SPEAKERS CONTENTS INSERTS
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SPECIAL EXAMINATION OF FREDDIE MAC
Wednesday, January 21, 2004
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance
and Government Sponsored Enterprises,
Committee on Financial Services,
The subcommittee met, pursuant to call, at 10:05 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard H. Baker [chairman of the subcommittee] presiding.
Present: Representatives Baker, Ose, Shays, Bachus, Oxley, Kelly, Ney, Shadegg, Ryun, Biggert, Kennedy, Harris, Renzi, Kanjorski, Inslee, Hinojosa, Lucas of Kentucky, Clay, McCarthy and Scott.
Chairman BAKER. I would like to call this meeting of the Capital Market Subcommittee to order and welcome back Members to start off a new year.
This morning we are meeting to formally receive the report of OFHEO with regard to their special examination of the business operations of Freddie Mac. This is indeed an important study and analysis, which I believe will assist the committee in making important policy determinations as we go forward. But we are also pleased to have a representative of Freddie Mac to appear later in the hearing this morning to give their analysis and comment with regard to the findings and recommendations of the Agency.
I believe it should be clearly understood by now that the current regulatory staff has done its best work in attempting to supervise and oversee the two most complex financial organizations in the world, but they have been historically underfunded and, I believe, lacking appropriate regulatory tools to be responsive to the complexities of these ever-changing enterprises.
Page 2 PREV PAGE TOP OF DOC The effort to create an enhanced regulatory system, however, should be viewed in its proper light, and that is we are attempting to provide stability for the secondary mortgage market into the next decade. We have been extremely fortunate. If any other public operating company had reported multi-billion-dollar restatements over a multiyear period, market reaction to that announcement would have been severe.
To date, we have seen no market dislocation, interest rates continue to remain low, pursuit of home ownership opportunities remains high, and we have been blessed with these unique circumstances in a time of significant corporate governance dislocation.
We cannot let this window of opportunity pass us by, however. We must act on the findings of the regulator. We must take advice from all interested stakeholders and ensure in the years ahead that the oversight and supervision is more than just adequate; that it is world class in nature, and that we can be hopefully preemptive in setting aside events which might bring adverse consequences to innocent home purchasers.
I view this as an extremely important effort, and I am appreciative of the willingness of the participants in the hearing today to give us their perspectives.
Chairman BAKER. Mr. Kanjorski.
Mr. KANJORSKI. Mr. Chairman, we meet for the first time this year for the purposes of reviewing the special examination report issued and the consent agreement reached in December by the Office of Federal Housing Enterprise Oversight regarding Freddie Mac's financial restatement of more than $5 billion. The report makes serious revelations about how insufficient accounting, audit and internal controls and a troubling culture nurtured by top managers resulted in an environment that led to significant earnings management at Freddie Mac. The constant decree alsothe consent decree also requires Freddie Mac to adopt numerous remedial reforms to prevent a similar situation in the future.
One year ago Freddie Mac first revealed that it would delay the release of the 2002 accounting reports pending the completion of a restatement of its financial records for earlier years. This announcement raised considerable concerns for those who monitor GSEs. It also began a period of intense scrutiny of the company by its regulators, lawmakers and the press.
Page 3 PREV PAGE TOP OF DOC Six months later, Freddie Mac's Board announced an unexpected management shakeup. This change in corporate leadership produced even greater concerns among those with knowledge of GSEs. For example, I observed that government-sponsored enterprises with public responsibilities and private capital have a special obligation to operate fairly, safely, and soundly. I believe and I continue to believe that today. The management of these entities must ensure that they produce accounting statements that reflect their real financial conditions.
At the time I also said that Freddie Mac must maintain sufficient capital reserves, adopt prudent management reforms, expedite completion of its earnings restatements, and employ appropriate accounting techniques to prevent similar problems in the future. I suspect that, before we complete today's hearing, we will discuss each of these issues in great depth. We have a responsibility to study these matters and ensure that the company follows its statutory mandate to operate in a safe and sound manner.
Additionally, the financial reporting problems by Freddie Mac renewed efforts by some to modify GSE regulation. As I said at our very first hearing on oversight of government-sponsored enterprises in March of 2000, we need to have strong independent regulators that have the resources they need to get the job done. I continue to support strong GSE regulation. A strong regulator will protect the continued validity of our capital markets and promote confidence in Freddie Mac and Fannie Mae. It will also ensure taxpayers against systemic risk and expand opportunities for all Americans.
Today more than 68 percent of Americans own the homes in which they live. Government-sponsored enterprises have contributed greatly to this accomplishment. Because our housing marketplace is one of the most important sectors in our persistently struggling economy, we must also tread carefully in our forthcoming debates over any legislation to modify the regulation of GSEs.
In closing, Mr. Chairman, I commend you for your sustained leadership in these matters and for convening this timely hearing.
Page 4 PREV PAGE TOP OF DOC Thank you.
Chairman BAKER. I thank the gentleman for his statement.
[The prepared statement of Hon. Paul E. Kanjorski can be found on page 51 in the appendix.]
Chairman BAKER. Mr. Shays?
Mr. SHAYS. Thank you, Mr. Chairman.
Mr. Chairman, Fannie Mae and Freddie Mac constitute the twentieth and fortieth largest institutions on the New York Stock Exchange and the second and fourth largest financial institutions. They play an extraordinary role, they are vital to our economy, they are vital to housing, but they play by different rules, and when you play by different rules, you have to have greater oversight, not lesser oversight, and, frankly, we have had both. They do not have to conform to the 1993 actexcuse me, the 1933 act. They do not have to conform to the 1934 act.
When we put them under the 1934 act voluntarily is when the problems of Freddie Mac became apparent. It just seems to me is an indication that we should get these very excellent companies under the same rules and make sure that they have a regulator that is going to do the job necessary.
I think OFHEO has done an excellent job in this report. It is just too bad we haven't seen this kind of effort earlier.
Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Mr. Shays.
Chairman BAKER. Mrs. McCarthy?
Mrs. MCCARTHY. Thank you, Mr. Chairman. I will wait until their testimony. Thank you.
Chairman BAKER. Thank you.
Page 5 PREV PAGE TOP OF DOC Mr. Ryun?
Oh, I am sorry. I did not see your arrival.
Mr. OXLEY. Thank you, Mr. Chairman, and I want to thank you for convening the hearing today on the recent report issued by the Office of Federal Housing OversightEnterprise Oversight. This report details the causes of Freddie Mac's restatement and management reorganization that followed, and this is a comprehensive report that highlights many of the concerns we have heard about the operations and the oversight of the GSEs.
As a result of this investigation, OFHEO and Freddie Mac have entered into a consent agreement which Freddie Mac agreed to pay $125 million in fines and made several significant changes to its corporate governance.
I appreciate all the hard work that Director Falcon and his staff has done on this report. Freddie Mac currently has debts outstanding in the trillions of dollars. There is no doubt that this company is critical to the housing market. Freddie supplies liquidity to institutions so they can provide loans to consumers seeking to purchase homes; however, with this important mission comes an equally important mandate to protect the taxpayers and to be honest with investors. As the OFHEO report demonstrates, Freddie Mac's senior management misled its investors, its Board of Directors and the U.S. taxpayers.
I am encouraged by the remediation efforts underway at Freddie. Mr. Baumann and his team have worked hard at difficult times to formulate a plan to return Freddie Mac to financial stability, and they should be commended for that. I believe with continued diligence and real reforms, confidence can be restored in the operation of this important company.
Director Falcon has presented an in-depth review of Freddie Mac, but the question remains where was OFHEO when these important trades were taking place? This investigation was not commenced when Freddie Mac announced its restatement; rather it began after the Chairman and CEO along with two other senior executives were released from the company. In fact, if Arthur Andersen had not been removed as the auditor for Freddie Mac, there would be no guarantee that the improper trading practices would not still be going on today.
Page 6 PREV PAGE TOP OF DOC I believe that OFHEO is underfunded and lacks many of the necessary powers to adequately oversee Freddie and Fannie. I support additional funding for OFHEO so it can fully examine the GSEs and hire a sufficient number of examiners to monitor these financial institutions.
The report we consider today makes several important recommendations for changes both at Freddie and at OFHEO. These recommendations are well thought out, and many of them should be implemented.
I look forward to the testimony of Director Falcon and Mr. Baumann. I hope this hearing will shed some light on what went wrong with Freddie Mac, what steps are being taken to remedy the situation, as well as what changes should be made to ensure that both Freddie Mac and Fannie Mae are properly regulated.
Mr. Chairman, I want to personally commend you for your steadfast interest in this issue going back years, and there is no question that, had you not been a bulldog in pursuing some of these issues, many of these would have not come to light. We would not be on thereally on the cusp of some major reforms with the GSEs, and had it not been for you, this would not have happened, and I appreciate the opportunity to be here, and I yield back.
Chairman BAKER. Thank you, Mr. Chairman, for your kind words.
[The prepared statement of Michael G. Oxley can be found on page 46 in the appendix.]
Chairman BAKER. Mrs. Biggert.
Mrs. BIGGERT. No.
Chairman BAKER. Mr. Ney?
Mr. NEY. I have something for the record.
Chairman BAKER. Mr. Ney submits a statement for the record. Without objection, it is adopted.
Page 7 PREV PAGE TOP OF DOC [The prepared statement of Hon. Robert W. Ney can be found on page 52 in the appendix.]
Chairman BAKER. Ms. Harris, do you have a statement?
Ms. HARRIS. Thank you, Mr. Chairman, and thank you for having this hearing today. I want to express my appreciation for your willingness to conduct these hearings concerning the special report of Freddie Mac.
I also want to thank Mr. Falcon of OFHEO and Mr. Baumann of Freddie Mac for their insights and willingness to testify before this committee.
Freddie Mac has taken encouraging organizational steps to improve their internal controls and to reform their corporate climate. Likewise, the OFHEO has drafted 16 carefully developed recommendations.
The vitality of the housing market and the importance of accurate corporate reporting are beyond dispute. Our Nation's economy requires beds to thrive. A healthy housing industry has helped buoy us, while other sectors of our economy have struggled. At the same time our consumer confidence levels have remained incredibly resilient, reaching levels typically associated with economic expansion. The result is a real growth rate in 2003, which is 4.4 percent up from 2.8 percent in 2002.
We must continue pursuing policies that support economic growth. MIT economist Lester Thurow argues that scandal always follows boom in capitalism. Ironically, Freddie Mac was still booming when the accounting irregularities were discovered, making this a truly unique situation requiring special attention.
I am sincerely interested in the measures that would restore public confidence while maintaining a strong housing industry, and I look forward to your comments.
Chairman BAKER. Thank you, Ms. Harris.
Chairman BAKER. Mr. Renzi, do you have a statement?
Page 8 PREV PAGE TOP OF DOC Mr. RENZI. No. Thank you.
Chairman BAKER. You're welcome.
With that, I would like to welcome back, who is certainly no stranger to the committee room, the Director of the Federal Office of OFHEO, Mr. Falcon. Thank you very much for being here today.
STATEMENT OF ARMANDO FALCON, DIRECTOR, OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT
Mr. FALCON. I am pleased to be here. Thank you, Mr. Chairman. I am pleased to be here.
Mr. Chairman, Ranking Member Kanjorski, Chairman Oxley and members of the subcommittee, I appreciate the opportunity to discuss with you OFHEO's report of the special examination of Freddie Mac. My prepared testimony will summarize the key findings and conclusions, and I request the committee include it, as well as the full special examination report, in the record.
Chairman BAKER. Without objection.
Mr. FALCON. My testimony expresses my own views and not necessarily those of the President or the Secretary of Housing and Urban Development.
A year ago tomorrow, Freddie Mac announced that completion of its 2002 financial audit would be delayed and that earlier periods would be reaudited. A switch to internal auditors from Arthur Andersen to PricewaterhouseCoopers had triggered a reevaluation of Freddie Mac's accounting policies, especially those relating to hedge accounting treatments for derivatives occasioned by implementation of FAS 133.
However, the reaudit and restatement process itself raised questions beyond merely the choice of accounting policies. On June 7, as Freddie Mac announced the abrupt departure of three of its principal officers, I ordered a special examination of the conditions that led to the accounting failures and management changes. Although some aspects of the special examination are not yet complete, the bulk of the work was finished this past fall. OFHEO issued a report of the examination, containing the findings and conclusions along with the appropriate recommendations, which the committee received in December.
Page 9 PREV PAGE TOP OF DOC Since the early 1990s, Freddie Mac promoted itself to investors as Steady Freddie, a company strong in profits, and developed a corporate culture that placed a very high priority on achieving such results. The examination showed that, to do so, Freddie Mac used means that failed to meet its obligations to investors, regulators, and the public. The company employed a variety of techniques ranging from improper reserve accounts to complex derivative transactions to push earnings into future periods and meet earnings expectations. Freddie Mac cast aside accounting rules, internal controls, disclosure standards, and the public trust in the pursuit of steady earnings growth. The conduct and intentions of the enterprise were hidden and were revealed only by a change of events that began when Freddie Mac changed auditors in 2002.
I will now summarize the areas covered in our report. First, the improper management of earnings. By 1999, Freddie Mac had established a practice of engaging in transactions for the express purpose of managing its reported earnings. Freddie Mac used several strategies to shift earnings into future reporting periods, reflecting the proclivity of management to increase operations risk in the quest for more stable earnings. Although some of the most egregious examples relate to earnings volatility challenges associated with the implementation of FAS 133, there were numerous other instances when Freddie Mac management engineered transactions with little or no economic substance to obtain specific accounting results.
Second, the incentives created by executive compensation. The compensation of senior executives of Freddie Mac, particularly compensation tied to earnings per share, also contributed to the improper accounting and management practices of the enterprise. The size of the bonus pool for senior executives was tied in part to meeting or exceeding annual earnings per share targets. While not tied directly to smoothing earnings growth, actions shifting earnings from one quarter to future periods helped to ensure that earnings per share goals, and consequently the bonuses tied to them, would be achieved in the future.
Page 10 PREV PAGE TOP OF DOC Third, weak accounting, auditing, and internal controls. The management of any corporation, especially a government-sponsored one, is responsible for maintaining a control environment that will accurately record transactions to provide for publicly financial statements that are consistent with the true financial condition of the firm. In that regard, the obsession of Freddie Mac with steady, stable growth and earnings was at the expense of proper accounting policies and strong accounting controls. Weaknesses in the staffing skills and resources in the corporate accounting department led to weak or nonexistent accounting policies and overreliance on the external auditor, weak accounting controls and an overreliance on manual systems. Given the size of the company and its role in the housing finance and capital markets, those weaknesses effectively increased the systemic risk posed by the enterprise.
Fourth, disclosure. In some instances, Freddie Mac normally circumvented prevailing public disclosure patterns in order to obfuscate specific market accounting transactions. A disdain for appropriate disclosure standards, despite all stated management assertions to the contrary, misled investors and undermined market awareness of the true financial condition of the enterprise.
Within Freddie Mac, no one took responsibility for public disclosures. Failure to assign responsibility and accountability for disclosure to an internal division contributed directly to inaccurate corporate and financial reporting. Such lack of assigned responsibility reflected a low regard that executive management had for that function.
Fifth, the Board of Directors. For the most part, the same long-tenured, shareholder-elected Directors oversaw the same CEO, COO, and general counsel of Freddie Mac from 1990 to 2003. The nonexecutive Directors allowed the past performance of those officers to color their oversight.
Directors should have asked more questions, pressed harder for resolution of issues, and not automatically accepted the rationale of management for the length of time needed to address identified weaknesses and problems. The oversight exercised by the Board might have been more vigorous if there had been a regular turnover or shareholder-elected Directors, or if Directors had not expected to serve on the Board until mandatory retirement age or beyond. Conversely, the service periods of Presidentially-appointed Directors are far too short, averaging just over 14 months, for them to play a meaningful role on the Board.
Page 11 PREV PAGE TOP OF DOC Based on these findings, the examination report recommended that OFHEO and Freddie Mac take a broad range of actions. As a general matter, the report concluded that OFHEO must ensure that Freddie Mac has established an adequate remediation plan and is allocating the necessary resources to establish a new corporate culture that rewards integrity and the acceptance of responsibility and that penalizes failure to meet appropriate standards of conduct.
The report also detailed a number of specific actions. To improve the effectiveness of the Board of Directors, Freddie Mac should separate the functions of the chief executive officer and the Chairman of the Board, impose strict term limits on Directors, and require the Board meet more frequently.
To address Freddie Mac's general neglect of operations risks and compliance issues, the report recommends that Freddie Mac establish a formal compliance program and a position of chief risk officer reporting directly to the CEO, with explicit responsibility for operations risk, as well as credit and market risk. In addition, Freddie Mac's central audit department needs to be strengthened so that it can play a more effective role.
To address accounting weaknesses, the report recommends that OFHEO consider and require the exchange of external audit firms. Freddie Mac needs to establish and maintain superior accounting controls and prevent underreliance on its external auditor. It should also document the legitimate business purpose of every significant business transaction.
To address inappropriate management incentives, the report recommended that Freddie Mac refocus its compensation program more on long-term goals, not on short-term earnings.
Until remediation efforts have taken full effect, Freddie Mac remains exposed to substantial management and operations risk. The report recommends that OFHEO consider addressing this concern by requiring Freddie Mac to hold significant regulatory capital surpluses, at least until it can produce timely and GAAP-consistent financial reports.
Page 12 PREV PAGE TOP OF DOC Finally, the Board recommends that OFHEO take three additional steps. First, OFHEO should implement regulations that provide for mandatory disclosure similar to that required of SEC-registered companies if Congress does not repeal the exemptions of the enterprises from securities laws. Second, OFHEO should expand its capacity to investigate and detect misconduct by including more substantive tests of internal control frameworks at the enterprises, including procedures to identify pressures to commit fraud and opportunities to carry it out. Third, OFHEO should conduct a special examination of the accounting practices of Freddie Mac.
Mr. Chairman, I want to inform you not just about the report, but also of actions OFHEO has taken prior and subsequent to the report. OFHEO directed the holding of termination benefits of senior management pending our review.
OFHEO directed that the current CEO and general counsel be replaced.
OFHEO entered into a consent order with the company's former COO, David Glenn, and secured both his cooperation in our investigation and a strong civil money penalty.
OFHEO entered into a consent order with the company, securing a significant money penalty, and imposing a plan of remedial action on the company that requires issues identified by our investigation be addressed.
Finally, OFHEO is pursuing legal actions requiring the termination for cause of the company's former CEO and CFO.
I have undertaken actions at OFHEO as well. Our examination force is being strengthened. The new Office of Chief Accountant will elevate our work in the important field of corporate accounting and reporting, and a new office of compliance will expand our capacity to conduct in-depth reviews of enterprise activities and better ensure their compliance with laws and regulations.
I would like to close my testimony with an urgent appeal to the committee for assistance in obtaining our 2004 budget. Once again, severe constraints have been placed on our operations. The short-term continuing resolution we are operating under prevents us from hiring the additional examiners and analysts we need to strengthen our oversight. In addition, we are unable to hire the help we need to conduct our review of Fannie Mae. If the long term is enacted which freezes our budget at 2003 levels, we will need to scale back oversight at a time when greater oversight has never been more urgent.
Page 13 PREV PAGE TOP OF DOC I urge the committee to help OFHEO to get the resources its needs as soon as possible.
Thank you, Mr. Chairman, and I would be happy to answer any questions the committee may have.
Chairman BAKER. Thank you, Mr. Falcon.
[The prepared statement of Hon. Armando Falcon Jr. can be found on page 61 in the appendix.]
Chairman BAKER. As I understand it, there were 16 different recommendations that were made as a result of your analysis, and I think it should be clear that, given the circumstances in which you addressed the significant attention given to this staff by this matter, there is no one better poised to make recommendations for reform than your office.
What troubles me is they are, frankly, recommendations; that it is up to the enterprise to determine which, if any, it chooses to implement.
One that I find extremely important, OFHEO should require Freddie to hold in a capital surplus limiting growth until they produce timely and certified statements. It appears that at least June of this year would be the soonest it might occur, and, as in the past, that date has the potential to slip.
Do you have the authority to mandate additional capital at this time?
Mr. FALCON. Let me be clear about these recommendations. I may not have been earlier, Mr. Chairman. These recommendations were produced by my staff to myself, and these are recommendations that I will decide whether or not they get implemented, not the enterprise, and I have taken them under consideration, and I agree with all of these recommendations.
Chairman BAKER. Well, in light of that determination, do you believe you have the authority to implement number 5?
Page 14 PREV PAGE TOP OF DOC Mr. FALCON. Yes.
Chairman BAKER. In light of your prior statement this morning, wherein you indicate if appropriations are not adjusted immediately, you will enter into a period of time in which there is great market uncertainty, great congressional uncertainty, about the ultimate resolution of these matters, why would we not move forward on the great majority or all of these recommendations, particularly in light of your inability to move forward on the forensic accounting analysis of conduct at Fannie Mae?
Mr. FALCON. It is my intent, Mr. Chairman, to move forward on these recommendations. Some will be implemented pursuant to an amendment to our corporate governance regulations, which we are currently drafting. Some of them will be fulfilled through action taken by the company, through working with the company to see them implemented, and others we are working to develop right now.
The one of specific interest to you on the capital surplus, I expect by the end of next week we will have developed a plan which would implement that provision.
Chairman BAKER. Well, given where we are and the uncertainty of what may be further determined as to the actual accounting conduct, no one hopes for any more bad news, but, in light of the fact we do not now know that the Agency may face budgetary limitations on its ability to pursue further examination at great detail, I would strongly recommend or encourage that action be taken as timely as possible, rather than waiting on the enterprise to certify its financials.
Do you have the authority to separate the functions of the CEO from the Chairman, or is that an enterprise determination?
Mr. FALCON. No, that is something we do have the authority to do, Mr. Chairman.
Chairman BAKER. Is there any item on your 16 elements that you feel you are constrained at this time to act on without proper authority to act, or all of these, without reciting them all, or is it in the posture of being reviewed by you at this time and determinations being made as to whether they will be required?
Page 15 PREV PAGE TOP OF DOC Mr. FALCON. I believe we have the authority to implement all of the recommendations that are included in this report. Now, whether or not any of our actions are challenged by one or more of the enterprises remains to be seen.
Chairman BAKER. And explain for me what that would mean procedurally should someone at the Freddie Mac Board adopt a resolution saying, we do not want to do ''X.'' what are their rights under the current structure, and what would be your ability to impose it under objection?
Mr. FALCON. Well, we would follow the normal procedures act of promulgating regulation and finalizing regulation. Once the regulation is final, they would certainly be free to challenge it in court.
Chairman BAKER. Back at the beginning of this, when Mr. Brendsel's departure occurred, there was an announcement of a severance package that amounted to almost $40 million that was going to be granted without adequate determination of his participation in the accounting manipulations. I wrote at that time and asked that you take whatever action might be permissible under law to preclude the granting of that bonus until such time as final determinations of fault had been made. It is my understanding that that is now in some state of legal discussion.
It triggered a similar question that we wrote a letter in December to your office asking, first, do you review and approveand I understand that you do review and approvecompensation and severance terms for both enterprisesfor executives at both enterprises? We were informed that, perhaps, by the middle of January we might receive an answer to our request for an analysis of the Fannie Mae severance packages, and to date we have not yet received it. Can you give me an idea as to when we might receive that information as well?
Mr. FALCON. Let meI believeis that the request where we may have partially fulfilled the request, but there is still a portion that is outstanding, Mr. Chairman?
Page 16 PREV PAGE TOP OF DOC Chairman BAKER. There was a request relative to salaries and compensation and a second part relative to severance, and you have provided the compensation information, but we have not yet received the severance information.
Mr. FALCON. Let me look into that and make every effort to try to get that to you by the end of the week.
Chairman BAKER. Terrific, because the principal concern there was we had clearly identified wrongdoing, and it appearsnot factually knownthat the executive may have had some responsibility for that wrongdoing. And to allow someone to profit as a result of those actions is highly inappropriate.
Before we would enter intoand I am not alleging any improper or inappropriate conduct of Fannie Mae, but I think we should know and have in advance the disclosure of those terms and to ensure that you as a regulator have the ability to stop, withhold, and ensure that the taxpayer interest is protected before determinations are made about someone's ability to mismanage numbers and be rewarded financially.
I have exceeded my time. I will be back.
Mr. KANJORSKI. Maybe next year, Mr. Chairman.
Mr. Director, I listened with great interest in your report, and let me see if I understood you correctly.
First and foremost, it was not your Agency that discovered the misstatement. The misstatement or the realization of the misstatement came about because sometime in 2002, an accounting firm was changed, and, in the process of that change, the second accounting firm picked up the restatement; is that correct?
Mr. FALCON. That is correct, Congressman.
Mr. KANJORSKI. That is very disturbing to me, because listening to some of your recommendations, I was trying to interpose myself as Director of Freddie Mac, and I was trying to figure out if the regulator did not pick up this manipulation that had been occurring for years, and only a new accounting firm picked it up, how would you expect a Director to have either access to the information necessary to discover this occurrence or to have the expertise necessary to pick up that?
Page 17 PREV PAGE TOP OF DOC Mr. FALCON. I think what we expect of the Board is that they ensure that there are adequate accounting controls and internal controls relating to the accounting function, such that
Mr. KANJORSKI. They did. They hired one of the best accounting firms in the country.
Mr. FALCON. Right; but this conduct occurred prior to the hiring of PricewaterhouseCoopers. This conduct occurred when Arthur Andersen was their external auditor, and it had occurred at a time when their internal audit function was very weak, and the external auditor was serving in essence as the internal auditor for the company as well. So you really had an internal auditor auditing their own work.
Mr. KANJORSKI. And I understand that, but how would you expect a member of the Board of Directors to know whether or not the internal auditing function is reliable? How would you know that? I mean, I have sat on Boards, and I rely on what the certified accountant firm says the condition of the company is, what the report back of the executive managementhigh executive management firm reports to the Board. How would I be expected to know whether or not there is compliance, whether there is stretching or smoothing of earnings, whether it is driven in 2004, for whatever reason?
In this instance, you suspect it is driven for remuneration under the contract, the employment contract, to the high management? I am just a little worried about that, because, one, we have spent, obviously, millions of dollars to have a regulator, and the regulatorI am not attacking you, at all, you have done a great job, but it shows the need for regulation at these large entities is so great from a standpoint of understanding what is going on that it is obviously not clear to most people that you would pick up an irregularity like this, and yet that irregularity can be horrendous in cost to the company and to the taxpayer ultimately.
Page 18 PREV PAGE TOP OF DOC I do not know what we do about it, short of having maybe dual auditing, or someone came up with the idea in the past a change of auditors periodically, because if we had not had a change of auditors here, they would still be doing what they were doing, and you would not have picked it up. The regulator for the government would not have picked it up.
Mr. FALCON. Right. The nature of the conduct that we found with the company was, by its nature, hidden and not transparent to regulators and tofully to the Board as well.
The Board was aware of weaknesses in the accounting function of the company, and, in fact, a plan was developed to try to improve the accounting function at the company, but that was not adequate to what was ultimately needed at the company. This was an areaas far as OFHEO's standpoint goes, this involved accounting transactions, the accounting for transactions which were designed to shift earnings into future periods.
Now, the role of a safety and soundness regulator is not to, on the secondary level, certify the work of the auditor. No safety and soundness regulator is equipped to do that, but I do not think that is adequate in the future.
What we are going to work on going forward through the creation of an office of a chief accountant is to look at expertise where we can look at more closely the work of a company to implement new accounting standards, the work of a company to account for certain novel or unique transactions which might be questionable. We have to do what has not been done by the safety and soundness regulators. That is what I think is necessary going forward.
Mr. KANJORSKI. The only thing I am trying to relate to you is I do not have a high degree of confidence at this point that we are any more prepared to meet a challenge of this nature in another entity; that we would either discover it, that we have the tools to handle it, that we have the transparency within the company to pick it up. And it is all nice and good to say, well, Directors are going to have to be more cautious and more responsible.
Page 19 PREV PAGE TOP OF DOC I do not know what you do as a Director. If your top manager is lying to you, if your auditors are lying to you, and if the government regulator that regulates you cannot pick it up, how do you expect the Director to pick it up? Short of camping on the site and shadowing the operations of the company, I do not know how you do it.
The other thing I am interested in here: Did you find that this was purely a profit-driven vehicle for top management to get a better return on their bonus programs or whatever it was?
Mr. FALCON. That was part of the cause of the problems in the company. It was not the only reason for the actions in the company.
The company very much wanted to try to show steady earnings growth, and because of market conditions in early 2001, they reaped a windfall in net income at the company. The result was they sought to shift that money around. In addition, they had to try to shift income around that was the result of
Mr. KANJORSKI. Right, I understand what they did, but do you feel you have gotten to the motive? Was the motive for self-reward under the schemes of the bonuses or payment system of management, or was there some other scheme?
I am sort of hurt to think that some of these fellows would have subjected this company's reputation and assets to extraordinary losses. I mean, the way I am running in my mind, this is probably a cost of over a billion dollars to this company, and certainly they did not get that kind of a package return from theiras a motive from their salary situations. So it seems the expense to the company far exceeds the benefits, the package benefits, these people received, so I am looking for some other motive that was there.
Mr. FALCON. And I think it is addressed in the chapter in our book which talks about the tone at the top. The company took great pride in meeting the expectations of analysts; hence, the nickname Steady Freddie. And ultimately it engaged in whatever means were necessary to continue to meet those expectations of investors.
Page 20 PREV PAGE TOP OF DOC Mr. KANJORSKI. I am sorry to be so long. I am shadowing the Chairman, however.
You found some difficulty with the counterparties in the derivatives, and, as I understand it in prior discussions with you, you do not necessarily know whether or nothow far your authority allows you to reach into determining whether the counterparties are sufficient to honor the commitments they make in derivatives. And of course that is vitally important as to whether there is any validity or value in the derivatives.
If you have a fake counterparty or a less than adequate counterparty, you have nothing, and it seems to me when we are dealing in the hundreds of billions of dollars, some people say trillions of dollars, of derivatives today, particularly with these GSEs, what scope of a program do you have to authorize or to ask Congress to authorize you with greater authority to get into the review, oversight and understanding of the effectiveness of counterparties in these transactions, derivative transactions, or does not that scare you?
It scares the hell out of me. I do not sleep very well. If these folks are doing what they did in Enron and manipulating what they did here, now they are playing a sissy game. They ought to be out playing with derivatives and setting off false counterparties, and they could be ripping off tens of hundreds of billions of dollars. What is your feeling of that?
Mr. FALCON. We are currently looking at the role of counterparties in the Freddie Mac situation, trying to discover whether improper conduct was engaged in by facilitating some of the key transactions the company used to shift earnings. We have not concluded that review yet.
Ultimately our authoritywe do not have direct authority over these counterparties; however, we do have authority over the two companies we regulate, and if we thought their entering into transactions with certain counterparties was an unsafe and unsound practice, we could take steps to limit their business dealings with those counterparties.
Page 21 PREV PAGE TOP OF DOC Mr. KANJORSKI. Do you examine or have the authority to examine the financial statements of counterparties?
Mr. FALCON. No, we do not.
Mr. KANJORSKI. So you have no idea whether they are strong counterparties or effective and well-asseted counterparties, do you?
Mr. FALCON. We do look at the counterparty's credit rating.
Mr. KANJORSKI. That is the whole point. You are relying on secondary, and whoever did the credit rating is probably relying on their oversight by a government regulator. There is sort of a tendency for everybody to think the other guy is making the examination, the study, or the determination; in fact, nobody is, and it could just as easily be a very similar transaction to Enron. A very bright financial fellow could structure counterparties that are straw counterparties, that have absolutely no value out there, and yet are handling these multi-billion-dollar transactions, with the assistance in a way of internal management, because they have a goal to affect their income stream as a result of success, but, in fact, the counterparty would be interested in eluding the operation, getting paid for something that they are not putting value up for.
Chairman BAKER. Mr. Kanjorski, if I might, the recommendation number 11 is Freddie should document legitimate business purpose for every significant derivative transaction, so the regulators have identified that as an area of concern. I am very anxious to see if they have the ability to enforce that.
Mr. KANJORSKI. Right.
Chairman BAKER. I thank the gentleman.
Mr. SHAYS. Thank you. I have questions, but I would like to follow other Members and hear what they have to ask.
Page 22 PREV PAGE TOP OF DOC Chairman BAKER. Mr. Ryun.
Mrs. BIGGERT. Thank you, Mr. Chairman, Director Falcon.
Going back to the Board of Directors, just for clarification, the Board is made up of Directors who are shareholder-elected, and then there is also the Presidential-appointed Directors?
Mr. FALCON. Yes, Congresswoman. There are five of them for each company.
Mrs. BIGGERT. Five?
Mr. FALCON. Five.
Mrs. BIGGERT. And in your statement you say the shareholder-elected Directors, I assume, are going to stay until they reach 65 or even beyond?
What is the average a Director has been a shareholder?
Mr. FALCON. The average tenure of a Director for Freddie Mac?
Mrs. BIGGERT. Mm-hmm.
Mr. FALCON. I believe it is probably over 10 years.
Mrs. BIGGERT. Okay. And then you say that, conversely, the service of the Presidential Directors isaverages just over 14 months, or was your statement that that is when they become effective?
Mr. FALCON. That is their average tenure on the Board. Their terms are for 1-year appointments, and some of them are reappointed, but the average tenure of a Director is 14 months.
Mrs. BIGGERT. Right. So do you think if they are serving as a Presidential appointment, if the tenure was longer, that maybe they would have been more effective, and maybe they would have been able to participate to something that was going on, misconduct?
Page 23 PREV PAGE TOP OF DOC Mr. FALCON. I think they could be more effective on the Board if they were allowed a longer term on the Board. However, my preferred approach is, I think, corporate governance would be better enhanced if shareholders were allowed to elect all Directors of the Board, rather than 13 of the 18 Board members.
Mrs. BIGGERT. Do you have any background in why there were Presidential appointments made, the reasoning for it?
Mr. FALCON. Just the nature of these being government-sponsored enterprises and the charters. That was part of the originalI believe it was one of the original charter provisions of both companies.
Mrs. BIGGERT. So there would be more oversight if there were just the shareholders?
Mr. FALCON. I believe shareholders would have a larger voice in the company if they elected the members of the Board, as opposed to just a portion of the Board members.
Mrs. BIGGERT. Okay. One of thesomething that companieswhen there is rapid growth, that is often seen as a stress on the institution, and we have seen dramatic growth in the operations of Freddie Mac over the last several years. Did not this growth as much as 30 percent raise concerns at OFHEO?
Mr. FALCON. Much of the growth has come in the form of the retained portfolio, which, over the last 10 years, I think, has grown maybe 7maybe 700-fold. They began their retaining portfolio operations with well less than $100 million, and I think they were at a 600- or $700 million enterprise, depending on what you are talking about.
That reflects a shift in the company's business strategy. As they became more of a portfolio lender, they began to take on credit risk associated with guaranteed mortgages, but the growth presented a new risk, which was market risk, which was part of holding these portfolios.
Page 24 PREV PAGE TOP OF DOC Mrs. BIGGERT. So that does not raise any red flag with OFHEO to investigate or ask for an examination?
Mr. FALCON. It does mean that the company has to devote appropriate resources to making sure they adequately understand and manage the risk associated with holding those large retained portfolios.
Up to this point we have seen them manage the risk associated with those portfolios in a very prudent manner, so we do watch the growth rate carefully. As long as they are able to manage the growth, we haven't seen the need to step in and slow down the growth.
Mrs. BIGGERT. So there is nothing that you would want to change in that which you think, maybe looking back, that you should have?
Mr. FALCON. No, Congresswoman.
Mrs. BIGGERT. All right. So do you know whether the enterprise or their auditors conducted their own stress test?
Mr. FALCON. They did maintain their own stress test while we were in the process of developing our stress test. I believe they have discontinued the use of those stress tests; in fact, I think it was one of their voluntary steps they had taken internally at the companies, but with OFHEO's stress test now fully implemented, I do not know if they continued to use their internal stress test.
Mrs. BIGGERT. So did you review their data that they had accomplished?
Mr. FALCON. We are familiar with the operations of the stress test they were running during this interim period, but we do run our own stress test, based on the data submitted by the enterprises to OFHEO, and I believe the stress test is a very robust gauge of risk, and it ties capital very closely to risk.
Mrs. BIGGERT. Thank you very much.
Page 25 PREV PAGE TOP OF DOC Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Mrs. Biggert.
Mr. SCOTT. Thank you, Mr. Chairman.
Mr. Falcon, let me ask you about the culture at Freddie Mac. Do you think there is a permissive corporate culture that neglected accounting and oversight and focused on the wrong incentives for executive pay there?
Mr. FALCON. I do, Congressman.
Mr. SCOTT. Have you seen any improvement in that culture at Freddie Mac?
Mr. FALCON. I have. Since the time that new management has been brought in, including the new Chairman of the Board of the company, the company has done a lot of good work in trying to implement a remediation plan, as well as steps to bring about a new corporate culture within the company, so I think they have done a lot of good work.
I think, since the events of that transpired in the past year, the Board has been very active in fulfilling its responsibilities, so I think companies also cooperated very well with OFHEO. So I think as a general matter the company has done a lot to resolve a lot of these problems.
Mr. SCOTT. Is there anything particular that you could put your finger on that might have caused this permissive culture there?
Mr. FALCON. It was the result of senior management at the very top focusing first and foremost on the desire to try to meet the earnings expectations of the investment community; and it meant trying to smooth out any spikes in income, whether they be down or up. In this case, it was upward spikes in income that were shifted into future periods. I think the company became overly concerned with the fact that if there was a spike that went up very high that the analyst community might then expect theraise their expectations for the company. So the desire was to try to meet expectations but not by too much, not exceed them by too much.
Page 26 PREV PAGE TOP OF DOC Mr. SCOTT. Now, you say that untilyou stated that until Freddie Mac fully complies with remediation, it remains exposed to substantial management and operation risk. Will OFHEO require Freddie Mac to hold significant capital surpluses?
Mr. FALCON. Well, as I have said, they have made good progress in turning around the corporate culture at the company and focusing on the highest standards. There remains much to be done. The company still has a ways to go before it can produce timely quarterly financial statements. The requirements of our consent order will need time to get fully implemented, and there are several very senior management positions that remain to be filled. So there is still much to be done at the company. In the meantime, these remediation efforts that are required in our consent order with the company will work to address shortcomings in the accounting area, in the internal controls area. However, in the interim, I think it is an appropriate for the company to hold additional capital until all of these corrective actions have taken full effect; and that is what we will address by the end of next week.
Mr. SCOTT. Okay. Well one final question, Mr. Chairman, if I could. The examination report recommended that OFHEO conduct a special examination of the accounting practices of Fannie Mae. On January 2nd, the Wall Street Journal stated that Fannie Mae has lost so much capital in the past 3 years that its capital is now below OFHEO's required minimum. Are you aware of that article?
Mr. FALCON. I am aware of the issue that you raise. I don't think it is comparing the same thing though.
Mr. SCOTT. What is your opinion on this?
Mr. FALCON. May I? I think the focus there has been on capital as reflected in fair value statements, as opposed to capital as calculated in our core capital standard. Our core capital standard is similar to that of every other safety and soundness regulator and is consistent with GAAP.
Page 27 PREV PAGE TOP OF DOC What a fair value statement does is try to market all the assets and liabilities of the company; and, in this case, that capital as reflected in fair value statements is lower than the capital as we calculated for core capital and minimum capital purposes. However, while fair value statements are useful indicators of the company's current liquidation value, it does not reflectit has some limitations. It does not reflect the ongoing concern value of a company. So that is the difference between the two standards, Congressman.
Mr. SCOTT. Thank you.
That is all my questions, Mr. Chairman.
Chairman BAKER. I thank you, Mr. Scott.
Mr. Shadegg, do you have questions? Mr. Bachus?
Mr. BACHUS. I thank the Chairman.
Director Falcon, as I recall, it was January when Freddie Mac made the announcement that it planned to restate its earnings. Then in June they announced the departures of Mr. Glenn and Mr. Clark and Mr. Brendsel, and it was at that time or the next day or two that you formed a special investigative unit to investigate.
Mr. FALCON. Yes, Congressman.
Mr. BACHUS. That is a lag of 6 months. Was theredid you do anything withimmediately after the restatement announcement or
Mr. FALCON. Yes, we did, Congressman. What we did was we were primarily focused on making sure that the company got the restatement and the reaudit done as soon as possible so that the company could be operating with certified financial statements. For a company of this size and their importance to our housing finance market to be operating without certified financial statements was not a good position to be in, and so we directed our focus mainly on making sure that that got done as quickly as possible. In the meantime, we agreed that the Board took the correct action in hiring an outside law firm to conduct a review of the circumstances arising from the restatement. In time, it turned out that that law firm's cooperation and disclosures to us were not adequate, and so we decided rather than wait for the completion of the restatement whereupon we would decide whether or not to conduct our own investigation under the circumstances, I decided it was no longer correct to wait any longer for the law firm or the restatement to get completed and we would conduct our own examination of this.
Page 28 PREV PAGE TOP OF DOC Mr. BACHUS. Were you caught off guard by the announcement that they would restate their earnings?
Mr. FALCON. I think it is never a position that any regulator wants to be in. At the time, until we got deeply into this, much of the appearance was, was this a matter of simply a disagreement between accountants, two different accounting firms or was this more, or was there more to it? As it has turned out, there was more to it. This wasn't just a disagreement between two accounting firms. This was a result of the misapplication of accounting rules, of the misuse of transactions to achieve accounting results. All of this was, by its very nature, misconduct that was concealed from us. Only with greater depth of examination can we try to catch this kind of stuff going forward, which is why I have pressed for greater resources and I am retooling the agency to be able to better focus and catch these kinds of accounting problems.
Mr. BACHUS. Well, let me ask you this. You formed the special investigative unit. Actually, it was 6 months after the original announcement of restatement. It was a 6-month lag, and it wasn't until afterthe day after they announced the departures, which indicates a really fundamental problem, I think, also. But why did it take so long to form this unit? In hindsight, would you have been better off to have began investigating it with your own unit in January?
Mr. FALCON. In hindsight, yes. However, this is a common practice of safety and soundness regulators, where often regulators will direct the Board of a bank or a thrift to hire independent outside counsel to undertake a review of any particular issues. So it is a common practice of regulators. However, given what we now understand was the seriousness of this and the conduct that was uncovered, yes, I would have preferred to have been in there much sooner.
Mr. BACHUS. Okay. Thank you.
Chairman BAKER. Yield back?
Page 29 PREV PAGE TOP OF DOC Mr. Hinojosa.
Mr. HINOJOSA. Thank you, Mr. Chairman.
Before I ask my question, Mr. Falcon, I want to stress that the housing market has served as the foundation of the U.S. economy since the stock market declined post-Clinton and post-9/11. During that time, Fannie Mae, and Freddie Mac have played a key role in supplying liquidity for the housing market, thereby supporting our economy in a time of need, especially when we had gone from a budget surplus to an incredible and dangerous deficit. It is my firm belief that whatever action that we decide to take in Congress, if any, with respect to any of the GSEs, we must not alter their internal structure or any aspect of their regulation that would harm them or our economy.
In your testimony, you ask for increased funding for OFHEO for fiscal year 2004. Some critics will say you don't deserve it because you failed to uncover Freddie Mac's problem. Others would say you need it because otherwise additional problems could arise if you don't have the manpower to oversee these two giants. Even though there is discussion of the creation of a new regulator, that likely will not be up and running until 2005, if at all. Consequently, you will need funding. How much money do you need to oversee the GSEs in this year, and how much is in your proposed budget in the omnibus bill which we have not yet passed?
Mr. FALCON. I appreciate your interest in this, Congressman. Our budget is $40 million. That is our 2004 budget. And that $40 million includes an amendment that the President requested to our 2004 request which would allow us to fund the special review of both Fannie Mae and the continuing review of one aspect of the Freddie Mac issue. In addition, it will allow us to hire additional examiners, I think some 18 examiners as well as a few other analysts to help us enhance our oversight. They are funds that we do need very much. We have developed plans on how we will utilize these additional staff resources and we are just waiting for the funding so we can begin to hire these people and plug them into our oversight.
Page 30 PREV PAGE TOP OF DOC Mr. HINOJOSA. Finally, Mr. Falcon, I have two short questions for you. How much money would you want Congress to give you if it decides to pass a supplemental early this year in addition to those $40 million? And, also, what is your opinion of the various proposals for new regulation of GSEs?
Mr. FALCON. As far as additional funds beyond the $40 million, we do have plans to increase the size of our examination staff beyond the amount that is included in our 2004 budget. It would be optimal to be able to begin to hire those individuals as soon as we can identify them, however, we have to manage our growth appropriately. I think the 2004 budget is of a sufficient amount that will allow us to do the growth that we desire for this year. Beyond this year, we will need additional funds to continue to enhance and strengthen our supervision. But we have to manage this growth in a proper way. So I think the 2004 budget is adequate. However, for 2005 we would like additional funds beyond our 2004 budget.
Mr. HINOJOSA. On the second question, what is your opinion of those proposals that are out there now for the regulation of the GSEs?
Mr. FALCON. My position remains the same as my testimony that I gave the committee last year. I do support strengthening of the safety and soundness regulation of Fannie Mae and Freddie Mac. I do think that we should start with the premise that a safety and soundness regulator for these companies should have all the same powers and authorities as every other safety and soundness regulator, and that is what I have tried to establish since I became Director of OFHEO. That involves a strong independent regulator, not part of the appropriations process, and I think this is appropriate because we are not funded with taxpayer dollars. We are funded through assessments on the two companies that we regulate. It also requires, I think, expedited hiring authority.
Let me just, instead of going on, just refer you to my testimony from my last appearance at the committee and say that remains my position as I stated in that testimony.
Page 31 PREV PAGE TOP OF DOC Mr. HINOJOSA. Thank you, Mr. Falcon.
With that, Mr. Chairman, I yield back.
Chairman BAKER. Thank you, Mr. Hinojosa.
Mr. SHAYS. Thank you, Mr. Chairman.
I can't disagree more strongly with anyone who believes that somehow allowing Fannie Mae and Freddie Mac to play by different rules than any of the other businesses that they compete with should be allowed to continue; and I would just like to ask Mr. Falcon, why shouldn't I feel that OFHEO is a captive of Freddie and Fannie? What confidence should I have that this organization isn't held captive by theseby both companies?
Mr. FALCON. I think since I have been Director of this agency we have demonstrated our willingness to take whatever action we feel is appropriate as a regulator, whether or not the enterprises agree or disagree with our actions. We have always conducted ourselves in this way, and we will continue to do so.
Mr. SHAYS. Let me ask you this: What has been your position on getting Fannie and Freddie to be under the 1933 and 1934 Securities Acts?
Mr. FALCON. I support removing those exemptions, the exemptions from those two acts.
Mr. SHAYS. Okay.
Mr. FALCON. I think our experience with Freddie Mac demonstrates that a system of voluntary disclosures just cannot work for these two companies.
Mr. SHAYS. When did you come to that conclusion?
Mr. FALCON. I think the report of our examination demonstrated that a voluntary system just cannot work well enough, and it is when I was presented with the results of our special examination that I came to this conclusion.
Page 32 PREV PAGE TOP OF DOC Mr. SHAYS. So we have had Treasury going back over a decade and a half recommend they be under Fannie and Freddie. We have had the head of the Federal Reserve suggest that they be under the 1933 and 1934 Act for many, many years. You come to this conclusion based on what you learned recently with what has happened with Freddie and this investigation?
Mr. FALCON. Yes.
Mr. SHAYS. Okay. How have you conveyed your feeling that this needs to happen?
Mr. FALCON. The rationale?
Mr. SHAYS. No, no. How have you conveyed to Congress and others that they should be under the '33 and '34 Act?
Mr. FALCON. It is a recommendation contained in the report that I submitted to the committee.
Mr. SHAYS. Okay. Can you cite that and read it for us?
Mr. FALCON. Yes. Congressman, if you look at the recommendations it is contained in page 164 of the report and it is number three.
Mr. SHAYS. Would you read it?
Mr. FALCON. Yes. OFHEO should establish a regulatory system of mandatory disclosures for the enterprises or their securities exemptions should be repealed.
That is the heading. Would you like me to read the entire
Mr. SHAYS. Pick out the most juicy part.
Mr. FALCON. The disclosure failures of Freddie Mac were extensive and damaging to the trust of the public in the future disclosures of the enterprise. It is clear that the financial disclosures of an enterprise should not be left to a system of voluntary commitments. Fannie Mae has registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, and Freddie Mac has promised to do so as soon as possible. To address the issue of the adequacy of enterprise disclosures completely, OFHEO should implement mandatory regulations that provide for mandatory disclosure similar to that required of SEC-registered companies and build staff resources necessary to oversee compliance. Alternatively, the Congress should repeal the exemptions of the enterprises from the Exchange Act and the Securities Act of 1933. Either option should result in the type of mandatory disclosure and oversight regime necessary to ensure safe and sound conduct.
Page 33 PREV PAGE TOP OF DOC Mr. SHAYS. Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Mr. Shays.
I just have a couple of follow-ups.
With regard to your assessment of the enterprises' capital adequacy, it has been clearly stated that the retained portfolios have grown, depending on the enterprise, 6 to 700 percent. I have knowledge that the purchase of their own mortgage back securities which was initially contemplated moving more risk out of the portfolio into the other sectors of the market now having been brought back in significant amount into their retained portfolio has resulted in significant increased leverage ratios. Given the uncertainties of accounting condition, is there any explanation why we shouldn't see some increase in capital surplus and at least some consideration of another approach to help with market discipline, given the financial constraints which you face and the uncertainties of the condition of the enterprises if we were to move to quarterly fair value disclosures?
Now I understand the calculation of fair value is distinct and different from core capital calculation. But any consistent measure against which previous quarter performance can be measured against the current data I think is a helpful tool to the markets to better understand the risk profiles of the various enterprises. Would you think it advisable or ill-advised to consider requiring quarterly disclosure of fair value?
Mr. FALCON. I think it might be well-advised if we could make sure that the calculations are consistent by both companies. They might not necessarily be consistent, and therefore you might not be able to properly compare one against the other.
Chairman BAKER. And that is the case together with general disclosure. We are moving toward comparability, but we don't have it today, do we, in a broad sense?
Mr. FALCON. In a broad sense, yes.
Page 34 PREV PAGE TOP OF DOC Chairman BAKER. With regard to the point made by members previously with the lack of adequate funding, it is my understandingand please confirm if I am correctthat OFHEO is the only principal Federal financial regulator that is subject to congressional appropriations for its enterprise operation, meaning that each year you must submit for budgetary consideration a budget which then has to be acted on by the Congress as contrasted, for example, with the OCC which oversees large commercial banks. They have a formula that results in an assessment, and that is an automatic calculation that enables that enterprise to engage in its regulatory function without the necessity of making its case, as it were, to the Congress. Is OFHEO's condition in that regard a unique one?
Mr. FALCON. Absolutely, Congressman.
Chairman BAKER. So that if we were to create a regulatory enhancement for your shop, having you funded independently of congressional action would be a very significant benefit to you.
Mr. FALCON. Absolutely. It would benefit us in many ways. It seems every year we have to slow down our operations as far as hiring goes and major acquisitions purchases by the agency until we wait for a budget to get enacted after the CR period is over. Being out of the appropriations process would allow us to engage in long-term planning and meet immediate funding needs on a real-time basis. Right now, we have to set our budget 2 years in advance and hope that the budget we had put together at that time still matches the requirements that we have. As we have found with this Freddie Mac situation, our budgetary needs have not kept up with our requirements, but we are trying to adapt as quickly as possible. We would have much more flexibility to do so were we not part of the appropriations process.
Chairman BAKER. And if you had those resources you would probably implement all 16 and get on with that forensic accounting business, too.
Mr. FALCON. Right, Congressman. Although, appropriations or no appropriations, we will look at moving on as many of these 16 as soon as possible.
Page 35 PREV PAGE TOP OF DOC Chairman BAKER. As a sort of follow up to Mr. Shays' line of questioning, with regard to recommendation number three, if you are unable to establish or find it unwise to establish a mandatory disclosure regime or part of that recommendation or their securities exemption should be repealed, that would require action by the Congress, would it not?
Mr. FALCON. Yes.
Chairman BAKER. Okay.
Mr. Kanjorski, do you have any follow-up?
Mr. KANJORSKI. Just if I could ask your opinion. After having made this detailed study and having the new accounting operations at Freddie Mac, do you have an opinion as to whether or not there is any systemic risk involved here with these GSEs or have you satisfied in your own mind that you know all the occurrences that have taken place and in your opinion is there any risk now to the system or to the taxpayers?
Mr. FALCON. There are two aspects of this that I would like to get into. First is, as a general matter, we published a study a year ago which identified and explained the nature of the systemic risk posed by the companies. Now, systemic risk is different from an imminent threat of a systemic disruption which would happen if either company experienced severe financial difficulties such that they would default on counterparty obligations or risk insolvency at this point or at any time. While Freddie Mac has experienced these accounting problems, have we felt that the company's safety and soundness was compromised? These were very improper practices which were not safe and sound practices, and we have taken all the action necessary. But is the company unsafe and unsound? We don't think so.
Mr. KANJORSKI. Now, just one other question. I have met with a lot of Directors in the Federal Home Loan Bank system and they have expressed to me their desire to have more expertise in the derivative area and particularly with the counterparties they are engaging in. Have you developed any scheme within theyour agency as to what can or should be done here to take the risk out of the counterparty situation, or are we just going along in the way it has occurred before, the restatement?
Page 36 PREV PAGE TOP OF DOC Mr. FALCON. I think there are mechanisms in place to try to manage the risk of counterparty defaults where the companyI mentioned the ratings of the companies, but that is not the main one. I think when the companies engage in derivative transactions they do obtain collateral for their exposure if there was a default and a need to replace the derivative. And there are netting agreements in place as well for the company. So I think there are mechanisms in place to try to deal with a potential default of a counterparty. But, ultimately, each player in this, whether it is us as the regulator, Fannie, Freddie or a bank regulator as a regulator of a bank counterpart, has to fulfill their mission in making sure that their part remains safe and sound.
Mr. KANJORSKI. Well, what do we do, though, toI mean, I was impressed when Directors come forward and say, look, this is beyond our understanding as Directors. We just don't know whether we are doing the right things or not doing the right things, and we have no one to call upon to provide with us that expertise. How can wewith this new derivative area that we are in, how can we take that risk or that absence of knowledge away and provide the knowledge that the Directors or the companies need or the taxpayers need with our oversight to see that that risk doesn't exist anymore? Is there any way of lessening it?
Mr. FALCON. On the part of the Board which you have mentioned, I think they have to be certain that they have adequate expertise within the company to understand and manage that risk, and they have to receive frequent and adequate reports from management about their activities in managing that risk. Now, ultimately, do you expect the Board to be experts in derivative transactions? I don't think you can reasonably expect that every Board member will have that kind of specialized expertise. So it is important for the Board to make sure that the company retains that expertise, but they have to adequately oversee that expertise as the Board of Directors, and it is the responsibility of OFHEO to make sure that all that takes place as well.
Chairman BAKER. If I can, I have just been advised that approximately noon or shortly thereafter we will have a series of votes. If members don't have any additional questions for Mr. Falcon at this time, then I would like to express my appreciation to him for his appearance so that we may get our next witness up.
Page 37 PREV PAGE TOP OF DOC Did you have any further, Mr. Bachus?
Mr. BACHUS. Mr. Chairman, if I could just ask one brief question.
Director, I asked earlierasked a question in January. When Freddie Mac announced that they were going to restate earnings, I asked you what response OFHEO took; and your response was that the outside law firm was hired to investigate the circumstances. But now they were hired by the Board of Directors, weren't they?
Mr. FALCON. Yes, that is correct.
Mr. BACHUS. Not by OFHEO.
Mr. FALCON. Correct.
Mr. BACHUS. Now what you said you all focused on was getting the restatements done.
Mr. FALCON. Yes.
Mr. BACHUS. Now let me ask you two questions. First, the outside law firm that was hired by the Board of Directors, they made a report which basically did not reveal what your special investigating unit found. I mean, it is rather incomplete, would you agree?
Mr. FALCON. It didn't cover all the areas or make the same kind of critical analysis that our's did, I believe.
Mr. BACHUS. Right.
Mr. FALCON. Yes, sir.
Mr. BACHUS. Do you think that there was any concealment? The reason maybe they didn't find some of these things, do you think there was any concealment?
Mr. FALCON. I don't have any evidence of that, Congressman.
Mr. BACHUS. Do you think that the reportthat their report was in some way compromised by
Page 38 PREV PAGE TOP OF DOC Mr. FALCON. In what way? I think
Mr. BACHUS. Well, that is the Doughty report I think you are referring to.
Mr. FALCON. Yes.
Mr. BACHUS. But your special investigative unit began to investigate the same matters, you found additional things, and that wasis that correct?
Mr. FALCON. Yes, that is correct.
Mr. BACHUS. I'm just saying, why do you think that they weren't found in the investigation that was authorized by the Board of Directors and you were able to find these things?
Mr. FALCON. Well, I think that report was focused primarily on the transactions and the nature of the transactions. We tried to get at the root cause of what happened with the company and how it got to that point, and we were going to look at not just the transactions but also the conduct of management and the conduct of the Board of Directors. Now, I guess an obvious limitation of that report by the outside law firm was its client was the Board and it was hired by the Board and I don't think it was going to take as critical a look at the conduct of the Board as we were prepared to do.
Mr. BACHUS. All right. Well, that is what I would suspect, also, that because it was hired by the Board and not OFHEO, does that indicate to you maybe if this were to happen again that it would be better for OFHEO to select then or investigate itself or at least select and charge the outside firm?
Mr. FALCON. I think that would be the presumptive course to take. Here, again, until a deeper review was conducted, it wasn't evident what kind of conduct we were really talking about at the company.
Mr. BACHUS. You said, as opposed to investigating the circumstances, you allowed the Board to hire an outside investigator which was charged with only limited scope which isin hindsight is a mistake. But you said you focused on the restatements, but those are still not complete.
Page 39 PREV PAGE TOP OF DOC Mr. FALCON. Our position at the time, Congressman, was we were focused on getting the timely financial statements and getting the reaudit, restatement done. At the same time, the Board hired this outside law firm to conduct its analysis of the circumstances that brought about the reaudit. At the time, we believed were making good progress with the restatement and that we would assess the work of this law firm to decide whether or not it was necessary for us to conduct additional review. When the events of June took place, it became clear that we could not wait for the law firm to finish its work and we would not wait for the restatement and reaudit to get completed either.
Mr. BACHUS. Well, that is why I am saying it only became obvious to you after the resignations that it wasn't a sufficient investigation of the circumstances.
Mr. FALCON. Right. And it was beginning to become clear that this was not just about a disagreement between the auditors but rather there was more going on at the company.
Mr. BACHUS. Okay. Now, there are still restatements to be done so Freddie Mac is still not current in that, am I correct?
Mr. FALCON. Right. Technically, the restatements have been done. What is lacking is there aren't quarterly statements for 2003 nor will there be a year end 2003 financial statement. That is what the company is working on right now.
Mr. BACHUS. All right. Thank you.
Chairman BAKER. The gentleman's time has expired.
Mr. Falcon, I wish to again thank you for your courtesy in appearing here today. We look forward anxiously to the final recommendations you may choose to make with regard to potential reform and certainly into the next year we will do our best to be of assistance with those funding concerns. Thank you very much for your presence.
Page 40 PREV PAGE TOP OF DOC Mr. FALCON. Thank you very much, Mr. Chairman, Congressman Kanjorski.
Chairman BAKER. At this time, I would invite Mr. Martin Baumann, Chief Financial Officer of Freddie Mac, to come forward.
Welcome to Capital Markets, Mr. Baumann. We certainly appreciate your courtesy in appearing here today, given the interest the committee has in this important matter.
As is the usual custom, your formal statement will be made part of the record. To the extent possible, if remarks can be targeted toward the 5-minute rule then that will enable members to ask appropriate follow-up questions.
With that, we welcome you as the Chief Financial Officer of Freddie Mac to make your statement.
STATEMENT OF MARTIN F. BAUMANN, CHIEF FINANCIAL OFFICER, FREDDIE MAC
Mr. BAUMANN. Thank you, Chairman Baker, Ranking Member Kanjorski and members
Chairman BAKER. I think that button on the bottom will have to be pushed. Try that.
Mr. BAUMANN. Thank you.
Chairman BAKER. No, try again.
Mr. BAUMANN. Can you hear me now?
Chairman BAKER. There we are.
Mr. BAUMANN. Thank you Chairman Baker, Ranking Member Kanjorski and members of the subcommittee.
My name is Martin F. Baumann. I am the Executive Vice President and Chief Financial Officer of Freddie Mac. I joined Freddie Mac in April of 2003. I was hired to build a strong finance function within Freddie Mac and restore confidence in the company's financial reporting. I am committed to developing an exemplary finance function that produces accurate, timely, well-controlled and transparent financial reports. Prior to joining Freddie Mac, I worked at PricewaterhouseCoopers for more than 30 years as a partner, as deputy chairman of the World Financial Services Practice and as the Global Banking Leader.
Page 41 PREV PAGE TOP OF DOC 2003 was a challenging year for Freddie Mac. In January, we announced a restatement of prior year earnings; and in June our Board of Directors made changes in the company's senior management. Freddie Mac has been working hard to regain the confidence of all of our stakeholders. Last year, we completed the restatement of prior year financial results. OFHEO completed its special examination, and we entered into the consent order. We are implementing a corporate-wide remediation program to ensure that the accounting of financial control issues that led to the need for the restatement will never happen again. We appreciate the subcommittee's patience as we have worked through these tough times.
Freddie Mac's mission is to insure a stable supply of low-cost mortgages for America's families, whenever and wherever they need them. We recognize our special responsibility to home owners, the public, Congress and investors. Despite our difficulties last year, we maintained our focus on fulfilling these responsibilities.
As the President said last night, the country is experiencing record home ownership rates. We are proud of the role we are playing in this important accomplishment.
Our highest priorities are remediation and compliance with the consent order, along with bringing our financial statements current. We are firmly committed to building a new organizational culture based on transparency, openness, and building of long-term results. We are headed in the right direction, and we have the right leadership to reach our goals in our new Chairman and Chief Executive Officer, Richard F. Syron.
Before addressing our remediation and compliance efforts, allow me to say a few words about the completion of our restatement and prior year results.
On November 21, 2003, Freddie Mac's Board of Directors and management team announced the release of the company's restated and revised financial results for the years 2000 through 2002. We are now completing our annual report for 2002 and expect to hold the related annual stockholders meeting this quarter.
Page 42 PREV PAGE TOP OF DOC Freddie Mac completed this restatement while maintaining our business fundamentals and delivering on our congressional mandate to make mortgage credit more available for America's families. We remain fully committed to our mission of helping make housing more affordable for more Americans and maintaining liquidity in the housing market which for the past several years has bolstered the U.S. economy.
The restatement did not affect the fundamental strength of Freddie Mac's business. Our business operations remain strong and interest rate risk and credit risk remain low. Our risk profile remains conservative, with an average duration gap of zero for November, 2003, unchanged from October.
Freddie Mac is currently engaged in an active remediation program that began in the spring of 2003 when the governance committee of the Board asked me to develop a remediation program to ensure that the factors contributing to the restatement would never recur. Thereafter, the Board approved a comprehensive remediation program that has been and is effecting far-reaching changes in the company's financial reporting, control and management functions. The consent order added further key items to our existing remediation program, resulting in an enhanced, comprehensive remediation program designed to ensure the integrity of Freddie Mac's financial reporting, controls and governance. We have been working closely with OFHEO to make sure that we take the remediation steps required by the consent order on a timely basis.
Our commitment to implementing the requirements of the consent order and the remediation program is unwavering. The activities we have already taken and are continuing and our continuing plans, including fulfillment of the requirements of the consent order, demonstrate our commitment to create a corporate culture in which the type of problems that led to the restatement will never happen again.
In implementing the consent order, Freddie Mac will be building upon its very significant efforts to improve the quality and depth of internal accounting personnel, the strength of the accounting function and management oversight of that function.
Page 43 PREV PAGE TOP OF DOC Freddie Mac has added over 100 professionals in accounting reporting and control areas, including a significant numbers of new officers and senior managers. We have also retained leading experts in the areas of public disclosure and corporate governance to assist the company in designing and implementing processes and practices in these areas.
We hired a Senior Vice President and Chief Compliance Officer who is responsible for overseeing Freddie Mac's compliance with policies, procedures and practices, including compliance with laws and regulations; and we have established and filled the new position of Chief Enterprise Risk Officer. We are also working to implement new systems to ensure the quality, integrity, transparency and timeliness of our financial reporting.
Finally, we have taken steps to ensure that Freddie Mac's corporate culture promotes integrity, high ethical standards and the importance of compliance. In this regard, virtually all of our employees have completed a corporate-wide training program on the company's code of conduct and the provisions of the Sarbanes-Oxley act.
Through the extraordinary efforts of Freddie Mac's Board of Directors, current management team and employees, we have met the challenges of the past year and we are looking forward to continuing to improve our reporting, governance and financial controls.
Together with Freddie Mac's new Chairman and CEO as well as our senior management team I will insure that we set the right tone at the top.
Now that the restatement is complete, Freddie Mac is focused on bringing our financial statements completely up to date. Our objective is to release quarterly and full-year 2003 results by June 30, 2004, and to provide the 2003 annual report shortly thereafter.
Freddie Mac remains irrevocably committed to completing the process of registering our common stock with the Securities and Exchange Commission under the 1934 Act, with the objective of completing that process as soon as possible after the company's return to timely reporting.
Page 44 PREV PAGE TOP OF DOC In 2004 we look forward to working with Chairman Baker, Congressman Kanjorski and the members of this subcommittee as you consider regulatory oversight proposals. Freddie Mac has long supported a strong regulator as critical to the achievement of our mission.
As I have outlined today, Freddie Mac is bringing our financial statements current and building for the future. We have taken significant steps toward achieving our goal of exemplary financial reporting and controls. The work that we have done, and continue to do as part of our remediation program, together with our commitment to fulfilling the obligations of the consent order, will enable us to reach that goal. While we complete this work, we are continuing to fulfill our important public mission, maintain our safety and soundness and meet our business objectives.
Thank you for the opportunity to appear here today.
Chairman BAKER. Thank you, Mr. Baumann.
[The prepared statement of Martin F. Baumann can be found on page 54 in the appendix.]
Chairman BAKER. I would assume that your public statements on the agreement reached with OFHEO came pursuant to direction by the Board. In mid December, press accounts give attribution to you for several points that appeared to be disputing the need for the recommendations of the regulator.
One, you stated it doesn't believe it needs to slow its growth with reference to Freddie Mac. We don't see any reason to change our business activities. We don't need to raise more capital. Freddie Mac hasn't agreed to OFHEO's recommendations. And then, finally, sort of the fitting last piece, putting a constraint on our growth could create risk. It would limit opportunity to create profits for shareholders.
Since that time, till now, has the Board's opinions been modified or are those your personal views at the time that have now been modified? I think the recommendations made by Mr. Falcon, or at least that he is contemplating, more accurately, are highly appropriate. Can you rectify the two sets of statements, or four sets of statements, together with the recommendations and your stated intent this morning to move toward implementation of those recommendations?
Page 45 PREV PAGE TOP OF DOC Mr. BAUMANN. Yes. Those responses are to a question regarding the accuracy of our capital; and as demonstrated by our reports that we have filed with OFHEO, we meet our minimum capital guidelines and, in fact, we exceed our capital guidelines with a healthy surplus. So Freddie Mac has a very strong capital base today. Freddie Mac uses this capital base to fulfill its housing mission on a day in and day out, buying mortgages, entering into transactions, raising our funds in the capital markets, bringing debt holders around the world to the investors around the world into ourinto Freddie Mac to invest into the U.S. mortgage market. This is athis is improving the mortgage market all the time and lowering the cost to families to acquire their mortgages and their homes.
So I think our activities have been operated in a safe and sound manner, as the Director mentioned today that the safety and soundness of Freddie Mac was not in jeopardy during this period of time when the financial statements were untimely, but our market risk and our credit risk have been well managed during all of those times and we have been able to fulfill our goal of continuing to invest in the mortgage market, to provide liquidity to that market and to attract investors, both in the U.S. and around the world, to our securities so that we can further invest in that market.
Chairman BAKER. Well, I appreciate the answer with regard to capital. I don't necessarily agree with your view of the matter. But set capital aside for the moment. There are 15 other recommendations. I can be specific. Does the Board intend to separate the functions of the CEO from the Chairman of the Board? That is number one.
Mr. BAUMANN. The new Chairman of the Board was appointed and it was discussed with the Director of OFHEO before he was hired and it is understood that that role would be a combined role of the Chairman and CEO at this point in time and that over time that that recommendation would be implemented.
Chairman BAKER. Okay. Number two, do you think that the financial incentives for compensation that are currently based on short-term goals and maintaining earning stability should be modified or has it been modified or do you intend to modify it, the method by which executives are compensated for performance?
Page 46 PREV PAGE TOP OF DOC Mr. BAUMANN. We are modifying greatly and already have modified greatly the way in which executives are compensated. There arein the past, there were short-term earnings targets, short-term growth in operating earnings and earnings per share targets that were part of the company's scorecard. The current year scorecard has no short-term earnings per share or operating earnings targets attached to it. Management compensation is being driven by a variety of factors. Mission is the first and foremost part of that. Building internal controls and getting our financial statements current is the second largest piece of that. Growing long-term value in the company is another part of that. But short-term earnings goals are not part of the scorecard for management compensation.
Chairman BAKER. Do you contemplate term limits for Board members, Board of Directors?
Mr. BAUMANN. These factors with respect to corporate governance are under consideration by the Board, and we will be talking to OFHEO about these recommendations. Again, these were recommendations, first of all, to Director Falcon from his staff. Director Falcon is the one who will determine how they would be implemented in terms of working with our Board and with management.
Chairman BAKER. And to the generic question, do you agree with Mr. Falcon's assessment that he has the authority to implement all 16 recommendations if he so chooses, or is that a position which Freddie would have objection to and take steps to litigate the implementation of proposed rules?
Mr. BAUMANN. We are working with OFHEO. We understand the issues that surrounded Freddie Mac in the past. The questions around the internal controls and the lack of accounting expertise, I, among others, was hired to fix those problems as well as the new CEO Dick Syron was hired to fix those problems and change the culture. We are working with OFHEO to accomplish all of these needed reforms.
Page 47 PREV PAGE TOP OF DOC Chairman BAKER. Well, let me hone in one more time because my time's expired, and I want to make sure other members have a chance for questions before we get into votes.
For example, go back to number one, splitting the functions of the CEO and the Chairman. Given the current understanding of the current CEO with regard to the combination of those responsibilities, can Mr. Falcon require the enterprise to separate those two functions, or is that something that you believe you have independent authority to maintain business structure?
Mr. BAUMANN. I think Director Falcon has already said that he can enforce regulation. He can put regulation into law and then we would have to comply with that. But having said that, we have nowe are not trying to argue these recommendations. We have signed a consent order and agreed to that consent order and implementing remedial actions. We are workingthese particular recommendations again are not yet immediate recommendations to us. These are recommendations to Director Falcon from the staff, and he is working on his determination of how they should implemented.
Chairman BAKER. So, to conclude, if Mr. Falcon is to determine any or all of these are appropriate actions to recommend or put into place, it would be your understanding as of today, understanding the Board may direct you at a later time, that Freddie Mac would not object to obfuscate, block, otherwise take legal actions to preclude the implementation of the recommendations of the Director.
Mr. BAUMANN. Again, as I said, we are working closely with OFHEO to try to implement these recommendations. To the extent Director Falcon agrees with all of them, and appropriate recommendations, we would work along with them to implement.
Chairman BAKER. And inappropriate ones you would not.
Mr. BAUMANN. If Director Falcon believes these recommendations are appropriate and makes the recommendations, we would work with him to implement them.
Page 48 PREV PAGE TOP OF DOC Chairman BAKER. Thank you.
Mr. KANJORSKI. In as simple a way as possible, could you tell us what the root core of the failure at Freddie Mac was in terms of not getting the restatements done? Do you believe that, as Mr. Falcon indicated, that it was just in the interest of executive compensation that this action was undertaken and no other reason?
Mr. BAUMANN. Since I joined the company in April, 2003, I have been working hard to improve our financial reporting capabilities and our internal controls and to get the restatements of prior years results done, which we accomplished in November of 2003, now working on getting the 2003 results issued. At the same time, the Board engaged Baker Botts to do an independent study of the factors leading up to the restatement and then OFHEO performed its own investigation of the factors leading up to the restatement. I think those reports speak for themselves, and I have not done any further investigation beyond those.
Mr. KANJORSKI. Are you satisfied that what has been indicated today here as to the root cause of this problem was simply the executive compensation desires? Or is there something more? I am trying to get to whether or not you are satisfied now in your nine months with Freddie Mac that we know what precipitated and caused this activity and that it is only simply a desire to increase compensation of a limited number of the executives. Is that your judgment now?
Mr. BAUMANN. Well, that isthat was the statement that came out of Director Falcon and his interpretation.
Mr. KANJORSKI. Well, I am asking you whether you agree with that interpretation or do you have some other sense or are you satisfied it was simply this exuberance, if you will, of the executives to gain compensation, additional compensation.
Mr. BAUMANN. I am satisfied that the investigations done by Baker Botts and the investigations done by OFHEO were thorough and examined the transactions and the culture in the company that led to the use of certain capital markets transactions forwith a view towards their effect on earnings. I am satisfied that the events have been uncovered that led to the conditions at Freddie Mac, and I think those two reports both put a lot of facts on the table about them. What individual motivations may have been back then I have not done any work to understand those individual motivations. I don't know of any other motivations other than those expressed so far.
Page 49 PREV PAGE TOP OF DOC Mr. KANJORSKI. What I am primarily interested in is getting to what the cause of this problem was, whether or not it is in your mind solved now. But particularly, again, going to the role of Directors, it seems to me this whole problem was discovered by the need or the decision to change auditors and that if auditors hadn't been changed even today these occurrences would be occurring and we wouldn't know about it. What, internally, have you done or can you do to correct that possibility in the future?
Mr. BAUMANN. Right. Thank you. We can do a lot, and we have done a lot.
As I mentioned in my oral testimony, I have hired more than 100, 100 accounting professionals who now work with me in the financial function. We have recruited some of the best people that we can find to add to accounting expertise needed in this company.
In addition to that, in my job as the Chief Financial Officer I don't have any direct responsibility for what the earnings numbers are. I don't run any businesses in the company, and I don'tand I am not tied to any earnings objective. My responsibilities as Chief Financial Officer are to ensure that we report results accurately, completely and transparently, with no bias whatsoever as to what the outcome is as to what those results are. My responsibility is to oversee internal controls in the company and to report if there were any weaknesses in our internal controls or oversight. So I have no responsibility for running the businesses.
As the Chief Financial Officer I have responsibility different than the past in the company. I have responsibility for the credibility of financial reporting and the quality of our internal controls. That, along with hiring of a new Chief Executive Officer, setting the right tone at the top in the company, along with building the accounting expertise and using consultants to build the right accounting expertise and controls will prevent this situation from ever happening again.
Page 50 PREV PAGE TOP OF DOC Mr. KANJORSKI. Are you completely independent of the Chairman, the CEO, and do you report directly to the Board or are you still dependent on your superiors in the chain of command?
Mr. BAUMANN. Okay. I report directly to the Chairman and chief executive of the company. I have direct reporting lines to the Board. I am the lead liaison in the company to the audit committee. I am the lead liaison directly to the chair of the audit committee with respect to matters that get reported there. But I do have a direct reporting line to our Chief Executive Officer.
Mr. KANJORSKI. How do you see that the Board in the future would know if there is this problem occurring? What are the controls that are in place now that would clearly give the Directors or the auditing committee or the Board the insight as to the existence or the potential existence of a problem and how would they know about it any greater than prior to this occurrence?
Mr. BAUMANN. In any company, as you were suggesting earlier, a Board does have to rely on the quality of the people and processes put in place at that company.
The Board has hired people that they believe are appropriate in the circumstances.
When I was hired in April, I interviewed with the Chairman of the Audit Committee, the Chairman of the Compensation Committee, the presiding Director of the company, all of whom set the ground rules for me, in terms of what their expectations were. I spent 33 years in the practice of public accounting, working with some of the largest financial companies in the world, ensuring that their financial statements were accurate and reliable and reporting to those audit committees of those companies in doing that.
I am committed to reporting to this Board of Directors on a regular basis on any matter that I think they would find to be important, and that is a message that I have delivered throughout this company, but this company is going to operate in an absolutely open and candid way, and anybody that has concerns about any issue, they should be reporting them to their superiors and to me, and we will report that to the Board.
Page 51 PREV PAGE TOP OF DOC We have also implemented certain things such as a hotline, which is a call base where employees can call outside of the company to a third company to discuss anything that they have a concern about, and we have mentioned that in a code of conduct in Sarbanes-Oxley that we have conducted.
Mr. KANJORSKI. It seems to me, again, because of your high ethical standards and the code you set you are satisfied this cannot happen again, but what happens if you get replaced?
Is it the chief financial officer, depending on what his ethical standards are, that could determine whether or not this could happen again?
Mr. BAUMANN. Certainly, again, the people one hires, the people one hires is important to the credibility of the process.
I believe the people I am hiring are highly ethical and also that have the same culture with respect to financial reporting, so the people I am hiring are of the same type.
We are also working on a succession planning model, such that we have in place, should I disappear for whatever reason, have in place succession plans with the right people, with the right skill sets, and that the Board will have preapproved that succession planning in order to keep this kind of culture of accuracy and culture of integrity alive.
Mr. KANJORSKI. One other question: Looking at this whole problem, have you estimated what the cost to the company is actually, what it has been, and what benefit would flow from the people who set up the mechanism of these restatement manipulations?
I am trying to get a proportion.
Did it cost the Board or the company a billion dollars?
Mr. BAUMANN. I do not know what benefit people got in the past, and again I
Mr. KANJORSKI. Not the people now. I am just talking about what is the cost in your judgment to the company?
Page 52 PREV PAGE TOP OF DOC Mr. BAUMANN. The cost that we spent in connection with the restatement during the year 2003 was a little bit more, approximately $100 million, and we anticipate spending similar amounts in 2004 on consultants in connection with building systems.
Mr. KANJORSKI. 100 million or billion dollars?
Mr. BAUMANN. $100 million, $100 million.
Mr. KANJORSKI. Of course, the fine, 125 million.
Mr. BAUMANN. $125 million fine is in addition to that, sir.
Mr. KANJORSKI. Now, do you have an idea, a rough calculation, as to the perpetrators, what did they gain out of this in terms of dollars?
Mr. BAUMANN. No, I do not have that, sir.
Mr. KANJORSKI. I mean, did they gain more than that 225 million or much less?
Mr. BAUMANN. I have no way to calculate that.
Mr. KANJORSKI. Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Mr. Kanjorski.
Mr. SHAYS. I defer.
Chairman BAKER. Mrs. Biggert?
Mrs. BIGGERT. Thank you, Mr. Chairman.
Mr. Baumann, in your testimony, you set deadlines for completion of the financial reporting for 2003 and 2004, and additionally I think you thought that the company would be registered with the SEC by 2005, and it seems like these dates have been moving since the agreement in 2001.
What steps will Freddie Mac take to meet these deadlines?
Mr. BAUMANN. Since I have been hired in April of 2003, as I said earlier, I have hired 100 accounting professionals, and I am using the resources of the best accounting consulting firms to work with us, in terms of building appropriate internal accounting systems and financial reporting capability.
Page 53 PREV PAGE TOP OF DOC As stated in the Baker Botts report, the company has lacked the accounting expertise in the past which led to the restatement and has therefore also led to the fact that we are not yet registered with the SEC.
We are 100 percent committed to the improving of the accounting expertise in the company and bringing in the kind of talent we need to get the financial statements current again and then to go on with our registration with the SEC.
I have met with the SEC on a number of occasions already as part of the restatement. They have agreed in discussions with me that they would reengage with us as soon as we complete our 2002 annual report, which I have indicated we expect to complete this quarter, and then using the 2002 annual report we will begin to go over the registration process and start to prepare the registration documents and get the decisions regarding disclosure matters for registration agreed with by the SEC.
We cannot become a registrant until our financial statements are again timely, but as soon as they are timely we hope to complete that as soon as possible thereafter.
Mrs. BIGGERT. Just a question about the SEC. If Freddie Mac had registered with the SEC, would disclosures that were mandated in the forms 10K and 10Q, would those have revealed the trading irregularities and the mismanagement misconduct?
Mr. BAUMANN. Well, one cannot completely answer those questions in hindsight, so the real answer is I do not know, but certainly the process of registering with the SEC is a very detailed process, where the SEC's Division of Corporation Finance reviews the financial statements, asks a lot of deep questions about financial reporting and the quality of disclosures around accounting principles, and a lot is uncovered as part of the registration process, so
Mrs. BIGGERT. With the registry with the SEC, what impact will it have on Freddie Mac business?
Page 54 PREV PAGE TOP OF DOC Mr. BAUMANN. Registering with the SEC under the 1934 act would not have any particular impact on the business. It will demonstrate that the financial reports of Freddie Mac are of the same caliber as other companies that are registered. We are building that expertise to get that registration done.
Mrs. BIGGERT. Okay.
Thank you, Mr. Chairman. I yield back.
Chairman BAKER. Thank you, Mrs. Biggert.
Mr. SCOTT. Thank you, Mr. Chairman.
How are you, Mr. Baumann?
Mr. BAUMANN. Fine.
Mr. SCOTT. I wanted to ask you about the incentive compensation plans.
How have you changed those incentive compensation plans for the senior officers at Freddie Mac?
Mr. BAUMANN. There are incentive compensation plans that officers of Freddie Mac and many employees of Freddie Mac participate in, both long-term incentives and short-term incentives.
The short-term incentives no longer have a current year's earnings per share or current year's growth in reported earnings as a major factor of that; in fact it is not a factor at all.
As I stated earlier, the incentives are based largely on meeting our housing mission, meeting our affordable housing goals as the largest component of the compensation package, of the incentives.
The second largest is geared towards completion of these requirements to get our financial statements current and to get financial statements issued by June 30, 2004, which is the target for the 2003 results for completing the internal control improvements, the remediation plan, and now the consent order required by us, by OFHEO.
Page 55 PREV PAGE TOP OF DOC There are some other goals about growing the fair value of the company, increasing the long-term fair value of the company as well, but they are minor parts of the goal, of the incentives.
The longer term incentives are really geared with employees involved in the short-term goals over a longer period of time and geared to their longer term success in achieving the mission of the company. So the answer is the short-term earnings goals have been removed, replaced by goals around our mission, more goals around our mission, affordable housing, and more towards our goals of improving our mission in the company.
Mr. SCOTT. One other question, recently Fannie Mae has expressed its preference for a new regulator as a Bureau of the Treasury Department rather than a new independent agency.
Has Freddie Mac taken a similar position in terms of a nonindependent regulator?
Mr. BAUMANN. No, we have not taken a similar position.Our position is that we support strong and vital, vigorous regulation. We think it is important for us and for the credibility of Freddie Mac and the fulfilling of its mission, and we are ready to work with this committee and with Congress at large and the administration in whatever regulator they choose to put in place.
Mr. SCOTT. Do you agree with Fannie Mae's preference for the Treasury Department?
Mr. BAUMANN. We arewe would be happy with that outcome, but we would also be happy to work with other outcomes as well. We are not stating a particular preference for this outcome, other than a strong regulation.
Mr. SCOTT. Okay.
Last December the Federal Reserve released a report that stated that Freddie Mac and Fannie Mae provided meager help to home purchasers.
Page 56 PREV PAGE TOP OF DOC Also, on January 9, in USA Today, they ask whether or not Americans were getting a bad return on their tax funded subsidies.
How do you respond to these charges, and if you disagree, what efforts will you undertake to further expand home ownership to communities that previously have been left behind?
Mr. BAUMANN. We do disagree with those findings, and we are committed to expanding home ownership, and we are supporting and want to work with the administration in initiatives to support home ownership.
Our job is far from complete. Home ownership is great in this country. The number of homeowners is great in this country, but that is not equal among all the entire population of the United States, and it is important to increase minority home ownership in the United States.
We are eager to participate in those efforts. Our new chairman and CEO Dick Syron is long a champion of home ownership for Americans as President of the Home Loan Banks in Boston and as President of the Federal Reserve Bank in Boston. He is eager to work with this committee and others to support home ownership among minorities and to grow home ownership.
The study was by an employee of the Fed. Certainly there are other third party studies that disagree with that report, and one can just look in the papers, as I have done recently, this weekend, and if you look at the survey of what the interest rates are for jumbo mortgages, which we do not participate in, versus conventional mortgages, which Freddie and Fannie do participate in, there is a difference of 26 basis points on average between the jumbo mortgage and the conventional mortgage. On a $200,000 mortgage that adds up to $11,900 savings for a purchaser of that home and that mortgage. That is a considerable savings for a homeowner, so we think we are fulfilling our mission, adding considerable value to Americans and home ownership and considerable savings to Americans.
Page 57 PREV PAGE TOP OF DOC Mr. SCOTT. Do you think there is any one piece of information why the Federal Reserve would release such a report, although you say it isn't one individual that was released through the Federal Reserve with their permission, with their permission, authority, so there must be some credibility there?
What did they hang their hat on to make such a negative statement about the performance of your agency?
Mr. BAUMANN. Their interpretation of numbers is often complex and different parties with the best intentions can come to different interpretations of results. A study was made and that was that particular person's interpretation of a variety of different measurements of economic data. There are other studies out there as well that would show a different answer.
I happen to think the easiest way to look at the information is to look at the variation between jumbo rates, which Freddie Mac did not participate in, jumbo mortgages, and conventional mortgages, which we do, and that is a savings, just as I said to you today. That is 26 basis points today, or 11-, over $11,000 savings to an American who has a $200,000 mortgage.
Mr. SCOTT. My final point, Mr. Chairman, is this: I am looking at a chart on home ownership rates, and it is broken down into the total USA, the white, black, Hispanic, other race, central cities, suburbs, and in each one of these categories there has been a slight increase in home ownership rate except for one, and that is the African American community.
It went down between 2001, 2002, when all of the other categories of, total, white went up, Hispanic went up, other races went up, but for the black home ownership, it went down.
What caused that? Why is there that aberration with that particular group when all the other groups, home ownership rates went up? What do you think accounted for that?
Page 58 PREV PAGE TOP OF DOC Mr. BAUMANN. I cannot answer that question exactly in terms of why that happened. I can tell you unequivocally that Freddie Mac is committed to minority home ownership, especially home ownership by African Americans of homes.
I am happy to bring that question back to Freddie Mac and ask our people to doour economists who work in those areas to give me a report on their assessment of that, and I would be glad to share those findings with you, Congressman.
Mr. SCOTT. I would be very interested in that because we would be doing our mission a great service if we could come back with some valuable information of what we are not doing for this minority group as opposed to other groups, because it is obvious that there is something there, and I would like for us to try to put our fingers on it so we can address it, and I appreciate that.
Mr. BAUMANN. We will do that.
Chairman BAKER. Thank you, Mr. Scott.
Mr. SHAYS. Thank you, sir.
I welcome you. Thank you.
In the report that OFHEO did, it said the special examination demonstrated that Freddie Mac knowingly departed from good public disclosure practices so as to obfuscate particular enterprise policies as well as specific capital markets and accounting transactions used to implement them. As a result, the public disclosures of Fannie Mae during the period investigated by the special investigation failed to comport with disclosures required by SEC registered companies which were assertively adhered to by the enterprise. The deliberate disdain of Freddie Mac for appropriate disclosure status in the face of its asserted compliance with best practices misled investors and constituted conduct that undermined market awareness of the true financial condition of the enterprise.
Page 59 PREV PAGE TOP OF DOC You would agree with that statement?
Mr. BAUMANN. There are many disclosures that were lacking, based on my review of transactions in the past, and we have said that we have agreed with the findings of the Baker Botts report that disclosures that were made in many cases were not those that would be expected of a public SEC registrant.
Mr. SHAYS. Okay, but I just asked you: Do you agree with the paragraph I read?
Mr. BAUMANN. I guess I would have to go back and read it word for word.
Mr. SHAYS. I will read it again.
Mr. BAUMANN. Sure.
Mr. SHAYS. You had my respect and admiration until you failed to even acknowledge what is in this report, and you were supposed to be in charge.
I will read the whole thing over again. I want to know if you agree or disagree.
The special examination has demonstrated that Fannie Mae knowingly departed from good public disclosureFreddie Mac knowingly departed from good public disclosure practices so as to obfuscate particular enterprise policies as well as specific capital market and accounting transactions used to implement them. As a result the public disclosures of Fannie MaeFreddie Mac, excuse me, during the period investigated by the specific examination failed to comport with disclosures required of SEC registered companies that were assertively adhered to by the enterprise. The deliberate disdain of Freddie Mac for appropriate disclosure status in the face of its asserted compliance with best practices misled investors and constituted conduct that undermined market awareness of the true financial condition of the enterprise.
Do you agree with that statement?
Page 60 PREV PAGE TOP OF DOC Mr. BAUMANN. I agree with the fact that the public disclosures were lacking by Freddie Mac. The characterizations of why, et cetera, there are OFHEO's characterizations of why they were lacking.
Mr. SHAYS. Tell me what you would disagree with this statement.
Mr. BAUMANN. I have not done the investigation to determine what the intentionality was. OFHEO did the investigation. I agree that the disclosures were lacking. I have not done the investigation to determine
Mr. SHAYS. I will read sentence by sentence, and you tell me what you agree or disagree with.
The specific examination has demonstrated that Freddie Mac knowingly departed from good public disclosure practices so as to obfuscate particular enterprise policies as well as specific capital market of Freddie Mac during the period investigated by the special examination.
Excuse me, I am going to read it over again.
The special examination has demonstrated that Freddie Mac knowingly departed from good public disclosure practices so as to obfuscate particular enterprise policies as well as particular capital market and accounting transactions used to implement them.
Do you agree with that statement?
Mr. BAUMANN. I agree that Freddie Mac's public disclosures were lacking in many respects. I do not know the extent to which they were knowingly lacking at the time and what decisions were made knowingly versus inadvertently. I have not done the investigation.
Mr. SHAYS. No, you just happen to be the Chief Financial Officer of the company.
Mr. BAUMANN. I
Page 61 PREV PAGE TOP OF DOC Mr. SHAYS. As a result the public disclosures of Freddie Mac during the period investigated by special examination failed to comport with disclosures required of SEC registered companies that were assertively adhered to by the Enterprise.
Do you agree or disagree with that statement?
Mr. BAUMANN. I agree our public disclosures in many cases failed to meet the disclosures of an SEC registrant.
Mr. SHAYS. The deliberate disdain of Freddie Mac for appropriate disclosure status in the face of its asserted compliance with best practices misled investors and constituted conduct that undermined market awareness of the true financial condition of the enterprise.
Do you agree or disagree with that?
Mr. BAUMANN. I do not know if there was a deliberate disdain or not.
Mr. SHAYS. Do you believe that it misled investors and constituted conduct that undermined market awareness of the true financial condition of the enterprise?
Mr. BAUMANN. I do not know whether it did or not. I know that there were some.
Mr. SHAYS. You do not think investors were misled?
Mr. BAUMANN. There is an SEC investigation going on right now to look into that, Congressman.
Mr. SHAYS. Do you think the disclosures of Freddie Mac did not mislead investors?
Mr. BAUMANN. We have said in the past that our public disclosures were not those
Page 62 PREV PAGE TOP OF DOC Mr. SHAYS. Why do you have such a difficult time answering my questions? It seems to me the answer would be yes and we can get on with it. How can I have confidence in your capability to run this company if you have a hard time even acknowledging that their practices misled investors and constituted conduct that undermined market awareness of the true financial condition of the enterprise?
That is a no-brainer for someone in your condition and position. Why do you have trouble answering that question?
Mr. BAUMANN. I did not do the investigation.
Mr. SHAYS. That is not what I asked.
You came in here and you told us you did not have enough people to properly provide information. You are asking us to wait 2 more years before you come under the 1934 act.
You came up to me, shook my hand, said: I am looking forward to testifying, and I am asking you a basic question, and I thought: Gosh, this is nice. We have someone finally taking over, he doesn't have to apologize for the past, and you think somehow you have to apologize for the past and obfuscate, it seems to me, some very logical questions.
Let me ask this again: The deliberate disdain of Freddie Mac for appropriate disclosure status in the face of its asserted compliance with best practicesthis is the part I am askingmisled investors and constituted conduct that undermined market awareness of the true financial condition of the enterprise.
Am I to agree that it misled or not misled?
Mr. BAUMANN. The SEC is making an investigation of
Mr. SHAYS. That is not what I asked you.
Mr. BAUMANN. It was not my job to make an investigation of the past reporting practices.
Page 63 PREV PAGE TOP OF DOC Mr. SHAYS. Do you think past reporting practices misled investors?
Think about it a second before you answer.
Do you think that the disclosures that have so far happened misled investors?
Mr. BAUMANN. I do not make answers like that until I do an investigation and come to a conclusion. The SEC is doing that.
Mr. SHAYS. So you do not think they were misled?
Mr. BAUMANN. There were two investigations that have been done.
Mr. SHAYS. That is not what I asked.
Were they misled?
Mr. BAUMANN. I have not made an investigation of past reporting practices to determine whether or not investors
Mr. SHAYS. I did not ask about intentions.
Why were you hired?
Mr. BAUMANN. I was hired to build the financial function that has sound internal controls, that produces, going forward, accurate, complete, and transparent financial results.
Mr. SHAYS. Was the information accurate that was disclosed by Freddie Mac?
Chairman BAKER. Mr. Shays, you are going to have to make that your last one, because we are going to
Mr. BAUMANN. Freddie Mac has clearly said that the financial statements in the past were not accurate. We have restated them to the extent of $5 billion.
Mr. SHAYS. So if they were not accurate, did not they mislead?
Page 64 PREV PAGE TOP OF DOC Listen to my question: If they were not accurate, is not it true, therefore, they would have misled investors?
Mr. BAUMANN. The financial statements in the past were not accurate.
Mr. SHAYS. And if they were not accurate, would that not mean it misled investors?
Mr. BAUMANN. I have not done a review to determine whether or not financial statements of the past were misleading or not.
Mr. SHAYS. If you had looked at the statements, would you have been misled?
Mr. BAUMANN. I would have been misinformed that the financial results were $5 billion different than previously recorded.
Mr. SHAYS. Let me just put on the record then that, Mr. Martinexcuse me, sirMr. Baumann, you and I are going to have a big problem. We are going to be on your back as much as you can imagine because all you had to do was say: Yes, it was in the past; that is why I am hired; I am hired to straighten out all this mess; I am sorry we misled investors by over $5 billion of earnings; that is why we hired 100 people; and we are going to get on it and we are going to make sure it never happens in the past.
The fact that you find so much trouble even agreeing to the basic logic of what was said in this report blows me away.
Chairman BAKER. And the gentleman's time has expired.
Do you choose to respond, Mr. Baumann?
Mr. BAUMANN. We are responding by improving our financial reporting, building best in class culture around the company, and building accurate, complete, transparent financial reporting.
Page 65 PREV PAGE TOP OF DOC There were some 20 civil suits that will address the question of how investors were either informed or not informed, and there is an SEC investigation.
Mr. SHAYS. Mr. Chairman, I would submit that the culture hasn't changed if the company cannot even acknowledge the fact that investors were misled by inaccurate information. Clearly the information was inaccurate. Therefore investors are misled. It doesn't take a brain surgeon to be able to say yes.
Chairman BAKER. Thank you, Mr. Shays.
Just a couple quick questions. Mr. Kanjorski wanted to ask a question as well.
On the example of the $200,000 mortgage, in excess of $11,000 savings to the home owner, I assume that was if the home was held to maturity over the course of the life of the loan. Typically, lower income individuals are going to be in that lower $100,000 range.
If you cut that $12,000, I rounded up to 12, over 30 years, cut it in half for a $100,000 loan, divide it by 30 years, crank it down to a monthly figure, that is $11.50. I am assuming that the average residential mortgage in your portfolio is somewhere around 100,000, probably is notprobably a little higher, but if we are trying to help first-time low-income home buyers, is an $11.50 a month risk worth taking?
I do not have an answer to that. That is just editorial comment.
Secondly, I have concerns and in discussion of GSE governance, with regard to guarantee fees and how those are apparently assessed varying institutions who engage in business activities with the Enterprises. I am not going to take the time today to get into it, but I will advise you that I am going to forward a letter with some amount of specificity and would like to request that a disclosure of the guaranty fee relationship at least to the committee be made.
I understand that as a course of business customarily there is a confidentiality clause that is signed by the counterparty that precludes them from making public statements about the guaranty fees, but it is something that I think has a dramatic effect on the cost of home ownership, and with that I yield to Mr. Kanjorski.
Page 66 PREV PAGE TOP OF DOC Mr. KANJORSKI. I just want to say I appreciate your responding to some of the questions propounded to you. I think it probably was done with good sense and good reality.
Mr. SHAYS. Could I ask the gentleman why?
Mr. KANJORSKI. Because this gentleman has testified previously in his opening statement why he came to this company, what he was charged with, what he has carried out, and he should not testify to a matter of subjective conclusion which is a matter of lawsuit. He would be putting his company at great risk without having done the detailed analysis himself, and that would be irresponsible.
Mr. SHAYS. Can I ask the gentleman one question, though?
Is it hard for someone to say that inaccurate information, therefore, would mislead?
Mr. KANJORSKI. I do not think it naturally follows that inadequate information does mislead. You have to get into the mind of the investor or the person that received that inadequate information, and in reality we may have found here that there in fact was no negative impact on the investor, that it was an internal matter of a very small proportion done by greedy or self-interested executives that caused this entire occurrence to come about, but in fact Freddie Mac may come out stronger as a result of what they put in place, and Chris, I like you very much but I do not think it is nice. Mr. Baumann is an executive of incredible experience and to put him on cross-examination, to try to force him to make an overwhelming conclusion that is not based on all the facts is, in my mind, not fair.
Now, Mr. Baumann, all that being said, that was just editorial on my part, I do want to get to one question.
In your testimony you said you were in favor of a strong regulator, and that is not quite the contest up here. There are some of us who believe it should be an independent strong world class regulator, something analogous to the OCC, and Mr. Scott had asked you questions on that, and it is very important, and I was not aware that Fannie Mae has gone back to the idea that they want some regulator under Treasury, which upset me quite frankly.
Page 67 PREV PAGE TOP OF DOC What would be your position if this Congress established a strong independent world class regulator analogous to the OCC? Would that be proper? Would Fannie Mae support that, or have you not taken a position on that?
Mr. BAUMANN. We have not taken an official position on that, and again we believe that the most important thing is for this Congress and the administration to resolve the question of regulation and to come to the best answer for Freddie and Fannie to support our mission going forward.
There are a couple of things we do think are important with respect to that, more around the level of capital and where it is set, between the Congress versus in the regulator itself and around approval of programs and activities that are we think today appropriate the way it is set up and we think that is an important matter so we can fulfill our housing mission. So we think those are important to discuss, and we hope they are discussed.
Our CEO Dick Syron is anxious to talk to this committee about regulation. He has a very, very enthusiastic interest and the best regulatory answer for Freddie and Fannie that winds up being in the best interest for the American homeowner.
Chairman BAKER. I thank the gentleman. I certainly express to you, Mr. Baumann, my appreciation for your willingness to appear here today. Certainly hope that, in the coming weeks and months, this committee can, with continuing counsel from the Enterprises, construct a regulatory system that is adequate to ensure continued home ownership and protection of taxpayers.
I do not believe they are mutually exclusive. I believe the goal can be
Mr. SHAYS. Mr. Chairman?
Chairman BAKER. Yes, Mr. Shays.
Mr. SHAYS. I want to apologize to the gentleman based on Mr. Kanjorski's comments. If I am getting into intent and they have a lawsuit, it was not my intent to try to have impact over the lawsuit. I was trying to, with all due respect, understand the mind of this company, to see if this company has changed, and so to you, sir, I apologize, in that respect, but would you just give me some hope that somehow the culture of this company is different?
Page 68 PREV PAGE TOP OF DOC Chairman BAKER. Mr. Shays.
Mr. SHAYS. With all due respect, sir.
Chairman BAKER. Sure.
Mr. SHAYS. Is there anything you can say that tells me there is a difference here and we can see something changed about this company?
Chairman BAKER. Mr. Shays, if I can respond, and Mr. Baumann can certainly make his own statement.
I would propose that if this committee forwards legislation and the Enterprise refrains from exercising its political power in blocking or obstructing meaningful reform, that in itself will determine whether or not there has been a change in the outlook on an independent regulator, and Mr. Baumann has repeatedly said this morning that he does not even wish to express an opinion as to the domicile of the regulator, be it independent, be it Treasury. If the Congress decides that it is an appropriate step for us to take, that the Enterprise would accept those determinations as independent judgments of this Congress, I respect that, and, Mr. Baumann, would you choose to respond to Mr. Shays?
Mr. BAUMANN. Thank you. I appreciate your comment, Congressman.
The press release that we issued on November 21, which described in excruciating detail the accounting errors that were made in the past, the level of the restatement and the accounting and control issues of the company, I think are at least a start of the evidence to show that we are committed to transparency and accuracy and completeness and candidness, and going forward we expect that that is what you will see on a regular basis, that our financial reports will be very candid, very accurate, very transparent and very complete.
Chairman BAKER. We have 4 minutes remaining.
Mr. SHAYS. Thank you.
Chairman BAKER. We have 4 minutes remaining. Our meeting stands adjourned.
Page 69 PREV PAGE TOP OF DOC Thank you.
[Whereupon, at 12:20 p.m., the subcommittee was adjourned.]