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House of Representatives,
Subcommittee on Capital Markets, Securities and Government Sponsored Enterprises,
Committee on Banking and Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 10:07 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.
    Present: Chairman Baker; Representatives Leach (ex officio), Fox, Sessions, Vento, Kanjorski, and Flake.
    Chairman BAKER. I would like to call this hearing of the Subcommittee on Capital Markets to order.
    We are meeting today for the purpose of reviewing a report of the General Accounting Office entitled ''Advantages and Disadvantages of Creating a Single Housing GSE Regulator'' in response to a request of the subcommittee issued in January.
    This morning, our purpose will not be to review the operations of any of the GSEs currently authorized and operating, but simply to recognize that between all the housing-related GSEs, approximately 12 percent of all the outstanding credit in the United States is now issued by these GSEs.
    In short, ensuring that the public interest is fully protected is a most important obligation of this subcommittee and the Congress, and therefore we are interested in learning more whether the appropriate regulators are responding to their responsibilities in this regard. It is apparent that there has not been success in meeting specific obligations over time, and the report this morning, I believe, will further outline concerns that the subcommittee should address.
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    I have a formal statement which I will submit for the record, and I recognize Mr. Kanjorski.
    Mr. KANJORSKI. Thank you very much, Mr. Chairman.
    Mr. Chairman, first of all, I would like to thank the GAO for a very thoughtful report. The most important thing we can do today is reiterate the importance of strong independent regulators with resources they need to get their jobs done.
    There is some logic behind the concept of merging regulators, but at this point in time I would be opposed to a merger, because I think it would distract the attention of the Congress from determining what the mission is of the GSEs and just how we are going to proceed along that line; and I think, further, it may block the modernization bill that you and I have developed for the Federal Home Loan Bank System.
    It is difficult to anticipate what ultimately would happen, but I would hope that the regulators would direct their attention to determining the mission of GSEs and how they can more effectively operate. I, for one, do not think the total mission of regulators is safety and soundness, but also that they should guide the GSEs in their mission, for if they have no mission, then we probably have no need for a Federal charter.
    At this time, I think that I would join most of the people involved with housing GSEs to say that we have a mission to define, we have an effort to get there, and we have sound institutions that afford us the opportunity to do so at no cost to the taxpayers. So I look forward to this hearing, but I think that considering a merger at this point is untimely.
    Chairman BAKER. Thank you, Mr. Kanjorski.
    We are privileged to be joined by the Chairman of the full House Banking Committee, Congressman Leach.
    Mr. Leach.
    Mr. LEACH. Thank you, Mr. Chairman. I appreciate your holding these hearings.
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    I don't have an opening statement. But, I think we as a committee have to be concerned with regulatory oversight which, in terms of mission, I think, has been more absent than present. And the issue is not whether the various GSEs do a generally good job, because to some degree they certainly do, but whether there are points of mission that have been exceeded and points of abuse of their privileges that have also occurred. I think that is a subject that the Congress should expect very professional oversight concerning whether it is done in a new way, which I am rather sympathetic to, or perhaps in the current legislative setting.
    Thank you.
    Chairman BAKER. Thank you, Mr. Chairman.
    Mr. Vento.
    Mr. VENTO. Thank you, Mr. Chairman.
    I think it is obviously an interesting hearing this morning with regard to creating a single regulator for the GSEs.
    You know, as someone who was involved in writing the laws that set up both of these new regulator entities, I mean, the Federal Housing Finance Board is more in an evolutionary nature than the establishment of OFHEO, which really grew out of a lot of concerns that we have had, and I think, frankly, that they are beginning to crystallize.
    Obviously, we would always, at least from my perspective, want to see things move more quickly than they do. But I think there is a special niche in terms of the GSEs with regard to Fannie Mae and Freddie Mac and OFHEO and the role that they play. And I think that we have opted against actually moving it into more of an oversight role with housing or with banking type of roles, because we think that the housing focus is the proper one within HUD, and the types of goals and mission established is unique with regard to these federally-chartered GSEs.
    I certainly have a lot of questions. I mean, obviously, anything can be done. I think that both of these regulators are moving in a way that has been competent. Obviously, as I said previously, you might want more speed with regard to some aspects, but I think it takes a while in order to develop a proper foundation to, in fact, put in motion an entirely new role in terms of a regulator such as OFHEO. And I think we would lose that if, in fact—and much would be lost, certainly the type of—some of the risk-based capital standards, which, to say the least, have been a great concern, both to us, to the regulator, and to those regulated—would, I think, slip in terms of trying to move in this direction.
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    I think that, at the very least, it is not the appropriate time. I think that you need to find a mission. I am afraid that this might fall in line with the ''Peter Principle'' in terms of merging things to the point where we found that the agency is unable to address it.
    Obviously, many of us—some have had really tough questions, I think, of the GSEs in any case in terms of the benefit they bestow and the profits they make and so forth. And I think this would simply complicate the issue and confuse the issue where today there is an element of clarity. And I, for one, at this point would prefer to keep the missions separate and provide that focus to the association with housing through the Housing and Urban Development Department.
    So in any case, I look forward to the hearing and a more careful study of the GAO report to us.
    Thank you, Mr. Chairman.
    Chairman BAKER. Thank you, Mr. Vento.
    Our first panelist to appear this morning is representing the General Accounting Office to present their finding, the Director of Financial Institutions and Market Issues, Jean Gleason Stromberg.
    Welcome Ms. Stromberg. It is a pleasure to have you here this morning.

    Ms. STROMBERG. Thank you very much.
    I prefer to summarize my written statement, if that is all right, and have the written statement be entered in the record.
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    Chairman BAKER. Without objection.
    Ms. STROMBERG. Mr. Chairman and Members of the subcommittee, appearing with me today are two assistant directors who have been involved with most of our recent GSE work: on my left, William Shear; and on my right, Kay Harris.
    We are pleased to be here today to discuss our recent report on creating a single regulator for the three housing GSEs: Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System. Our work has focused on three issues: First, the advantages and disadvantages of creating a single GSE regulator; second, whether safety and soundness and mission oversight should be vested in that regulator; and third, several possible structures for such a regulator.
    As we testified last week before a joint hearing of this subcommittee and a subcommittee of the Government Reform and Oversight Committee, the outstanding volume of federally-assisted GSE credit is large and rapidly increasing. At the end of 1996, more than $1.8 trillion of GSE debt was outstanding, about 95 percent of which was associated with housing.
    As you know, the current regulatory structure for the GSEs and the housing GSEs is relatively recent. The Federal Housing Finance Board which was created in 1989 regulates both mission compliance and safety and soundness of the Home Loan Bank System. OFHEO, which began operations in 1993, regulates the safety and soundness of Fannie Mae and Freddie Mac, and HUD regulates their mission compliance and has general regulatory authority over matters not made exclusive to OFHEO by statute.
    In our 1991 and 1993 reports on GSEs, we identified criteria that a GSE regulatory agency should meet to facilitate effective regulation. Those criteria were: First, objectivity and independence from the enterprise; second, prominence in Government, so that if it spoke, someone would listen; third, ability to achieve economy and efficiency; fourth, ability to achieve consistency and regulation; and fifth, separation of primary and secondary market regulation.
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    There have been significant changes in the structure of the regulatory oversight of the housing GSEs since our first report in 1991. On the basis of our subsequent work, however, we believe that the criteria that we laid out then remain sound.
    None of the current regulators meet all of our criteria, and they are unlikely to do so unless combined in some form. We believe that a single regulator could meet our criteria, and we continue to support the creation of a single housing GSE regulator.
    We recognize that the housing GSEs operate and are structured differently and have different constituencies. They do have a lot in common, however. The risks they manage are similar, if in different proportions. They all have an interest in residential housing and in the housing credit markets. We think that valuable synergies could be achieved and expertise shared both in the evaluation of how the enterprises manage credit, interest rate, and other risks and also in assessing the adequacy of capital.
    We also believe that a single housing GSE regulator could foster competition among the three GSEs while providing some consistency in the rules and regulations. For example, the Finance Board recently approved several Federal Home Loan Bank pilot programs that involve services that Fannie Mae or Freddie Mac might also provide.
    Both the Finance Board and OFHEO had to assess the competitive impacts of these programs, but neither one had the full information that might have been available to a single regulator. Had a single regulator been responsible for all three, a single assessment could have been made that could have combined consideration of competitive effects and also tried to ensure consistency of oversight.
    Making judgments about competitive issues would be difficult because of the competing interests. Part of the benefit of a single regulator, however, would be that it should not be dominated by any one interest and thus, with complete information, would be in a position to make a more balanced judgment than any one regulator alone could make.
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    The most often mentioned disadvantage of creating a single housing regulator is the potential disruption in the operations of the existing regulatory agencies. These effects are real, but they should be short-term, and the outcome in the long run should result in more effective regulation.
    As to combining regulation of mission compliance and safety and soundness, our ongoing work has strengthened our belief that the housing GSE regulators would be more effective if combined into a new entity that oversaw both functions. We have been supporting this position since 1991 with the important caveat that any such entity must be fully independent from the GSEs that it regulates.
    As we have noted, there is a difference between a safety and soundness regulator that confirms a GSEs compliance with its statutory purposes, as articulated by Congress, and one like the Finance Board that participates in the corporate governance and the promotion of the GSE.
    Some critics of combining the functions have voiced concerns that the regulator would be subject to inherent conflict in making decisions. We think that the tension that is caused by having both private and public characteristics could be best understood and accounted for by having a single regulator with full knowledge of the financial condition of the enterprises, who regulates the goals that Congress sets and assesses the efforts to fulfill them.
    As you are aware, the link between mission and safety and soundness is established in the housing GSEs charters, each of which acknowledges that economic considerations of the activities undertaken cannot be ignored.
    In today's economic environment, balancing safety and soundness and mission may not be an issue. In more troubled times, however, it would be important that one regulator be responsible for both to help ensure that balance is maintained.
    In our report, we also point out that combining the functions would facilitate assessing Fannie Mae and Freddie Mac for the full cost of overseeing their mission compliance, a cost that is now borne by the taxpayers as part of HUD's budget. It would also, of course, facilitate congressional oversight.
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    Last, with regard to an appropriate regulatory structure for a stand-alone single regulator, we considered both a stand-alone agency and an independent office within an Executive Branch agency with either a single administrator or a board.
    What is important, in our view, is to ensure that the entity has independence and prominence that would allow it to act independently of the influence of the housing GSEs, which are very large and politically influential institutions. The need for independence favors a stand-alone agency which should be more removed from the potential political influence of a Cabinet-level department and be in a better position to ensure that safety, soundness and mission are equitably overseen.
    The advantages and disadvantages of having the new regulator as an independent office within an Executive Branch agency would depend on that agency. HUD and Treasury would be the most appropriate agencies for such a situation. Each has something to offer, but each also involves potential conflicts.
    We also considered whether a new entity should have a single director or administrator, or whether it should have a board. We found that the board structure best fits our criteria for an effective regulator for many of the same reasons that a stand-alone agency may be preferable to an Executive Branch agency.
    One advantage of a board is that it would best be able to establish the requisite independence in government and would allow Congress to provide balance in decisionmaking. Both HUD and Treasury could be represented on a board, thus providing a structure where any potential conflicts could be addressed. In order to realize some of the benefits of a single director, the chair of the board could act as a chief executive officer in charge of the agency.
    Among the financial regulators, we could not find any examples of stand-alone agencies that were not headed by boards or of independent offices that were not headed by single directors. There are probably good reasons for those structures being linked.
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    In the case of a single housing GSE regulator, we believe that the stand-alone agency with the board has the advantages of allowing different perspectives, providing stability, and bringing prestige to the agency, as well as allowing Congress an opportunity to provide balance for the regulator's decisionmaking by requiring that the members of the board have certain expertise.
    In closing, Mr. Chairman, I want to mention one additional issue that may need to be addressed in your deliberations, whether any new regulator for the housing GSEs should be included or excluded from the appropriations process. Most financial institution regulators assess the institutions they oversee for the cost of regulation and, thus, are typically not subject to the appropriations process. OFHEO, however, is subject to that process and has less control than some of the other regulators over its resources. This can subject the agency to budgetary pressures that may conflict with its needs as a safety and soundness regulator. We recognize, however, that the appropriations process does provide an additional mechanism for congressional oversight.
    This concludes my prepared statement. My colleagues and I would be pleased to try to answer any questions.
    Chairman BAKER. Thank you very much. I note that the GAO has now for some time—you make reference in your remarks and your testimony to reports dated as far back as 1991 where similar conclusions have been reached as to the propriety of combining the regulators. Has there been any structural change, from your perspective, over the past 7 or 8 years that could lead us to question why we should proceed with a consolidated regulatory agency? Have the market conditions and the operations of the entities remained basically the same?
    Ms. STROMBERG. As we have pointed out, there have been changes in the regulatory structure, but none of them are consistent with the changes that we recommended in 1991 to 1993 based on our criteria.
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    As to whether there have been changes in the way the GSEs operate and the enterprises themselves, I don't believe that it is changes in those operations that have affected our recommendations. The criteria that we set out then for independence and prominence in the Government for consistency and economy and efficiency remain, in our view, as valid today as they did then. The fact that we are not in a time of crisis means that there hasn't been the same need seen for change perhaps. But it hasn't changed our view that the appropriate regulatory structure would reflect the criteria that we set out.
    Chairman BAKER. One reason for asking that is, in 1994, HUD issued an opinion which suggested that consolidation might be an advisable course to follow. I was trying to determine if there were conditions that—in your mind, that could have led to the conclusion HUD appears to reach today, which is that consolidation is not appropriate? From my view, there aren't significant structural changes either in GSE operation or market conditions that warrant a change from the HUD position of 1994 to the HUD position of 1997.
    With regard to the question of prominence, in looking at the relative staffing size budget of OFHEO and the Finance Board, as opposed to the similar regulatory entity within HUD, there appears to be a significant mismatch. Both OFHEO and the Finance Board appear to have 100 or so employees and budgets in the $12- to $15-million range, while HUD is much more diminished in size and in budgetary capability.
    In your view, is there any justification at this point for these budgets? There is a problem one way or the other; either we are spending too much with OFHEO and the Finance Board, or we are not spending enough with HUD if they are, in fact, engaging properly in their mission. Do you have any insight with regard to that imbalance? Or is that something else that is just another weight on the side of a consolidated regulator?
    Ms. STROMBERG. We have not done work on assessing the efficiency of the GSE regulators; and so we really can't comment on whether the size is appropriate now. I do think that part of our view of prominence is that a larger agency would be able to more effectively hire and attract and retain better—not better, but more experienced personnel because it would offer more opportunities.
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    Chairman BAKER. My concern is with regard principally, to the mission compliance. HUD has a budget of about $2.5 million toward that regulatory goal, while the other two entities aggregate, oh, considerably more, with almost $18 million for the Finance Board and OFHEO is the same, $15 million. It seems to me if mission compliance is an important element to HUD, that they are not, at least from that perspective, properly geared to respond to that requirement.
    With regard to independence, there is another issue in that, particularly regarding political independence, where a regulator in effect joins with one of the GSEs for a mission-related purpose, for example, multifamily risk-sharing programs, where the mission is basically something encouraged perhaps by HUD. The program is to address a legitimate public need.
    But one of the housing GSEs then is the consumer of the debt issues created as a result of that program. Doesn't it seem a little inappropriate to have basically a partner in a business transaction regulating the compliance with the mission statement?
    Ms. STROMBERG. Well, I think, as we pointed out in our report, that is one of the problems with having any single agency be in HUD, that there is a potential for conflict between HUD's interests and some of its partnerships with the enterprises and their acting as the regulator.
    Chairman BAKER. With regard to another programmatic operation, it has been reported that HUD never formally questioned Fannie or Freddie with regard to underwriting the Jumbo and B&C loan programs. Would not that be an appropriate step for a regulator to take with regard to entry into new products?
    Mr. SHEAR. We think that HUD's focus has been on the numeric goals. And we notice, with respect to new products, they just ruled on the mortgage protection program and approved it, but yet we find that when it comes to nonmortgage investments, in entering into new activity, that OFHEO devotes more resources to looking at that activity as a safety and soundness regulator than the focus that HUD has had.
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    We haven't conducted an audit of HUD's operation in terms of determining what is the appropriate level of activity. Yet we have observed that their focus has been on the numeric goals and on fair lending issues.
    Chairman BAKER. Do you have knowledge in recent months or the last couple of years, of any Fannie or Freddie product which HUD has denied?
    Mr. SHEAR. No. If there is such a product, we are not aware of it.
    Chairman BAKER. I have overused my time. I will reserve the right for a second round of questions.
    Mr. Kanjorski.
    Oh, Mr. Leach, would you choose to be recognized at this time?
    Mr. LEACH. I would rather Mr. Kanjorski.
    Mr. KANJORSKI. Ms. Stromberg, I have some respect for your background here. I see that you are a graduate of Wellesley College. I have a daughter and two nieces who graduated from that school, so I feel close to you.
    Ms. STROMBERG. They have good judgment.
    Mr. KANJORSKI. That's right.
    Ms. STROMBERG. So do you for sending them there.
    Mr. KANJORSKI. In light of the fact that we are looking at putting together a five-member board, and given some of the difficulties we now have filling vacancies on the FHFB—and I see the structure that you recommend is representative of the HUD Secretary and a representative of Treasury. Don't you think perhaps that may be too political, in terms that a majority of the individuals involved would be political appointees, or nominees, and in opposition to that, why not put someone with regulatory experience in lieu of a representative of Treasury? Either pick the Comptroller of the Currency, or the FDIC Chairman, or someone of that stature who has a set term of office and a high recognition.
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    Ms. STROMBERG. Well, we tried not to make a recommendation in the report. We tried to spell out the different possibilities and the advantages and disadvantages of each one, although we did think that a board was preferable to an individual. The five-person board is what we discussed in the most detail. And we did indicate that it might be appropriate to have Secretaries of HUD and Treasury on the board in order to balance some of the safety and soundness and mission interests.
    Mr. KANJORSKI. The representative of a Secretary or the Secretary of——
    Ms. STROMBERG. Well, I think that we contemplated it would be similar to the way the Finance Board operates now, where the Secretary is officially a member of the board, but designates someone to attend——
    Mr. KANJORSKI. Someone who holds a position requiring Senate confirmation?
    Ms. STROMBERG. We didn't get into that. I think we have left it to the discretion of the Secretary. But we didn't really get into thinking about the details.
    Mr. KANJORSKI. Let me ask you, if this were to be undertaken, what kind of a delay in the risk-based capital standards for Fannie and Freddie would occur, in your opinion; or would there be a delay?
    Ms. STROMBERG. I don't think I can answer that. Bill, do you have any observation?
    Mr. SHEAR. Could you please just repeat the question?
    Mr. KANJORSKI. Well, if we were to move toward restructuring the regulation process, what kind of a delay would that cause in the establishment of the risk-capital-based standards that OFHEO is working on?
    Mr. SHEAR. It would be a transition that we think would take a longer, probably, transition, than just the relatively simple transition that OFHEO has now in choosing a new director. We expect there would be some transition to a new regulator, a new board, and policy decisions associated with the stress test and risk-based capital standards. You would have a board that would have to—there would have to be a consensus among the board for those policy decisions about relationships among certain economic variables.
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    So there would be more of a transition than toward the one that OFHEO will probably go through. But how much more of a transition we are not—we couldn't really specify how much more time it would take.
    Mr. KANJORSKI. Well, OFHEO right now is preparing, I understand, the new standards. So, could we assume, then, that that would be totally put off until the regulatory process was reorganized and put in place? And would that be a year, 2 years, 3 years?
    Mr. SHEAR. I think it would be a more appropriate question of OFHEO on how it would affect the process. But our view of it would be that OFHEO expects to go through a notice of proposed rulemaking some time in 1998, and would probably establish a rule based on their current timetable in calendar year 1999. And they are moving forward on that.
    I wouldn't think that they would put it completely off the shelf and that that development would stop or in any way would be slowed down. I would think that the major component would be one of, basically, the people that would be in charge of the new entity would, in a sense, have to buy in on certain policy-types of options. The technical parts, I would think would proceed.
    Mr. KANJORSKI. So it would be reasonable to assume, since we are already having difficulty getting appointments through now for confirmation, and we are moving ever-closer to the presidential year, that if we were to make this merger today, it couldn't really be put into place until after the election of 2000?
    Mr. SHEAR. It is one that we really can't forecast that well. But to take an example from OFHEO's current situation where there is an acting director, but there is a search being conducted for a new director, progress is being made. And, if necessary, the acting director has indicated to us that, you know, decisions would be made going forward.
    So, it is hard to to project, but it seems like progress would continue.
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    Mr. KANJORSKI. Thank you.
    Thank you, Mr. Chairman.
    Chairman BAKER. If I may suggest to the Members, that was a second bell. Before I recognize the Chairman, I would suggest we break for the vote and return momentarily.
    Thank you. The hearing stands in recess.
    Chairman BAKER. I would like to reconvene this hearing of the Subcommittee on Capital Markets. The Members will be returning from the floor vote momentarily. And at this time, I would like to recognize the Chairman of the full House Banking Committee, Mr. Leach.
    Mr. LEACH. Thank you very much. I appreciate your calling this hearing to begin with. Your leadership, Mr. Chairman, on this issue is extraordinary.
    Let me just ask Ms. Stromberg: It seems to me that the dilemma in the current system is the way it is organized in that, first, to give the GSEs credit, they pay for their regulation, but it is appropriated. And it is my impression the reason that the legislation developed this way was there was a lot of GSE concern that Congress accepted. I think, perhaps dubiously, that they would be vulnerable to too much independence of their regulators and that, in essence, the implication is that if the regulator is too stiff, that Fannie and Freddie just might have a little bit more influence with legislators than OFHEO. And I don't know why one might draw that conclusion, but that is an assumption.
    The second dilemma that I think is very important to what the Chairman is suggesting might be a new approach about combining—that you have a dilemma between safety and soundness and mission, and that both should probably be looked at simultaneously.
    Let me just give some examples. Almost all new activities, or expanded activities of GSEs, can enhance their safety and soundness. But that doesn't mean they always relate directly to their mission. Whether an expanded area is insurance or expanded beyond mission needs is something else, it appears to me that you ought to have the judgment at the same time.
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    Let me give a couple of examples, and I will just use Freddie Mac as an example.
    Freddie Mac has suggested that it is appropriate to have long-term bond investments that use its Government capacity to borrow at a given rate, and then simply to arbitrage into a lower-valued security and then they get the automatic arbitrage. If there is anything that is printing money in the system, I don't know what is a bigger example of that. I think, from a mission perspective, that ought to be looked at extraordinarily carefully, although from a safety and soundness perspective it is obvious it enhances the safety and soundness of the company.
    Likewise, something that has, in my judgment, gone unlooked at—and it is very serious. Freddie Mac makes the case that for liquidity purposes, it should have a short-term portfolio, and there is obviously a case for that.
    But then how large should it be? Is it 14 times capital, which is their current size? Is that defensible in any conceivable way to mission, or is that the same precept as the long-term?
    Then once Freddie Mac gets into holding mortgages on its own, rather than simply serving as a secondary market to serve a tertiary market, which was the way it was largely conceived, you have a case that their liquidity, their own is being put into holdings of mortgages, and that they are substituting the Government's borrowing powers for liquidity, and that that is a very doubtful practice in—at least of a given magnitude.
    So, I just raise these in the context of whether the two regulatory functions of mission and safety and soundness supervision shouldn't be merged into the same judgmental place. Does that make sense to you or not?
    Ms. STROMBERG. Well, that is an easy question for me to answer in the sense that we do think they should be together, mission and safety and soundness, and that some of the kinds of issues that you are talking about are some of the reasons why it is appropriate for—in our view, for one entity to be looking over the whole operation and not simply one side or the other.
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    Mr. SHEAR. Mr. Leach, to add to that, as you know, we are conducting a study of nonmortgage investments at Freddie Mac with some comparison to Fannie Mae. We recently issued an interim report on that subject, and there are slightly different issues with nonmortgage investments in terms of the long-term bonds, such as the ones you mentioned with Freddie Mac, and then the preponderance of the nonmortgage investments at both enterprises being relatively short-term.
    But there are issues associated with both, and there are issues associated with the size of it, which we continue to look at.
    From the standpoint of regulation, one of the things that we observed in our interim report was that HUD's focus as a mission regulator has been on numeric goals and fair lending, and there hasn't been attention paid until recently toward what you could call their ''responsibilities'' under their general regulatory authorities, which we think this would fall under.
    And so we observed that, and we think that having the responsibility and the authority within one regulatory body to deal with mission and safety and soundness would provide a better—it is another example of why we think it would provide a better regulatory framework.
    Mr. LEACH. I appreciate that.
    Mr. Chairman, I have more questions, but if you are going to have a second round, I think it would be appropriate to——
    Chairman BAKER. Thank you, Mr. Chairman.
    Mr. Vento.
    Mr. VENTO. Thanks, Mr. Chairman. You know, I think that obviously in 1989, when we separated this off and sent the piece to what became the FDIC now in terms of the insurance funds, and Home Loan Bank System separated from the Housing Finance Board, and finally in 1992 rewrote the law, obviously, under that model, Fannie and Freddie didn't do very well. I mean, because there are a lot of problems.
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    I think many issues were not addressed. I mean, there wasn't exactly a great institutional framework in which to springboard into regulation in the early 1990's.
    In any case, I am listening to my colleagues. I think we are presented with a problem in terms of whether or not we really believe in the privatization of the secondary market programs, with regard specifically to Fannie and Freddie.
    As for HUD, you know, being criticized here, I guess, today for not—in some vein, that is the way I would interpret it, for not taking aggressive enough action in terms of making decisions with regard to the programmatic aspects of functions. And I mean, I think they have been engaged.
    I don't know that the guidance that we have given them—I mean, it seems to me there were no, as I say, benchmarks that were established in 1992 when we wrote the law—in fact, for the fulfillment of the social responsibility of Fannie and Freddie. So we have sort of had to evolve that, as it were, to where we are today.
    I think it, in my judgment, seems to be working. And I think it is in no small part due to the leadership in HUD and in Fannie and Freddie.
    Nevertheless, let me just go on. So we broke these up. I think it is a valid question. I think, in fact, the report fairly treats the topic. Obviously, GAO has come out with this idea of combining or having these combined. I don't think they meant the same thing that they operated prior to 1989, obviously.
    Is that right, Ms. Gleason Stromberg, not how they functioned prior to 1989? Well, that is a rhetorical question anyway.
    Let me just go on to—I think your answer would be yes, I believe. And——
    Ms. STROMBERG. That is good.
    Mr. VENTO. In any case, you know in one case you talk about sort of the creative tension. You know, I was sort of disturbed by the tenor of things. We all sort of—the civics book classic is that the regulators end up being, you know, influenced to a greater extent by those that they regulate, especially in this advocacy rule.
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    I mean, there are those that might suggest that the office of the Controller of the Currency is advocating for a national bank, so that State bank regulators are advocating for them, or the Federal Reserve Board for bank holding companies. In fact, I think they sometimes have made generous interpretations of what the law means so as to give them new powers. I think valid questions are to be raised whether or not, in fact, in that particular context of advocacy, in terms of products and functions and so forth, that in fact the regulators are being, to a greater extent, interested in the outcome as opposed to the quantitative type of work that is done.
    In OFHEO, we actually have this separated in the Federal Home Loan Bank, or the Finance Board; we don't for the System. But you are saying you would like to see these back together?
    Ms. STROMBERG. Yes. I think our view would be that the Comptroller and the other entities that you mentioned regulate a number of different entities that do have some different interests. And our view is that it is easier for a regulator to be independent if it regulates people who have different interests and different——
    Mr. VENTO. So—pardon me, you are saying the critical mass isn't enough? So, in a sense, the Federal Housing Finance Board isn't now functioning—in other words, since there is this risk, but if they had a bigger critical mass, they would be better off; is that what you are saying?
    Ms. STROMBERG. That is the basis for one of the—for the criteria.
    Mr. VENTO. Well, you know the issue, of course, just in terms of the economy, one of the reasons we went in the direction we did, we think that HUD has some housing expertise, so that we were eliminating duplication probably to a large extent in trying to separate these out.
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    Nevertheless, let me go on to point out that on page 15 of your statement, that if—of the document, I note that—I want to refer to page 15. It says that ''Finally, HUD's history of operational weakness and inefficiencies could taint the representation and hamper the effectiveness of any office within it.''
    In other words, you are saying that because HUD has a besmirched reputation—this may go back to the days of Sam Pierce or someone else—I don't think we want to lay that necessarily on the Kemp or on the Cisneros group. However, we have not reviewed OFHEO's relationship with HUD, or potential impacts this arrangement may have on OFHEO's operations.
    In other words, you did not make an evaluation of whether or not OFHEO and HUD's relationship, in terms of oversight of product and other functions, really is coordinated; is that right?
    Ms. STROMBERG. That is correct.
    Mr. VENTO. Well, Mr. Chairman, I think that is an important point. I know you are probably under some pressure to get the report out. But I think it is an especially fundamental point when we are talking about the combined operation, and when you make no judgment, or are not able to make a judgment about how well they are coordinated or collaborated, and then, you know—then making a judgment that they ought to be combined under this critical mass sort of question that I raised.
    On page 20 you say, ''We have not studied the regulatory effectiveness of the Federal Home or Finance Board, OFHEO or HUD, or the effectiveness of coordination between OFHEO or HUD. Therefore, we have no position on the effectiveness of current regulatory oversight of the housing GSE.'' So you are not really making any judgment of any sort as to the regulatory effectiveness of these, except that, in theory, you think that they ought to be involved, under my question or my statement, in a critical mass. Am I interpreting that correctly?
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    Ms. STROMBERG. Well, we are relying on the criteria that we developed in the early 1990's, based in part on the experience in the thrift crisis and on a variety of other work that we did. But this criteria would be what would be essential for what——
    Mr. VENTO. OK.
    Ms. STROMBERG.——An effective regulator——
    Mr. VENTO. My time has expired, but just to rephrase it: In other words, you are not saying anything about the end product of 1997, of what they do? You are simply basing it on some model that was developed under a previous set of circumstances; is that correct?
    Ms. STROMBERG. Well, we are saying that a structure that reflects the criteria that we came up with is the one we think would be the most effective regulator, particularly in times of difficulty or crisis, which we have not yet faced under the current setup.
    Mr. VENTO. I just submit, this does not then suggest what we have is not working today.
    Thank you, Mr. Chairman.
    Chairman BAKER. Thank you, Mr. Vento.
    Mr. Sessions.
    Mr. SESSIONS. I have no questions at this time, Mr. Chairman. Thank you.
    Chairman BAKER. Thank you, Mr. Sessions.
    Mr. Flake.
    Mr. FLAKE. Thank you very much, Mr. Chairman. And, indeed, we are gratified that you are holding this hearing. It is an area of particular concern for me as we are addressing the question of regulators for the GSEs, and these particular entities, which are involved heavily in a lot of the community development projects around the country, in my district, as well as in many of the others.
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    Obviously, there is a great deal of concern on my part that we do not do anything that causes tremors in this particular area of the marketplace.
    So I would like to ask, Ms. Stromberg, as you move forward in trying to make some determination on what serves the best interests of all of our communities and all of our citizens, are you compelled to believe that, as we are covering the structure—as one of the officers originally of OFHEO myself—that these entities will not be able to continue to do as they are mandated under the current oversight from OFHEO?
    Ms. STROMBERG. ''Compelled'' is a strong word.
    Mr. FLAKE. It is. I am sorry. I will retrieve that word and replace it with whichever is not so strong.
    Ms. STROMBERG. We are—again, based on the experience that we have had and the work that we have done, we believe that the most effective regulator in difficult times would be one that meets the criteria that we have developed. That is not to say that the existing System would necessarily fail, only that, in a time of crisis, we think the odds are better that one that was structured differently would be more successful at both avoiding difficulties and dealing with them if they should occur.
    Mr. FLAKE. You suggest that the odds are better. Are there statistics at this point to suggest that we are experiencing, to some degree, a level of risk that would suggest that this entity cannot continue in the foreseeable future to provide the necessary oversight?
    Ms. STROMBERG. I think the issue is not that the System is in current danger or in any danger at the current time. It is just that our experience has been that if you are going to try to improve a system and make changes in it, it is better to do it when things are working than to come when they are not.
    Mr. FLAKE. Which flies in the face of the traditional axiom, ''If it ain't broke, don't fix it.''
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    Ms. STROMBERG. It does. But I think we would say, although it is not broken in the sense that it is not working, we really haven't done the work to, as we have said, to say, whether it is working or not, that we think that a different structure would be more effective in the long run at dealing with the kinds of issues that may come up—and just for the reasons that we have been talking about.
    We also have some problem with the lack today of the Finance Board meeting our criteria of independence and their involvement in the System, which does raise some questions which we have raised consistently over the years also.
    Mr. FLAKE. Mr. Shear, I see by your body language that you would like to make some comment on this issue as well.
    Mr. SHEAR. I was listening. I wasn't really going to add any comment on it.
    But since you have asked, the last statement that Ms. Stromberg made as far as part of our criteria is for an arm's length regulator, we think is an important issue. To some degree, our criteria comes out of the thrift crisis which—you could say that that occurred during a different period of time, but you had a situation where a crisis did occur, and it seemed like all the—everything politically and all the motions that went in place worked against resolving or mitigating the problem. We don't view this regulatory arrangement as solving all the problems or all the issues associated with regulating the housing GSEs. Yet, at the same time, we think that, especially if an economic crisis did occur or there was some type of problem with the functioning of financial markets, that a single regulator would have—would be in—a single regulator with independence and arm's length that combine both safety and soundness and mission would be better able to deal—to mitigate such a crisis.
    Many times in financial markets, we are talking about—as Ms. Stromberg pointed out, we are trying to lower the probability of a very adverse outcome. So, in the current environment, it might be hard to visualize that, but yet we think this is an appropriate time to be considering such a suggestion.
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    Mr. FLAKE. But in an atmosphere where, unlike what happened in the thrift crisis, or what led to it, the changes that we made here in this body to open up the possibilities for levels of involvement—that is, had historically not been a part of that industry—and open doors for persons to come into it who had not even been in the banking business or financial services industry in the past.
    Without seeing any kind of changes on the radar at this point, I am not so sure that we do our best in trying to shape policy based on a continual referral to what happened in the thrift crisis. I mean, I think when we look back on it, those of us who have been here long enough would have to confess that it was one of the most difficult of all of the challenges that we, as a committee, faced, and I think we would never want to see that happen again.
    But the question still is, as we move forward—and my time has expired—do we just fix things with assumptions when things seem to be going relatively well, and therefore, without the basis of assumptions, you at least have entities that are functioning in a manner that we anticipated when we first started the process in 1992? So just do it now, based on new assumptions which always have to be tried?
    And even the best assumptions can ultimately lead us to some serious, serious mistakes. I would just wonder if, in fact, we need to make those changes? And I guess, over time, we will make some determination of what is best.
    I yield, Mr. Chairman.
    Chairman BAKER. Thank you, Mr. Flake. With your indulgence, I would like to pursue another round of questions, just briefly. I know the Chairman, who stepped out and will be back momentarily, also would like to follow up with just a few further questions.
    I think that maybe to refocus, perhaps, the direction of some of the questions, this morning the purpose is not so much to inquire as to the current operational condition or success of any of the GSEs, but rather to focus on whether the regulators of those GSEs have the tools with which to satisfy the Congress that taxpayer interest and mission are being adequately addressed.
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    In that regard, I think—and it has not been specifically stated—what you would perhaps see as an advisable direction would be the creation of a new entity, which certainly would have HUD representation, certainly would have Treasury representation, a chairman and perhaps two to four additional appointees that would be Presidential-level appointments.
    Would that be a type structure that you are considering as appropriate?
    Ms. STROMBERG. Yes. I think that is one of the ones that we have talked about the advantages of and probably the one that we saw the most advantages in.
    Chairman BAKER. And the purpose would be to ensure that this new entity would have the appropriate level of staffing and competence to understand and review the risk portfolio of the various types of investment products that are continually being developed and marketed and, in your view, am I correct, are perhaps not thoroughly understood or properly reviewed at this time? Is that your conclusion?
    Ms. STROMBERG. I don't think we were drawing a conclusion on the current state of things so much as on the possibility that having a larger agency that had more functions would be able to attract and maintain people who were able to deal with a lot of the difficult issues and the very complex ones that there are.
    Chairman BAKER. For example, the development of a stress test. That has been under way now for some years. Every year we are told it would be next year. That might be an element that would be important to address, for example, is that correct, the construction of a stress test model?
    Ms. STROMBERG. I am not sure that the stress test is necessarily something that would depend on whether there was a single regulator or whether it remained as it is. How that comes out depends on the decisions that are being made by the people who are putting the stress test together.
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    Chairman BAKER. My point is that perhaps the staffing or capability of the resources necessary to tackle something that is obviously very complicated and difficult needs to be reviewed. This need is demonstrated by the fact that for 5 or 6 years we have been told it is in the offing, but it never seems to occur. With regard to the independence of the board from the operations of the regulated entity, would you think it appropriate for a regulator to, for example, appoint board members of the affected regulated entity?
    Ms. STROMBERG. No. We have taken a position in the past and we would still take it that it is inappropriate for the regulator to appoint board members. We specifically were critical of the Finance Board and its powers over the Federal Home Loan Bank System in that regard going back to the early 1990's, and that is still a concern of ours. We think that interferes with the independence of the agents—the regulator.
    Chairman BAKER. And what about with regard to the view that ''If it ain't broken, don't fix it''? And to be correct, we are not suggesting this morning that there is anything wrong with the operations of any of the housing GSEs under discussion. What I think the subcommittee is interested in knowing is that the regulatory structure is in operable condition. That is where I think there is considerable room for discussion and debate.
    Nothing in this proposal to consolidate would in any way affect the GSEs ability to achieve its stated mission. In fact, I think quite the contrary is the case, we don't now know from a regulatory perspective if, as a certainty, each of the GSEs is complying with the publicly stated mission. Is that a correct observation?
    Ms. STROMBERG. We haven't done any work where I could tell you whether or not the current regulatory structure system is doing its job on mission.
    Chairman BAKER. It would certainly appear that just the disparity between the numbers of staff and dollars spent between the regulators for mission compliance, that in itself raises, in my view, those questions.
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    I am told that the Chairman will not be able to return at this moment to follow up on his next round of questions.
    Would other Members like to follow up with questions?
    Mr. Flake.
    Mr. Vento.
    Mr. VENTO. Thank you, Mr. Chairman. Isn't it likely, Ms. Stromberg, that in fact if HUD were a function of the mission issue that HUD now regulates with regard to the GSEs and others were to be transferred into this overall agency, that they would have to develop that expertise to deal with that, within that—not within that agency but within that regulator?
    Ms. STROMBERG. Well, any regulator that was going to be a single regulator would clearly need to have the expertise to deal with mission and safety and soundness. They would have to get their personnel from somewhere, too. Presumably, they would get people who did have some expertise.
    Mr. VENTO. One of the major points that you are making was that, of course, that—well, just to finish up this thought before I get on to that, I notice on page 20 you say, ''We do not claim that significant costs could be saved by creating a single regulator, although some costs could be saved by combining administrative functions.''
    So this isn't a money issue; it is whether or not it is effective based on the model of the S&L problem. Do you agree with my comments earlier when I said there hadn't been an institutional memory that a regulation of, specifically, Fannie and Freddie—not so much, I guess, the Federal Home Loan Bank System, because I think there had been some there—but not certainly current to what is taking place today. But that had to be regrown, as it were, based on the type of model and regulatory structure we established in 1992.
    Did you look at the history of this? You can't talk about what is going to happen today, but do you know what the history of this is? Obviously, I joked about the 1989 problem, but could you tell us, could you give us any type of insight into what existed when it was transferred in 1992?
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    Ms. STROMBERG. Do you know?
    Mr. SHEAR. Mr. Vento, we realized that it was important to create OFHEO as an independent safety and soundness regulator. So its relationship with HUD has—when it comes to safety and soundness, is one of an independent regulator. It is an arm's length independent regulator, so it meets part of our criteria for an effective regulatory structure. It meets part of the criteria, but not all of it.
    Mr. VENTO. Can I just——
    Mr. SHEAR. And I think—as far as the legislative history, I think what you are referring to, the idea of having an independent regulator was viewed as important rather than HUD, by itself, serving both functions.
    Mr. VENTO. No, my question is that there is some concern here about the fact—I think the Chairman said something about the stress test which we wrote into law, incidentally, and even some of the criteria are written into law, so this hasn't all been left to OFHEO, but my question is, what what was the regulatory system before 1992?
    What I am saying is, this had to be, it wasn't necessarily the institutional structures that weren't the requirements. All of this has had to come on-line, or much of it that I see as a problem today is—and the question today had to come on-line and had to be grown at HUD or grown at these models; or these rules had to be prescribed and developed, because there wasn't that type of a regulation before.
    Ms. STROMBERG. That is correct. That this is a relatively recent development then in the regulatory system.
    Mr. VENTO. Despite the fact they were regulated by the Federal Home Loan Bank in 1989 and it was taken away and given to HUD, and obviously it was a holding pattern at that point, right? I mean, I am just trying to understand, because we can't talk about—I am just trying to understand the history of when it was combined with the Federal Home Loan Bank System, of course, that it went to hell in a hand basket, to put it bluntly.
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    Ms. STROMBERG. I am afraid I am missing something.
    Mr. VENTO. Well, I mean, Fannie and Freddie were regulated by the Federal Home Loan Bank System. They were all one—just Freddie—Freddie, but were regulated by the Home Loan Bank Board. And so they regulated FSLIC. So they had it all together.
    Ms. STROMBERG. Right.
    Mr. VENTO. And it didn't work. I mean, I don't think it worked.
    Ms. STROMBERG. But they also were promoters of the System. They were involved in the way the System was operating, and they were not an independent——
    Mr. VENTO. Well, I mean, I think that that—I would suggest that a lot of the regulators end up being sort of promoters of the System. I mean, the Federal Housing Finance Board now is a promoter of the System, believe me. Not to take that away from anyone; I think they see that as a mission. I think the Comptroller sees that as his mission; and others, including the Federal Reserve Board—I mean, you don't concede that particular point, you don't believe that they are promoting their role?
    Ms. STROMBERG. There is a—when we talk about promoting the System, we are talking in part about having official duties that involve you in the governance and management of the System.
    Mr. VENTO. I am talking about the way it works, you know. I mean, OK, so if we—you know, maybe the System says you are going to be objective, but I think many of the Members, you know, or the public would find this a distinction without a difference.
    I think OFHEO, frankly, is much more independent. I think we would be better if we had more of that element in much of what happens with regard to the regulatory system.
    In any case, my time has expired, Mr. Chairman. Unless you had a follow-up, I am sure the Chairman would permit you, Ms. Stromberg, to follow up.
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    Ms. STROMBERG. That is all right. Thank you.
    Chairman BAKER. Thank you, Mr. Vento.
    Mr. Flake, any further questions?
    I wish to thank you for your appearance here this morning. And also I would indicate that in light of comments this morning with regard to the mission statement, that I may well forward a request at a future time for GAO to review HUD's mission and, accordingly, the affordable housing oversight responsibilities with regard to mission compliance. And certainly we will want to discuss that with you further.
    But I do very much appreciate the insights given and your willingness to be here today. Thank you.
    Ms. STROMBERG. Thank you very much.
    Chairman BAKER. I am reminded, too, that we will be forwarding some additional follow-up questions as well.
    Our next panel this morning, Panel Two, please come forward. I welcome each of you here this morning.
    The first to present testimony will be Mr. Nicholas Retsinas, certainly no stranger to the subcommittee, Assistant Secretary for Housing and Federal Housing Commissioner, Department of Housing and Urban Development.
    Mr. Retsinas, it's always a pleasure.

    Mr. RETSINAS. Thank you, Mr. Chairman and Members of the subcommittee. Thank you for this opportunity, and, Mr. Chairman, if I might add, thank you for your interest in this subject. As the previous panel has pointed out, and as you have pointed out, while this is not a time of crisis per se, it is appropriate always to look and ask ourselves the question, can and ought we do our job better?
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    With your permission, I would like to submit my written testimony with its exhibits for the record.
    Chairman BAKER. Without objection.
    Mr. RETSINAS. What I would like to do this morning is give a really brief opening statement, so we can engage in the kind of dialogue that I hope can be productive to move this agenda forward. I really want to cover three points: The Department's fundamental reaction, if you will, to the GAO report; a brief description of how the current regulatory structure works, both as it relates to the secondary market, Government Sponsored Enterprises, as well as the Federal Housing Finance Board; and then some specific observations that we have on the GAO report.
    As has been, I think, pointed out in an earlier panel—and again, I do respect the contribution of the GAO—I believe the current structure generally works well. As a matter of fact, to jump ahead to our conclusion, we really see no compelling reason for change. Of course, as you point out, Mr. Chairman, things can always be better; and as some of your colleagues pointed out, things unfortunately could always be worse.
    As we look at the regulatory structure, there really are three factors that we need to take into account. First, it has to do with the people who are really conducting the regulations or the capacity of the regulator; second, the environment and the support those regulators receive and, in no small measure, the support it receives from this body and from the Congress as a whole; and third, clarity as it relates to what is the goal or the intent of the regulated entities. All of those things are important.
    I daresay there is no one structure that guarantees that all of those could be carried out. If you had the right structure and the wrong people, it wouldn't work. Sometimes if you have got the right people and the wrong structure, it could work. So it is really a mix of a variety of different factors, and, generally speaking, I think my colleagues here this morning really are the right people as it relates to the environment that exists today.
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    As we look back to how we got to the regulatory structure that exists today, it was a product, a very conscious and purposeful decision by the Congress that came up over time, often, as is unfortunately almost always the case, a reaction to a particular problem or a particular issue. We don't always have, in a sense, the luxury of this hearing and this discussion to think about the future, absent a crisis and a problem.
    As we look back to the origins of the Federal Housing Finance Board, which my good friend and colleague Chairman Morrison will talk about, it really was part of an outgrowth of the whole thrift crisis and how we better organize ourselves to carry that out.
    As we look at the circumstances that prompted the GSE Act of 1992, preceding my tenure here in Washington, as I recollect and as I look back on that, there was considerable concern expressed by the Congress about the exposure to the taxpayer and questions as to the mission of those GSEs. That Act set forth a particular structure that was a result of a compromise of a variety of different interests and approaches.
    I confess to you, when I joined the Administration in 1993, I wanted to focus most of my attention, if I could, Mr. Chairman, on the secondary market GSEs and HUD's responsibility. When I first got here in 1993, I had some initial reservations about the distinction and separation of safety and soundness and mission. What has changed in those 4 years is a reflection that, generally, it has worked pretty well. There really has been coordination and consultation between the independent safety and soundness regulator within HUD and the mission responsibility of the Secretary's office.
    As I look at the performance of the GSEs, which you note has generally been positive, I really do believe that the legislation passed by the Congress and our regulation pursuant to that legislation has made a difference.
    Clearly, I have a special interest in the role of the GSEs in filling credit gaps. There really has been significant improvement in the percentage of mortgages that go to low- and moderate-income home buyers. Some statistics would illustrate that point.
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    In the case of Fannie Mae, for example, they have gone from 34 percent of all their loan purchases for low- and moderate-income borrowers to 45 percent, an increase of about one-third over the 4-year period. Freddie Mac has gone from 29 percent to 41 percent, an increase of a little over 40 percent. More importantly, or as importantly, as a result of the increase in lending to underserved people and areas, I think there is a greater awareness and understanding of the GSEs.
    For example, earlier this year, we released a public-use database to cast more sunlight, and we believe more sunlight is a way to further illuminate what their important role is. But I would be the first to say that dissemination of information on GSEs' activities is not the only way to regulate.
    Also, as you point out, the Department is represented on the Federal Housing Finance Board by the Secretary, who is an ex officio member. I think that linkage has been valuable and useful. I have certainly used that role on the Finance Board to further focus and hone in on the issue of mission and how best we can clarify what is an evolving mission for that Federal Home Loan Bank System.
    Let me conclude with some observations on the GAO report. First, I agree wholeheartedly with the conclusion that mission oversight cannot be left behind. Safety and soundness is absolutely important, absolutely necessary. But to those who argue the mission is an inappropriate agenda item, I would agree with Congressman Vento, if there is not a mission and clarity in mission, why does the entity exist? So mission oversight is key.
    Second, I note in the GAO report they do not suggest the creation of a single regulator as cost savings. Indeed, I do not think there is evidence that there would be substantial cost savings. In my tenure here in Washington, I have learned, in part counseled by yourself, among others, that bigger isn't always better, that consolidated isn't always better, necessarily. Indeed, sometimes in an effort to be consolidated and to be bigger, we end up with a one-size-fits-all philosophy that doesn't always work.
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    Third, I would suggest that the three GSEs that are the indirect subjects of our discussion here this morning, while they are all housing GSEs, they are different. Fannie Mae and Freddie Mac are secondary market GSEs. The Federal Home Loan Bank System was created to support portfolio lending. But as you know, perhaps better than anyone in this Congress, that mission is evolving over time, and I would argue, ought to evolve over time.
    Fourth, I concur with the GAO report about the continued need and importance of having connection to the Executive Branch of Government and to the Administration.
    Context of housing policy is important. Whether that context takes place within a department, as in the model with OFHEO and the secondary market GSEs, or representation on the board, those kinds of connections are important. Do they inevitably lead to attention? Yes. Because the whole issue of having someone experienced—whether it is in general finance, from the Treasury Department, or housing policy, from HUD—inevitably overlaps with those issues. But you wouldn't want a department that knew nothing at all about the subject to be that linkage; you would not want that kind of policy.
    Fifth, an observation about the timeliness of the GAO report and their recommendations. This is a time of change. Clearly, on your agenda I know, Mr. Chairman, are changes related to the Federal Home Loan Bank System. I think I would like to see the evolvement of those changes before we come to a conclusion of how best to oversee where that GSE is moving.
    My last comment is that while this discussion is an important one, because how we regulate and who regulates are very legitimate items of this Congress and certainly a primary concern of this Administration, all of us ought to focus our attention on a better understanding of the role of GSEs in this broader issue of housing finance.
    So with that, Mr. Chairman, thank you again for the opportunity; and I look forward to answering your questions.
    Chairman BAKER. Thank you very much, Mr. Retsinas.
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    Unfortunately, we have got another vote. Second bells have rung, and we will stand in recess, and I will return as soon as possible. Thank you.
    Chairman BAKER. I would like to reconvene our hearing. I am certain other Members will be returning momentarily. But in deference to our witnesses, I would like to call the hearing back to order and, at this time, recognize Mr. Bruce Morrison, Chairman of the Federal Housing Finance Board.
    Welcome. Good morning.

    Mr. MORRISON. Thank you very much, Mr. Chairman, and thank you for the opportunity to be here. I have submitted a written statement, and would ask that it be made part of the report.
    Chairman BAKER. Without objection.
    Mr. MORRISON. And I will try to summarize the issues efficiently.
    First, I want to thank you and your colleagues—in particular, Ranking Member Mr. Kanjorski—for your leadership over the past several years, but most particularly in the full committee markup, regarding the bank modernization bill, for having included in H.R. 10 substantial amendments with respect to the Federal Home Loan Bank System.
    Some of those amendments address some of the issues that are being discussed here this morning, but more broadly, they represent a continuing commitment on your part, which we very much support, that the structural inefficiencies and anachronisms of the Federal Home Loan Bank System be modified in order to make the System all that it can be in the changing economic times ahead. I want to thank you for that leadership and also for the opportunity to consult with you as you put that package together.
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    Second, with respect to this morning's discussion, one of the things—at least at the Finance Board—that is most relevant is that you are emphasizing the importance of mission regulation. It should be obvious, I think, and it certainly is obvious in the statutes in question, that the Congress expects that Government Sponsored Enterprises will not only be operated safely and soundly, of course, but that they will conform to a mission to serve the public in a way that justifies the Government support they receive.
    This seems obvious, but some information that comes to me in the process of trying to improve our mission regulation regime and also that is mentioned in the GAO report suggests that some believe that congressional oversight, by itself, would be sufficient to pursue this mission regulation scheme. And I think that the subcommittee would agree that while congressional oversight is very important, it is not something that, on a day-to-day basis, Congress or its staff can accomplish in terms of regulating the mission performance of GSEs. And I hope that this hearing underscores your commitment and your committee's commitment to see to it that mission regulation is an important component of regulating GSEs.
    Third, I want to agree with both of my friends and colleagues at the table that we do not have a crisis situation that cries out for any kind of immediate action. And whether this is the ideal time to act or the time not to act, because ''if it ain't broke, don't fix it,'' is a matter of point of view; it is probably somewhere in between. I think that what that does recommend is that any thought about changes doesn't have to be on a fast track and can be on a very considered basis; and more exploration will certainly not lead to some negative consequence that is right on the horizon.
    With respect to disruption, I am sure that any change would lead to some disruption. I imagine it could be managed. With respect to OFHEO's work in developing the stress test, we shouldn't do anything that will impede their ability to get that work done and get that in place. It is clearly important work. It is clearly going to set some standards beyond just the GSEs affected by it; and to whatever extent OFHEO is concerned about disruption in that regard, I think their concern should be taken seriously.
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    With relation to the ideas that GAO put forward, I would say that there is a lot of merit to their fundamental recommendations. I think that the combining of safety and soundness and mission regulation is a better choice if one is writing on a clean slate; and if one is moving toward any particular change, I think it is preferable. There is no question that there are interactions in most major decisions between issues of safety and soundness and issues of mission. It will be better that the greatest degree of coordination be achieved in that area, and the greatest degree of coordination can be achieved within a single entity. That does not mean that the coordination between HUD and OFHEO is failing; it just means that there are extra burdens to be overcome, and they can be avoided in a particular agency, and I think that is an advantage that the Finance Board has in its structure.
    Independence, as opposed to being part of an Executive department, I think is also a virtue. Once again, it doesn't mean that the other alternative doesn't work; it doesn't mean that it isn't working. It means that if you are looking at this from a structural standpoint, there are many other matters on the agenda of Executive agencies that can be brought into play in various ways in the political process that are avoided when you have a single-focus independent agency, and that is an advantage.
    Finally, the GAO raises issues of governance and the Federal Housing Finance Board's role in governance of the Federal Home Loan Banks as a concern about arm's length independence; and I have several things to say about that.
    First, H.R. 10 really is the remedy to the problem. H.R. 10 does those things that change the problems as far as responsibilities for governance decisions that the Finance Board is required to make, and those provisions should be enacted into law as soon as possible. And we very much would like to see that.
    We have, on our own initiative, engaged in delegation of these responsibilities to the extent that we can under existing statute. And I think that the problem is not significant at the present time, but it can be made better by enacting H.R. 10 and fully separating the Finance Board from anything in that day-to-day governance world.
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    No one should be misled, however, that sometimes in discussing this issue, when individuals use the words ''involvement in governance,'' what they have in mind is a criticism of mission regulation. The fact is that mission regulation, and safety and soundness regulation, for that matter, do interfere with management decisions by their nature. They are not day-to-day management interventions, and they can be done in a more results-oriented way if they are done right.
    But it is a fact that regulation does interfere with management discretion; otherwise you wouldn't need it. And in that sense, one should be aware of the use of the word ''governance'' as a cover for some who are opposed to mission regulation itself. I am very much in agreement with what I understand to be GAO's distinction, but one should be careful with the words because they sometimes are not used precisely.
    Finally, one of the focal points of this issue for GAO is the appointment by the Finance Board of public interest members of the boards of the banks. This is a fairly theoretical point, and one should beware of reading too much into this appointment authority in terms of any kind of interference in the day-to-day management of the banks.
    One of the positive results of Finance Board appointment of public interest members to the boards has been that our concern about mission and the regulation of mission and attention to mission have been enhanced by our ability to recruit people to serve in those positions, who understand the community credit needs that the banks are supposed to serve.
    Now, the White House can do that, too, but they have a lot longer list of people to appoint, and sometimes those things don't move as quickly as some of us would like. So we have to keep in perspective that some of these theories may, in fact, lead us to a better theoretical structure, but not actually get the job done as well.
    Thank you, Mr. Chairman.
    Chairman BAKER. Thank you very much, Mr. Morrison.
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    I have been asked by Mr. Kanjorski, in his absence, to ask that other members of the Federal Housing Finance Board be able to submit written statements for the record. And without objection, certainly that request will be honored.
    Our next witness this morning is Mr. Mark Kinsey, Acting Director of the Office of Federal Housing Enterprise Oversight, OFHEO.
    Welcome, sir.

    Mr. KINSEY. Thank you, Mr. Chairman and Members of the subcommittee. I appreciate the opportunity to discuss with you OFHEO's views on the topic of creating a single regulator to oversee the three housing GSEs. My remarks this morning are a summary of my written testimony which, with your permission, I will submit for the record.
    Chairman BAKER. Without objection.
    Mr. KINSEY. I would say at the outset that my views and remarks during this hearing are my own. They do not necessarily represent the position of the President or the Secretary of HUD.
    Let me begin with a very brief outline of OFHEO's current responsibilities and its current relationship with HUD.
    OFHEO was established in 1993 as an independent entity within HUD. The office is headed by a director appointed by the President and confirmed by the Senate for a 5-year term.
    OFHEO's primary mission is to examine and regulate Fannie Mae and Freddie Mac for capital adequacy and safety and soundness. Congress has given OFHEO specific supervisory responsibilities to accomplish our mission. It is important to note in the context of this hearing that these supervisory responsibilities are exclusive to OFHEO. They are exercised without the review or approval of the HUD Secretary.
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    OFHEO also has specific independent operational authorities. These include determining budget requests, managing operations, and reporting directly to Congress.
    While OFHEO's budget is subject to the congressional appropriations process, the office is fully funded through direct assessments on the GSEs. OFHEO's independence from HUD, as presently structured, creates the environment of accountability and credibility required by OFHEO to do an effective job. OFHEO's relationship with HUD also provides a broad avenue for coordination of HUD's programmatic operations with OFHEO's safety and soundness concerns.
    In its report issued earlier this month, the GAO concludes that GSE regulation would be more effective if existing responsibilities at OFHEO, HUD, and the Federal Housing Finance Board were combined into a single entity. GAO further concludes that the best regulatory structure would be an independent, arm's length, stand-alone regulatory body headed by a board.
    In comparison to the existing oversight arrangement, GAO concludes that its preferred structure would be more independent and objective; be potentially more prominent; be better positioned to ensure consistency of regulation among the housing GSEs; and would provide better coordination and sharing of expertise. I would like to comment on these conclusions.
    First, the question, would a combined structure be more independent and objective?
    OFHEO, as currently structured, has sufficient independence from HUD to do its job effectively. This independence is bolstered by OFHEO's exclusive authority over safety and soundness and capital matters as well as independent budget and management authority. GAO agrees on this point, noting, and I quote, ''The existing regulatory structure is one way to accomplish the objectives of maintaining a link with HUD and also having a safety and soundness regulator with sufficient independence.''
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    On the topic of objectivity, objectivity means operating in a manner that is perceived to be, and is in fact, independent of the regulated entity. Current law provides an explicit arm's length framework for OFHEO's operations. Reinforcing this independence is a prohibition against employment at a regulated GSE by any senior OFHEO official for 2 years after leaving the office.
    Question: Would a combined structure be more prominent?
    GAO concludes that a combined structure would provide the housing GSE regulator with more prominence. Now, while a broader mission could increase OFHEO's prominence, it does not follow that increased prominence would significantly enhance our ability to regulate effectively.
    A unified regulator, by virtue of its size and regulatory breadth, would likely be given more attention by the industry, the media and of course Congress. Nonetheless, OFHEO has, we believe, done an effective job of establishing its reputation as a strong, cost-efficient regulator, with a lean but highly skilled staff.
    GAO argues that added prominence could help a single regulator attract and retain staff members whose special mix of expertise and experience are required to examine and monitor the GSEs. Hiring and retaining staff has been a concern for OFHEO. We believe that a combined structure might help attract staff in some areas, such as examinations, but not in areas needed to develop the stress test.
    Question: Would a combined structure be better positioned to ensure consistency of regulation?
    The importance of regulatory consistency depends upon the extent to which the activities of one or more regulators overlap. We have found relatively little overlap with HUD's GSE programmatic regulation and even less with the Finance Board's regulations. Programmatic rules for Fannie Mae and Freddie Mac have only modest safety and soundness implications, and so far, Fannie Mae and Freddie Mac have competed only tangentially with the Home Loan Banks. This could change in the future, of course, as indicated by the Chicago Home Loan Bank's pilot program.
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    Question: Would a combined structure provide better coordination and sharing of expertise?
    In general, OFHEO agrees with GAO that a combined structure should provide for better coordination and sharing of expertise. But the key to an efficient combined structure is effective communication, not whether the regulatory components are housed under the same roof or report to the same person. In this regard, OFHEO's relationship with HUD has functioned very well.
    I would now like to comment on two other issues in the report, Mr. Chairman. First, GAO prefers a stand-alone, independent agency governed by a board. This is in contrast to an independent office within an Executive Branch agency governed by a director. GAO notes, however, that based on existing regulatory examples, either arrangement is plausible. We agree, and reemphasize our belief that the OFHEO-HUD structure works well. We believe that a director-run office is more efficient and more accountable.
    Second, the process of combining the three housing GSE regulators could be disruptive to existing processes at a very critical time. OFHEO agrees with GAO's observation that this disruption could be significant in terms of OFHEO's completion of the risk-based capital standard.
    In conclusion, Mr. Chairman, OFHEO finds theoretical merit in GAO's arguments for creating a single regulator for the housing GSEs and in the concept for combining safety and soundness and mission regulation. This suggestion by GAO is an option worthy of the subcommittee's consideration. By the same token, however, OFHEO believes that its current regulatory structure is equally valid and is working effectively.
    Thank you. I will be pleased to answer any questions.
    Chairman BAKER. Thank you very much.
    Mr. Kinsey, I have had some consternation with OFHEO's performance with regard to development of the stress test. Since the 1994 annual report, I have quotes from you every year, something to the effect of expectations to complete work on proposed rule on risk-based capital, and it would always be the following year. And I regret to read in the 1997 report that after having been told last year that it would be available for imposition in the Spring of this year, that it will be looked toward implementation in 1998.
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    In the absence of a currently operative stress test, on what basis does OFHEO set capital standards?
    Mr. KINSEY. We set capital standards right now on a set of capital ratios that are determined in our minimum capital regulation.
    Chairman BAKER. Those are actually set by Congress; is that correct?
    Mr. KINSEY. Most of them are. There are some components that are not. We have a completed regulation on that.
    Chairman BAKER. My point being that we really don't have a capital standard established by OFHEO that is based on an understanding of the risk the entities take in the market today. Rather, it is founded in a generally congressionally-described, and I might point out, is really a maximum capital standard, which is also a bit unusual, in that most of the time Congress sets minimum capital standards, leaving the regulator the right to set additional standards where the risk taken warrants such additional capital.
    That is very troublesome. Not in an—and I wish to quickly add, in light of everyone's comments here today, the forest is not on fire. All the entities are operating successfully. We have a wonderful market, and if somebody is not making money in the finance world today, something is really wrong with them. But given that description, now is the time to begin a discussion rationally of what regulatory changes are needed, rather than waiting until the crisis and doing the work, I think in an inappropriate way.
    Given this problem in getting the stress test developed, can you generally say that it is because of the complexity of the issue and the limits on staffing that are available to you? Or what would you basically say has been the reason for this dragging on now for 5 years?
    Mr. KINSEY. It hasn't dragged on for 5 years. This office was created on June 1st of 1993, when our first director, Aida Alvarez, was appointed, and she was the very first director. We did not really get a core group of staff to be functioning as a regulator until the summer of 1994. So we have effectively been in business for about 3 years.
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    But I might point out that in March, I sent you a letter giving you a time-line on the development of the stress test. And we are right on target with that time-line. We briefed your staff in March on what we call our ''financial simulation model,'' which is the platform that we will create the stress test with, and we said we were within weeks of having in place a model capable of analyzing policy options for the stress test. We are now using the FSM, or the financial simulation model, to do just that.
    In the letter, I also told you that by the end of July, we would be in a position to engage OMB and other Administration parties in informal discussions concerning how the FSM functions and OFHEO's general approach to applying the stress test to the enterprises. Just this past Tuesday, we have opened up those discussions with OMB; and in the weeks to come, we fully expect to be briefing OMB, Treasury and probably HUD staff on how the FSM works. And the idea for doing this is that we can completely get the staffs at these three agencies very comfortable with our model, so when we get the regulation finally written and we submit it for approval to OMB, that we will have moved the process along considerably, because it is a very complex model.
    In March, I thought that by September of next year we would have a proposed rule to OMB. I think we are still on that time-line.
    Chairman BAKER. Well, I think it is critically important in order to assure anyone that there is a relationship between capital requirements and the actual business activities.
    Mr. KINSEY. There absolutely is. That is——
    Chairman BAKER. OK, thank you.
    Mr. Morrison, in your testimony today—you are here as Chairman, but has the Finance Board actually taken any position on the matter of regulatory reform at all?
    Mr. MORRISON. As far as the structure of the regulator, no, we haven't. As you mentioned in your earlier comment, you invited other members of the board to do so. Mr. Retsinas is a member of the board, but he also has another responsibility here and is speaking in that role.
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    We have two other members of the board and a vacant seat. We have not deemed this a matter that should go through a formal policy adoption, which we would have to do at a formal board meeting in order to be——
    Chairman BAKER. A policy?
    Mr. MORRISON.——To be presented here. If the Congress wished us to take such a position, obviously it would be submitted in accordance with those rules.
    Chairman BAKER. And I do appreciate your comments with regard to the Home Loan Bank provisions and H.R. 10 and I agree that they would move us in a positive direction with regard to regulatory structure in the absence of any other proposal.
    But there is another area still of concern with regard to current investment practices, with each district bank operating quite differently. Take the Des Moines circumstance where two-thirds of their income in the last report was generated from the investment side as opposed to the advance window, which is, I think, very telling with regard to compliance with mission. Now, I am not adverse to investments, because I realize you have to have cash in order to implement, often, the public policy requirements. But to the extent that becomes the principal direction of the entity as opposed to compliance with the public, stated mission, that is a problem.
    From your view, is there a discussion ongoing as to perhaps some standard policy being adopted at the national level for banks, or is it still out there?
    Mr. MORRISON. There is a process ongoing, and several things should be said about the investment practices of the Federal Home Loan Banks.
    First, coming forward from 1989, the banks were placed in a position where they were serving a radically reduced membership and had imposed on them by the Congress new financial responsibilities in terms of a $300-million-a-year REFCORP payment and affordable housing program assessment—all of which have appropriate reasons for their being there, but they were, in fact, substantial obligations—so that the banks were forced in the early 1990's to find a way to earn enough money to pay their way.
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    To do so they developed something which had not existed prior to 1989, which was a substantial investment portfolio. And the Finance Board, during that time, did increase the permission given for investment activities; and the banks have taken, for the most part, full advantage of that increased permission.
    The financial circumstances now are not the same as they were then; there are more options. Some of those options may be made even clearer by legislative changes. It is something that the Finance Board has been examining in in some detail. We have published, for comment, the financial management policy that currently exists, and we are in discussions with the banks about ways in which the investments can be reduced and limited more in the direction of mission-oriented activities.
    It is our approach that the investment versus advances distinction isn't the critical one. The critical one is, does the asset support credit availability for housing finance or targeted community investment in accordance with the mission of the System? And we would be hoping that over a period of time—and any change here will have to be over a significant period of time—the regulator can assure the Congress that the cost-of-funds advantage is being invested in mission-oriented activities, and we are in the process of doing that.
    It would be greatly advanced by the changes that are in H.R. 10, because we could move more quickly, but whether or not H.R. 10 becomes a law, you have my personal commitment that we will continue to look for ways to change the balance sheet, to have it focused more on mission assets and less on nonmission assets that merely provide income.
    Chairman BAKER. Thank you, Mr. Morrison.
    I have gone far beyond my time. I will come back, Mr. Retsinas, after Members have had their opportunity.
    Mr. Vento.
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    Mr. VENTO. Well, thanks, Mr. Chairman.
    Chairman Morrison, you talked about some of the employees would be more interested. I mean, you don't have uninterested employees now, do you, in terms of——
    Mr. MORRISON. No, we have terrific employees, as a matter of fact, Congressman. But the fact is, of course, that the challenges of the housing finance and community investment marketplace that are addressed by our banks that we regulate, and addressed by Fannie Mae and Freddie Mac, have a lot of complexity in them and there would be added opportunities for cross-pollination across those lines.
    Is that a reason in and of itself to change a structure that currently works? No. Is it a benefit of a combined structure? Yes.
    Mr. VENTO. What is—and everyone is talking about the crisis. Can you tell me something about this crisis that might occur? That is one of the major tenets here. I guess I am not convinced by the uninterested employees or by board versus director.
    I think there is some merit to the director role. I think it is sort of refreshing, from my standpoint, to see one person responsible for the specific responsibility. But does anyone want to talk about this crisis that I keep hearing about that might occur, that somehow then, if we had a combined regulator critical mass, as I referred to it earlier, that that would somehow function better?
    Mr. MORRISON. Well, first, I don't think anyone has identified a particular crisis that is going to occur. But I guess we would all say, if we knew it was coming, it wouldn't be a crisis.
    Mr. VENTO. Yes, that is true.
    Mr. MORRISON. My comment on that would be that you yourself, I think, correctly identified that all regulators have as part of their job, creating a viable business environment for the entities that they regulate. Where the line is between promotion and appropriately carving out a business set of rules that are viable for the entity, is subject to different points of view and different applicables, and that, I think, is what you were correctly referring to.
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    The one thing that you do want in this area where there are huge amounts of money in play, is that the regulator be sophisticated, the regulator have high credibility here on the Hill, and the ability to take decisive actions and to recommend decisive actions in the Executive Branch and on the Hill if problems develop. That hasn't always been the case, and I think in the 1980's there was weakness in that regard, and we wouldn't want to do that again.
    Mr. VENTO. No, I agree. I think it is the whole issue. It isn't helpful to me to have the Administration reach down and take Alvarez from this role. Not that I have any concern; I mean, I think that Mr. Kinsey is doing an able job. But it is not helpful, because the continuity issue says, well, this is a little more status over here.
    That is not a helpful matter in terms of this. But on the other hand, I sometimes think putting people politically in charge, as we have for the Federal Home Loan Bank Board, wasn't exactly a good thing either with the board or the absence of members on the board.
    Mr. Assistant Secretary Retsinas, what about the coordination issue? Has there been tension between OFHEO and HUD with regard to their joint responsibilities or overlapping responsibilities?
    Mr. RETSINAS. As I indicated earlier, Congressman, there really has been a great degree of coordination and consultation, and in all candor, that exceeded my initial expectations. For example, recently we reviewed a matter to determine whether or not it constituted a new program. That discussion required a great deal of consultation. Not only was it effective, but we were able to reach a conclusion working together well within a very tight schedule imposed by our own regulations.
    So I think the recent evidence had been very, very positive in terms of the degree of coordination and consultation. From a real sense, not a theoretical sense, but from a real sense, there really has been good cooperation.
    Mr. VENTO. Mr. Kinsey.
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    Mr. KINSEY. I would agree with that.
    Mr. VENTO. Mr. Kinsey, I obviously notice your comments with regard to the director role versus the other. Now, with regard to the stress test which apparently, as you point out, has been an issue that has been before OFHEO for the last few years at least and has not—now you didn't have any model to reach out there? This is something you had to build from the ground up; is that right?
    Mr. KINSEY. That is correct.
    Mr. VENTO. Do you have any comments with regard to my concerns about the regulatory structure and the fact that much of what you are doing had to be, in fact, invented at this point, as it were?
    Mr. KINSEY. I think you are absolutely correct on that point. As I mentioned earlier to the Chairman, we really did not have a core group of staff to begin the regulatory work until probably around the summer of 1994. And from that time on, we needed to go through what we call a ''discovery process,'' find out exactly how Fannie Mae and Freddie Mac conduct their businesses, find out exactly how they model their risks, find out exactly what kind of data they have.
    These are very large and complex organizations. That takes a long time to do.
    Mr. VENTO. Well, I am running over my time a little bit.
    I just think, for my standpoint, I would like to see this function continue, I mean, at least to see what the—you know, not because—I don't think there is a crisis. I think to some extent the GAO report suggests that you have a solution here. But, you know, I am kind of looking for where the problem might be. Nobody knows where it is. But, I mean, certainly we could have circumstances at some time. Mr. Kinsey—pardon me for mispronouncing your name—did you have a comment on that?
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    Mr. KINSEY. Given the mission that we have had to accomplish, I think we have made tremendous progress in what we have to do and what is required by law for us to do. And I really have no apologies to make for that. I think——
    Mr. VENTO. No, I tend to concur with you. You know, I am concerned, too, Mr. Chairman, about the—you know, I see the secondary market, Fannie and Freddie, as being significantly different even though the roles are similar in terms of housing finance. I see them being significantly different from the Federal Housing Finance Board that our former friend and colleague leads. I see the end—we are, of course, redefining those missions. So I think that this is something that is interesting to note, that GAO believes what they believe and what they wrote and studied before. But I am looking for the substance of where the problem is here and trying to understand the crisis.
    But I, from one standpoint, think we did this right; and while there are differences that might agree over stress tests, or how you regulate, I also think we have some questions that are substantively different with regard to the nature of private entities that we are dealing with here in terms of the Federal Home Loan Bank System versus the GSEs or the Fannie and Freddie or the secondary market institutions.
    Thank you, Mr. Chairman.
    Chairman BAKER. Thank you, Mr. Vento. And I might point out that the question of whether there is, or is not, a regulatory crisis might well be answered with the GAO report, or if there is any basis for it, which is expected some time next month.
    Mr. Leach, if you will proceed sir.
    Mr. LEACH. Sure. Thank you. Well, first, let me just stress—I don't think it is said enough—the housing GSEs have done a fabulous job in much of the mission they have been set out to do.
    The question then becomes, when you develop a system—as this Congress, in effect, did—that, in effect, socializes advantages to these institutions, but privatizes profit. Whether the abuses crop up and whether the whole nature of the American financial system is turned upside down, I happen to think is as clear-cut an abuse of power as I have ever seen in public life, is the long-term investment strategy of Freddie Macs. I wrote the HUD Secretary regarding these practices. Leland Brendsel has written me a long, rambling letter and a shorter, crisper letter to you, but in my judgment, they don't address the issue.
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    I also think that it is a very serious circumstance when you look at the size of the short-term investment portfolio and the rationale of liquidity does not stand up once these institutions use their liquidity to buy, in effect, instruments on their own. And I think this abuse of circumstance ought to be looked at.
    Mr. LEACH. I mean, it is not lost on the world that these are profitable institutions; and profit is not wrong. But it is interesting that in a measurement I had never seen before, Fortune Magazine recently put out a statistic of per employee, the most profitable public companies in America. Number one was Fannie Mae, which had over an $800,000-per-employee profit; number two was Freddie Mac; and way down the list from those numbers were purely private companies. And again, it is to the credit of Fannie and Freddie that they do well, but one raises the question, if they did not have governmental powers, could they do as well as they are?
    It is also interesting, from a safety and soundness point of view—and maybe the rest of the world is too intensely involved in safety and soundness—but the capital of housing GSEs is about a quarter of the Basle standard, and maybe the Basle standard is too stiff, but the competitive differential with the private sector is extraordinary. It simply means that one kind of company that has again privatized profit can leverage far more than institutions that don't have governmental privileges, and I think that is worth looking at. So it strikes me that maybe the Government ought to have an interagency task force to look at some of these issues, perhaps led by Treasury.
    But I would like at this point to ask Mr. Retsinas, is a review of Freddie Mac's long-term portfolio still on HUD's agenda?; or do you visualize this as something that has been sufficiently resolved to your satisfaction?
    Mr. RETSINAS. The review is ongoing, and let me elaborate and let me preface and comment, if I could, on your question and your usual very astute observations on these issues.
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    I concur with your opening statement that the housing GSEs have really made a very significant contribution to housing finance in this country. I daresay, from my perspective, they are a significant part of why we have the best housing finance system in the world. I think most people around the world would agree with that.
    Mr. LEACH. I agree with that.
    Mr. RETSINAS. I believe it may not be simple, as you again so well understand—that the nexus between Government as an undergirding of that system and private sector delivery system in large measure makes for the housing finance system. That doesn't make it perfect and indeed, as we reported to you, I believe it was last year or it might have been a year-and-a-half ago, Mr. Chairman, when we talked about privatizing the GSEs, it was a fair question.
    I certainly recollect our conclusion and the conclusion of the Department of Housing and Urban Development, which is that there is no compelling reason for change at this time, but that is a fair question to review periodically. With regard to the specific question you pose about investments, that is the subject of ongoing review. I believe I have sent you a copy of requested information.
    One of the concerns I would bring to your attention, if I may, Mr. Chairman, is in the statute itself. The statute talks not only about our overall mission responsibility and housing goals, which we have talked about, but it also talks about the new programs and how we look at new programs. It is very specific on what is covered and not covered. What is covered are the different kinds of mortgage programs and products, not the investments.
    In all candor, one of the difficulties, Mr. Chairman, in our review, is trying to find the appropriate hook, if you will, for that review. But the review is ongoing; we haven't come to a conclusion, but I again take the liberty of being candid with you.
    Mr. LEACH. I appreciate what you are saying, but I am not a thousand percent convinced that mission doesn't include what they do as an institution.
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    Mr. RETSINAS. I am not saying it is either; I just point out that limitation.
    Mr. LEACH. I appreciate that.
    I am in a dilemma. I think these are two of the best-run institutions in the world. I think they have some of the best leadership in the world; when I talk to foreigners and they ask me about housing, I say, ''Look at the Fannie-Freddie model.'' And so it is awkward to be critical.
    On the other hand, there is a competitive circumstance developing and—I mean, this morning we are reminded that antitrust is a circumstance in the world with the Boeing merger with McDonnell Douglas, and each passing year—the Chairman mentioned the 12 percent of a given market.
    This duopoly of power gets to be more extraordinary, and certainly all of the analyses—for example, in the S&L industry—are that S&Ls have very little future in housing finance, partly because it is very difficult to compete with the power of the United States Government backing two companies which are, in effect, national S&Ls.
    I don't pretend that legislatively this is an issue that is very easy to cope with, but I would say that the public has placed some modest responsibilities on the Administration, and that these are responsibilities that I think should be taken seriously.
    I personally believe HUD has done more in recent months than it has done before. The GAO has made it very clear that historically HUD has never looked at this kind of issue, but I think you probably have an obligation to, and I appreciate your personal attention to it.
    Mr. RETSINAS. Thank you, Mr. Chairman.
    Mr. LEACH. Thank you.
    Chairman BAKER. I regret that we are interrupted one more time by a vote. We will recess momentarily and return.
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    Mr. VENTO. Mr. Chairman, I appreciate that, and I especially appreciate our Chairman's comments. I wanted to just point something out on this board and director issue. I mean, the board that Mr. Morrison chairs right now is having difficulty filling the position, so I don't think that this—in spite of the testimony from the GAO, and the board issue, I hope that Members would keep an open mind with regard to this model. I am certainly concerned about that and the sort of balancing act that seems to have been going on, based on giving our esteemed colleagues in the Senate the ability to do what they do.
    Chairman BAKER. I think there will be more than enough discussion yet to come on this subject to satisfy everyone.
    We will stand in recess for a moment. We will return as quickly as possible.
    Chairman BAKER. I would like to reconvene our hearing. I am certain—well, there may be Members coming back, depending on when the next vote is. This has turned into a track meet.
    Mr. Kinsey, do you believe that once the risk-based capital standard model has finally been perfected and applied—do you have any opinion at the moment as to whether the capital requirements for Fannie and Freddie may change as a result of the imposition of that stress test?
    Mr. KINSEY. Our position on this really hasn't changed much from last year about this time when Ms. Alvarez testified. Based on our work relating to the credit stress benchmark, which is already out in a proposed regulation, and based on our examinations and other research we have done, we think that all of that evidence suggests that the risk-based capital requirement will, in fact, be higher than the minimum capital requirement.
    Chairman BAKER. Thank you.
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    Mr. Retsinas, there were several areas, I think, that we needed to explore. In 1994, HUD's position was a little different than it is today. What, in your judgment, has changed from then until now with regard to the need for a consolidated regulator?
    Mr. RETSINAS. As I indicated in my remarks, circumstances and events are factors. As I believe I tried to be very candid with you, the initial observations that I had early on, when I joined the Administration, were that I was skeptical of the separation of mission from safety and soundness. As I have learned that it is possible to have a coordinated relationship, it doesn't seem to be the problem I once thought it was.
    Similarly, as we now have a better understanding of the important role of the Federal Home Loan Bank System and Federal Housing Finance Board, it is our position that the debate ought to continue and ensue on the evolving role of the Federal Home Loan Bank System. Once that debate is clear, including not the least of which is consideration of the legislation you have suggested, then perhaps it is time to revisit once again the relationship of that System with the other housing enterprise system and whether the regulatory apparatus would come together in a different way.
    Chairman BAKER. With regard to what I understand GAO may have prescribed this morning with a Treasury representative, a HUD representative, a chairman, presidential-level appointees, whether it be two additional or four additional, what is there, in your mind, that is defective or problematic about that structure, as opposed to what we have in place today?
    Mr. RETSINAS. As it relates to the Federal Housing Finance Board, the Department, the Administration and I, endorse the notion of representation by both the Department of Housing and Urban Development and the Department of the Treasury. I think that is a good model, and one that can add value to the system and to the oversight.
    On the matter of the chair and how many other members, that is clearly a matter of discussion, but on the principle of involvement by the Executive Branch, I believe that is a sound and prudent course to follow.
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    Chairman BAKER. And with regard to that structure, do you see it potentially being a more effective managerial tool than the current one, which is basically divided; or do you see advantages as a result of a——
    Mr. RETSINAS. Mr. Chairman, are you referring specifically to the Home Loan Bank System or the broader housing GSE?
    Chairman BAKER. The broader issue.
    Mr. RETSINAS. I think it is potentially better, but unfortunately, also potentially worse, as the case may be.
    Chairman BAKER. How is that?
    Mr. RETSINAS. Well, as I indicated, I believe that the current oversight is generally working. I do not see such inherent advantages in one structure or another. I am concerned that all housing GSEs are not the same, and therefore, any obvious advantage isn't so clear to me, particularly when you don't even have the marginal benefit that it will cost less.
    Chairman BAKER. Well, you make a point in defense of the fact that all housing GSEs are not the same, and that is absolutely clear. There is a difference with regard to capital standards, with investment strategies, with profitability; that is the problem.
    All of this is conditioned upon the precept that Congress has established a Government Sponsored Enterprise, given it a particular set of operating parameters, and in consideration for that, said, ''You should do the following things.''
    I don't know how well we are today balancing the view as to whether they achieved their publicly stated goal in relation to the benefits granted to conduct that activity, and I think that is a problem. For example—and I am not being critical—but by way of demonstration, are there products which Fannie or Freddie have come to HUD for, for approval, but which have been denied?
    Mr. RETSINAS. No, there have not. As a matter of fact, the statute is clear. Our review has to do with programs and not products, and there have been two programs in recent years that have been brought to our attention. We have conducted that review, the more recent one consistent with our new regulations. The bar that is set by the statute—not necessarily inappropriately, but I say it more descriptively, if I may—is a relative standard. I don't know whether it is low or high, my analogy.
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    Chairman BAKER. That is OK.
    Mr. RETSINAS. The bar is whether a proposed new program is consistent with the GSE charter, which is a relatively broad charter, and whether it is detrimental to housing finance; not whether or not it is helpful or supportive, but is it detrimental? That is a different kind of standard imposed on us in terms of reviewing it.
    But, to answer your question on new programs submitted by the GSEs, we have not rejected them in recent years.
    Chairman BAKER. Well, in light of the fact that the constraints under which you approve or disapprove are centered in statutory constraints, and in light of the fact that one of them is operating in the negative—that you must demonstrate it is a disadvantage to the housing finance market—I would very much appreciate—I will put it in writing, but I would like the department's observations about what might be a better principal base of guidelines, as opposed to something that keeps you from making what you believe to be the best judgment.
    Mr. RETSINAS. I would like that opportunity, Mr. Chairman, and welcome that opportunity.
    Chairman BAKER. Terrific. And with regard to the consolidation question, with three different entities basically prescribed to do generally the same function, with entities with significant budgets; except for the case of mission oversight by HUD, there is not a potential. I mean, I am not suggesting, first, that consolidation should be a yes or no question based solely on the issue of financial consolidation. I think the principal question is whether the regulatory function is being properly conducted. But even so, I won't ask the question, but just respond to that. I think that consolidation does offer the potential for saving significant dollars in the operations of these three respective targeted agencies.
    I have a series of other questions. But I have kept you here so long and we have been interrupted by so many votes.
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    Oh, Mr. Leach has returned. I am sorry, Mr. Leach; did you care to ask another round of questions?
    Mr. LEACH. I have no further questions. Thank you, Mr. Chairman.
    Chairman BAKER. Thank you, Mr. Chairman. I wish to thank each of the participants here—especially for your tolerance, if nothing else—and I do have additional written questions I would like to forward for your review and response, and I appreciate your courtesy.
    Our hearing stands adjourned. Thank you.
    [Whereupon, at 1:04 p.m., the hearing was adjourned.]