That's expressly——

    Mr. SHAYS. Maybe you didn't hear my question. If your charter allowed it?

    Mr. HOWARD. Yes.

    Mr. SHAYS. And we tell you you can't go into that marketplace. Why do you think we do that?

    Mr. HOWARD. To focus our efforts where Congress deemed they were most necessary.

    Mr. SHAYS. So you have a problem with this subcommittee overseeing your activities?

    Mr. HOWARD. No.
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    Mr. SHAYS. Do you have a problem with our investigating the possibility of providing more regulations?

    Mr. HOWARD. No.

    Mr. SHAYS. That's good.

    Mr. HOWARD. Terrific.

    Mr. SHAYS. We'll be watching.

    Mr. HOWARD. We look forward to it.

    Mr. BRENDSEL. Congressman, could I make an additional comment? And indeed, with regard to the last point, we in fact welcome the oversight.

    Actually I think it makes us a better organization, a better company, and it's really better for the Nation as a result.

    Finally, the other point I wanted to make is the issue of benefits or advantages relative to others. Mr. Howard said it's a complex issue. It's more complicated than simple, I think, as has been reflected here today in our conversation.

    Freddie Mac recently requested that James Miller, former Director of OMB in the Reagan Administration, and James Pearce with Welch Consulting, do a study to look at our companies' advantages, the benefits we receive, and then the benefits to consumers. That was a report they issued on January 9th.
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    Two points I would leave you with. One is it clearly shows that the benefits realized by the Nation, consumers and homebuyers, the value of those greatly exceeds the advantages realized by Freddie Mac and Fannie Mae.

    The second point they make is, in fact, there are many other institutions in the marketplace in residential mortgage markets elsewhere that possess their own set of federally bestowed advantages, specifically banking institutions that have federally-insured deposits and that are members or are able to borrow from the Federal Home Loan Bank system, which are themselves Government-chartered corporations.

    And so, their final conclusion was, in fact, that we were a more efficient way for the Government to support and encourage the flow of mortgage credit to this Nation's mortgage markets.

    Mr. Chairman, I'd like to submit that report for the record.

    Chairman BAKER. Without objection.

    Mr. Hinojosa.

    Mr. HINOJOSA. Thank you, Chairman Baker.

    I would ask Mr. Howard a question. Can you please tell me what the predatory lending is and how it differs from subprime lending?
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    Mr. HOWARD. Predatory lending in my view—and I'm not the world class expert on this—does not have a precise definition. In general, they are lending practices that are not in the best interests of the consumers, and typically the consumer is not made fully aware of prior to committing to a loan.

    We have categorized predatory lending practices into certain groups. And at that point, the basis for the guidelines that we put out to our lenders.

    But precisely because there is not a specific definition of predatory lending, we entered into discussions with numerous parties to try and come up with a right balance, because the flip side of too restrictive guidelines is that people who have only one place to get credit find they can't get credit anywhere, which is an outcome we don't want. So we're attempting to find that fine line between making sure that people have loans they can afford, even if they have to pay a higher rate because of their past credit, and abusive practices that end up causing them to lose their home.

    Mr. HINOJOSA. I think Freddie Mac—I'd like to ask you what is your company doing to respond to the problems that Mr. Howard just outlined?

    Mr. BRENDSEL. In predatory lending?

    Mr. HINOJOSA. Predatory lending, yes.

    Mr. BRENDSEL. We refuse to purchase certain kinds of loans that are generally regarded as being associated with predatory lending practices, excessive interest rates on those loans, single-premium credit life insurance, prepayment penalties that extend for an excessive period of time.
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    We also refuse to deal with certain lenders that we have determined are associated with predatory practices. So it's a combination of having policies against purchasing certain kinds of loans and also policies against dealing with lenders that are associated with abusive practices.

    Mr. HINOJOSA. Thank you for that explanation. I wish to yield the balance of my time to Congresswoman Jones.

    Ms. JONES. Thank you, my colleague. Let me begin with the question on restrictions and go through maybe a few restrictions that Fannie Mae has as a result of being a Government sponsored enterprise.

    You're restricted to a single line of business, residential mortgages. Is that correct, Mr. Howard?

    Mr. HOWARD. Yes it is.

    Ms. JONES. You are confined to mortgages under the loan limit, currently $275,000 for a single family loan. Is that correct?

    Mr. HOWARD. Yes it is.

    Ms. JONES. You're required to operate in all markets at all times. Is that correct?
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    Mr. HOWARD: Yes.

    Ms. JONES. Must meet percent of business goals for affordable housing, correct?

    Mr. HOWARD. Correct.

    Ms. JONES. And meet a rigorous risk-based capital test in addition to six voluntary agreements or policies you just recently accorded yourself to. Is that correct?

    Mr. HOWARD. Yes. Although currently we're meeting the interim test because the regulatory test has not been officially promulgated.

    Ms. JONES. Now let me go to the charter purposes. One, to provide stability in the secondary market for residential mortgages. Is that correct?

    Mr. HOWARD. It is.

    Ms. JONES. To respond appropriate to the private capital market, correct?

    Mr. HOWARD. Yes.

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    Ms. JONES. To provide ongoing assistance to the secondary market for residential mortgages, including activities relating to mortgages on housing for low- and moderate-income families, and following a reasonable economic return that may be less than the return on other activities by increasing the liquidity of the mortgage investments and improving the distribution of investment capital available for residential mortgage financing, correct?

    Mr. HOWARD. That sounds right.

    Ms. JONES. And finally, to promote access to mortgage credit throughout the Nation, including central cities, rural areas, and underserved areas by increasing, quote, ''the liquidity'', unquote, of mortgage investments and improving the distribution of investment capital available for residential mortgage financing charter purposes, correct?

    Mr. HOWARD. Yes.

    Ms. JONES. And it is not your intention in any of the activities that you engage in, Mr. Howard, Mr. Brendsel, to act outside of those chartered purposes.

    Mr. HOWARD. It is not.

    Ms. JONES. Is that a fair statement?

    Mr. BRENDSEL. That's correct.

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    Ms. JONES. Thank you. I yield the balance of my time, Mr. Chairman.

    Chairman BAKER. Thank you, Ms. Jones.

    Ms. JONES. Mr. Hinojosa's time actually.

    Chairman BAKER. Thank you, Mr. Hinojosa-Jones.

    [Laughter.]

    Chairman BAKER. Mr. Shays.

    Mr. SHAYS. Mr. Chairman, I didn't really need a full 5 minutes just to say that I really appreciate both witnesses appearing before us.

    You know, I'm new to this subcommittee. I find this a very interesting subcommittee to serve on. I appreciate your chairmanship of this subcommittee.

    But I have a lot of constituents who both work with you and appreciate your partnership and also compete with you. I have a lot of consumers who have benefited deeply by what your organizations do, but I'm absolutely convinced that the playing field isn't level. And because it's not level, we have that oversight responsibility.

    I look forward to learning more about what you all do and how you try to conform to your charter and so on. Thank you. I thank you, Mr. Chairman.
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    Mr. HOWARD. We look forward to working with you on that.

    Chairman BAKER. Thank you, Mr. Shays.

    There being no further comment from Members, I just wish to wrap our hearing up today.

    Someone asked earlier in the course of the hearing who would be the overseer to assure third parties that the terms of the voluntary agreement are successfully implemented over time.

    Since we joined hands at the start, I guess it would be appropriate for us not to release hands until we get a regulatory structure that we can pass this responsibility off to.

    So I will announce, with the agreement of Mr. Kanjorski, who had to leave a little bit earlier, that we will continue in this fashion on some semi-annual or annual basis to receive reports from the enterprises using today's report as the benchmark against which future measurements can be made.

    Second, and it's has been referred to widely, but we will have legislation to introduce in the near term on the suggested regulatory structure, which I have not yet, but do intend to visit with both of the GSE management teams before the bill is finally brought.

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    I also shared that with Mr. Kanjorski and assured him that we would get him a copy of the bill before it would be finally introduced.

    We will also soon receive the report from the CBO relative to the now long-awaited subsidy evaluation which could be the subject of an additional topic.

    Suffice it to say we are going to move very slowly, but I want the Members of the subcommittee and the representatives of the GSEs to understand that we're going to have a very thoughtful through-the-summer type of discussion, no rush to judgment. But I do believe that the steps we take in here build a platform of a cooperative agreement that can be carried forward, and that we won't find it necessary to result in some of the exchanges which occurred in last year's debate and that we can jointly perform the service of making good public policy while not adversely affecting home ownership, and I think at the same time enhance the marketability of the two enterprises' products by creating a regulator that does have credibility.

    To that end, gentlemen, I look forward to working with you and Members of this subcommittee.

    Mr. BRENDSEL. And we welcome the opportunity to work with you, Mr. Chairman.

    Mr. HOWARD. As do we.

    Chairman BAKER. Thank you very much. The hearing is ended.

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    [Whereupon, at 4:20 p.m., the hearing was adjourned.]