Segment 1 Of 2     Next Hearing Segment(2)

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U.S. 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 10:05 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), Lucas, Jones, Ryan, Sweeney, Biggert, Terry, Roukema, Cook, Riley, Kanjorski, Velazquez, Bentsen, Weygand, Waters, C. Maloney of New York, J. Maloney of Connecticut, Hooley, Jones, Capuano, Hill, and Vento.

    Chairman BAKER. I would like to call the Subcommittee on Capital Markets of the House Banking Committee to order. The purpose of our hearing today is to receive testimony from regulators of the Government Sponsored Enterprises and to consider the implications of H.R. 3703, legislation introduced intended to enact a new regulatory format for Government Sponsored Enterprises. I think it appropriate at the outset to set the circumstance in which this hearing will be conducted, at least from my perspective.

    It is not held with a belief that the current financial condition of Government Sponsored Enterprises is in any way in jeopardy. They have enjoyed tremendous economic opportunity over the last decade. All are well funded, all are well managed, and all operate very successfully in today's marketplace. This hearing is not an attack on Government Sponsored Enterprises. I believe that if they conform to the mission statement in their charter, they provide a valuable public service.
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    It is not an effort to create or enact an unwarranted, unneeded, complicated regulatory scheme. It is, however, an effort to insure there is competent regulation on the activities of these enormous and extremely complex entities. I would point out that in 1992, the Congress acted with the creation of the office of OFHEO and required that entity to construct a stress test for the sole purpose of determining capital adequacy of these enterprises.

    Regrettably, as we meet here today eight years later, that stress test has not yet been implemented. My understanding is that one GSE has actually asked for a two-year extension to consider the potential implications of the implementation of that stress test. I am still learning a great deal about the GSEs, but know the basics about finance. Whenever I go in for a loan, the bank examines my personal statement, my collateral, makes a very difficult decision and then, at some future point, extends the credit, but capital and financial condition come first.

    I find the GSE circumstance to be just the opposite. Since 1992, when we said as a Congress ''establish a method to identify and establish if capital adequacy is there,'' over $2 trillion of debt has been extended by the GSEs as we are here today, and we still cannot objectively determine whether by regulator analysis whether the GSEs are adequately capitalized. That is unacceptable. This hearing will be followed by others. There will be no intent to rush to judgment. I certainly hope that there will be constructive suggestions to follow from all interested parties as to how this can best be constructed and certainly understand that our modest proposal can be perfected in a number of ways.

    I am particularly pleased this morning that the Chairman of the full committee, Jim Leach, has joined us and I would like to recognize the Chairman at this time for any remarks he would like to make.
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    Mr. LEACH. Thank you, Mr. Chairman. I think your hearing outline is very thoughtful. These are issues that Congress has an obligation to review on a continual basis. We set up the housing GSEs for a public purpose. They have served the purpose, in many regards, very well, but one of the real questions we all have to think through is what are the rules at any given point in time. And there are issues of stress tests that this subcommittee should review.

    There are also issues of competitive advantages in the marketplace even if one accepts the stress test that has been put on the table, because even with that stress test, the housing GSEs can leverage capital more than their competitors. This gives them an enormous competitive advantage in the marketplace on leveraged capital, as well as on the simple fact that they can, particularly at given points in time, purchase capital for less than their competitors.

    Issues have been raised, as the Chairman well knows, about the role of these GSEs and the total debt that they are issuing relative to Treasury bills. The Chairman has indicated and set out charts showing that at a possible point in time in the next three or four years, there will be more housing GSE debt than Treasury debt. But I would like to stress a second issue and that is that competitors of GSEs—commercial banks—are now holding, on the average, housing GSE securities almost equal to their capital.

    And that means, if you think of the too-big-to-fail doctrine, that if one of these GSEs fails, the Government is in an awkward position that will have a gigantic rippling effect on the banking system. This is another reason why prudential levels of capital have to be looked at very carefully. Now we are all fortunate as a society that these are well-run institutions. If they were not well run, we would be in a real pickle. And so we have to congratulate the leadership of both of these GSEs.
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    And, finally, I would just conclude by saying that one of the lessons in the last decade appears to be that the powers that these institutions have been given, coupled with the excellent management of the institutions, means that if they expand their authorities beyond the housing area, they have advantages in those areas. That raises the whole question of mission and that is something that I am pleased that your subcommittee has decided to look at carefully.

    Anyway, I want to thank you for your very thoughtful leadership. Whether one agrees or not from any Member's perspective with conclusions that you have drawn in the bill that I co-sponsored with you, the fact is as a committee these are issues that just demand review, and frankly, on a continual basis. Thank you, sir.

    Chairman BAKER. Thank you very much, Mr. Chairman. I do very much appreciate your willingness to co-sponsor the measure and would also point out that Senator Phil Gramm, the Chairman of the Senate Banking Committee, has commented that this is just a modest first step, but in only the way that Senator Gramm can say it. We are stumbling along over here trying to get it right, and I think we look forward to working with the Senator as well on his areas of concern and coming to some conclusions in this, but thank you for your interest and your support.

    Mr. Kanjorski.

    Mr. KANJORKSI. Mr. Chairman, thank you for the opportunity to speak briefly about H.R. 3703, the Housing Finance Regulatory Improvement Act, the subject of today's hearing. Let me begin my remarks by once again commending the Chairman for his leadership. In H.R. 3703, he has developed a legislative proposal certain to provoke considerable public debate about the future regulation of the housing Government Sponsored Enterprises, or GSEs.
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    He has also focused our subcommittee in recent years on a number of public policy issues affecting the operations of GSEs. Last year, for example, I worked closely with him to finally enact legislation to reform the operations and mission of the Federal Home Loan Bank System. Additionally, as a result of the Chairman's initiative, our subcommittee held several hearings in the 105th Congress on the effectiveness of the Office of Federal Housing Enterprise Oversight, the Department of Housing and Urban Development, and the Federal Housing Finance Board in pursuing their respective mission compliance oversight and safety and soundness supervision objectives.

    The Chairman also requested and received a series of reports from the General Accounting Office about the operations of the current GSE regulators. Then, after building a substantial legislative history about the performance of the GSE supervisors, the Chairman introduced H.R. 3703 in the 106th Congress, a bill designed, among other things, to create a single overseer for the housing GSEs.

    From my perspective, we need to have strong, independent regulators that have the resources they need to get the job done. Moreover, as one of the few remaining Members of the subcommittee who experienced the Congressional battle to resolve the savings and loan crisis, I am acutely aware of the need to protect taxpayers from risk. It is in the public's interest that we maintain a strong regulatory regime over Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. I am, therefore, pleased that our current GSE regulators are operating increasingly more effectively.

    Additionally, our Nation's current system for housing finance is not only extremely successful, but it is also the envy of the world. Almost 67 percent of Americans own the homes in which they live. This success, however, should not stop us from asking whether and how we can do a better job of increasing home ownership rates. We should always examine ways by which we can lower mortgage rates and improve regulatory efficiency.
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    That said, we should move forward cautiously in this area. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 is only now beginning to produce its intended results. By the end of this year, OFHEO hopes to finalize its dynamic risk-based capital standard for Fannie Mae and Freddie Mac. That rule will further help to protect taxpayers against systemic risk. HUD will also complete its work on updating the affordable housing goals for the two enterprises. These goals, as I understand, will force the GSEs to aggressively increase lending in underserved areas. Finally, the Finance Board is developing the many regulatory changes needed to implement the Federal Home Loan Bank Modernization Act of 1999. The creation of a single regulator at this time could delay all of these important activities. Furthermore, pursuing significant legislative changes could upset the housing finance marketplace. Fannie Mae, Freddie Mac, and the Federal Home Loan Banks all help to lower mortgage rates for consumers. We must work to ensure that our work does not raise those costs for consumers or inappropriately discourage investors.

    In closing, I hope that we are not on a fast track toward marking up this legislation. There is no pressing need for reform at this time. We should, however, carefully, deliberately, and objectively proceed in examining the public policy issues related to the mission compliance and safety and soundness regulation of GSEs. I look forward to debating the merits of this legislation.

    Mr. Chairman, as an aside, over the last several days I have met with many of the representatives of the various interests affected by this legislation. Because of the complicated nature of these relationships, I urge the Chairman to consider holding hearings in a different mode, such as a round table discussion, or perhaps a debate, where the various entities could come in and debate some of the issues that we are going to have to resolve.
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    And I think that would have two salutary effects. One, it would clearly inform a large portion of the Membership of this committee who have not gone through these issues before. Two, it would give us on a real time basis the opportunity to have issues proposed and then a response quickly proferred. That way, we could really cut to the chase of the matter. So I would urge in future hearings that we think about broad round table discussions where all the interested parties are brought to bear and have an open debate on the issue.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    First, to comment about your work with me on Home Loan Bank. Together we worked about a decade to go from the starting blocks to the finish line. The point is we finally made it, although I hope our clock doesn't run quite that long. I am confident together we will make the finish line on this one. I would welcome comment from all parties. In fact, having encouraged the GSEs and all interested groups to give written comment about their perspectives on the legislation and renew that this morning and certainly will consider every possible method to get information before the Members.

    You are very correct. This is complicated business. It is very important business. And we do not wish to do anything that adversely impacts housing markets. I would restate the obvious though. Somebody needs to stand between the taxpayer and the debt if things don't continue to work as well as they are and that is an extraordinarily large potential liability. I share your view of the 1980's, having come from one of the States that was unfortunately one of the most hard hit by that series of events and would remind the gentleman we do not wish to revisit those days for lack of regulatory oversight, and I know he shares that view.
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    Mr. Sweeney.

    Mr. SWEENEY. Thank you, Mr. Chairman. I would like to see unanimous consent to revise——

    Chairman BAKER. Without objection.

    Mr. SWEENEY. And I will submit a formal statement. As a relatively new Member and understanding the complexities of the issues attended here, let me just say that I am thankful that you are having this hearing, because I think it is absolutely proper and correct that this subcommittee engage in the oversight of the housing GSEs. I also will operate under a couple of premises while keeping an open mind. Before we agree to do anything here I would like to be sure that we are not jumping to address problems that are not there; and second, any effort undertaken should encourage innovation and fair market competition. I congratulate you on holding these hearings and I look forward to participating.

    Chairman BAKER. Thank you very much.

    Mrs. Roukema.

    Mrs. ROUKEMA. Thank you, Mr. Chairman. Again, I would ask unanimous consent to have my full statement in the record.

    Chairman BAKER. Without objection.
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    Mrs. ROUKEMA. And I do want to extend congratulations to you for raising this very legitimate subject and it is worthy of examination by this subcommittee and by the full committee as already has been stated by a number of Members. I also want to acknowledge that the proposal certainly raises relevant questions about the three regulators. Consolidation of these regulators is something which must be carefully considered, as has already been very carefully pointed out by other Members here today.

    But while the current system appears to cry out for regulator consolidation, I will acknowledge what the Chairman has already acknowledged and that is that we need to move slowly and carefully with full examination. First of all, as has been noted, I believe, the Gramm-Leach-Bliley Act has made significant changes to the statutory scheme for the GSEs and the Federal Home Loan banks. The changes in membership, capital and expanding collateral that is eligible for advances were among the most important changes of that legislation.

    And again while consolidating regulators might not appear to pose any risk, there is the question of unintended consequences, as I think several Members have all pointed out. I don't want to belabor that point, but we do really have to look at and have an examination of the real world experience of Gramm-Leach-Bliley and see whether or not we need to fix any of these unintended consequences before moving on to consolidation.

    That having been said, however, I think we have mutual motivations here. I believe that we are all committed to doing the best and right thing without unintended consequences. There is a potential negative impact on the American dream of home ownership, as properly has been pointed out. I think all here recognize that we are at an all-time high in terms of home ownership. We want to continue building on that American dream. In considering doing what Mr. Baker is proposing here, we are faced with the question: if it isn't broke, don't fix it.
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    I think that is too simplistic. Many people have said that in addressing this question. I do think we can accept the fact that none of us want to do any harm. We will apply the ''do no harm'' principle to this. I am very happy, Mr. Chairman, that you have raised the issue. There are a lot of legitimate concerns as have already been outlined with respect to safety and soundness in capital standards and these are the things that we are initiating a long—well, if not a long, certainly an in-depth study with all relevant information before we move ahead here.

    But you have made a good step—an excellent step, if not a giant step—perhaps one could say, in the right direction and opening up this legitimate subject. But again I expect this Congressional review process to be a thorough one and I hope I can say we will do no harm to the American dream of home ownership. Thank you very much, Mr. Chairman.

    Chairman BAKER. Thank you, Chairwoman Roukema. I certainly appreciate your courtesies and continuing interest in this matter.

    Mr. Cook.

    Mr. COOK. Thank you, Mr. Chairman. I would ask unanimous consent to have my full opening statement put into the record.

    Chairman BAKER. Without objection.

    Mr. COOK. I want to say we are particularly pleased that one of the important GSEs, Fannie Mae, has established a very important and new presence in my hometown, Salt Lake City. At the same time, I want to commend the Chairman for some thoughtful questions that are clearly being brought forth in this proposed legislation. I am most interested in getting the benefits of this hearing to know exactly what kinds of regulations are appropriate and necessary if that needs to be the case and I just want to commend you for holding these hearings.
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    Chairman BAKER. Thank you very much, Mr. Cook.

    Mr. Hill.

    Mr. HILL. Thank you, Mr. Chairman. And I would just like to echo the comments of other Members. We are living in the best of times. Some people would say these are the good old days, a period of unprecedented prosperity. Home ownership is at record levels. To a great extent interest rates are at also record low levels. But I think this is an appropriate time to examine the risks and the regulatory framework for these GSEs and make sure that when the inevitable business cycle turns the other way we don't get caught not understanding what the risks were and what the situation was so I would commend the Chairman for holding the hearing and look forward to the testimony of the witnesses.

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

    Mr. Riley, did you want to make an opening statement?

    Mr. RILEY. No.

    Chairman BAKER. At this time I would like to recognize our first witness for the hearing today. And a special word of thanks. I know that special efforts were made to meet our schedule and for that I am grateful. The Under Secretary of Domestic Finance, Gary Gensler, who will give us his views with regard to the current GSE safety and soundness issues. Thank you and welcome.
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    Mr. GENSLER. Mr. Chairman, Representative Kanjorski, Chairman Leach, and Members of the subcommittee, I appreciate the opportunity to testify on the supervision and regulation of Government Sponsored Enterprises. My prepared remarks are divided into four parts. First, a little background on GSEs. Second, GSEs' role in the capital markets. Third, a general approach the Treasury has taken to mitigating systemic risk. And then, fourth, turning my thoughts to the Administration's views on the bill.

    With your permission, Mr. Chairman, I would like to submit my full written remarks for the record, but summarize it, if that would be all right.

    Chairman BAKER. Certainly. Without objection.

    Mr. GENSLER. The Nation's interest in a vital housing market is strong, and the three housing GSEs have done much for home ownership in this country. Our capital markets are the most competitive and efficient in the world and generally operate without the Government providing differential treatment among financial institutions. Government Sponsored Enterprises are an exception to this general approach. The Government provides them with benefits to affect market outcomes.

    The potential benefits they bring to the particular market must be balanced, therefore, against potential systemic risk and effects on market competition. And reconsideration of this balance is appropriate from time to time as financial conditions change. With no particular problems on the horizon this is an ideal time to review the status of GSEs. The Federal Government initially created GSEs to provide credit to illiquid thrifts and to provide assistance to the secondary market for mortgages.
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    Much has changed, however, since this early history. Our capital markets have developed increasingly sophisticated techniques and tools for financing mortgages. Today, the GSEs are large, sophisticated financial institutions. Similar to other financial institutions, they hold and manage risk. They are owned by the private sector. They have large balance sheets and are leveraged. And in these ways the GSEs are very similar to other large financial institutions.

    The GSEs' growth has been aided by numerous benefits derived from their Federal charter. Congressional Budget Office, GAO, and the Treasury have consistently identified three advantages provided to the GSEs.

    First, the GSEs continually operate with significant funding advantages over other private companies in equal or better financial condition. While various estimates vary on this, my written testimony shows benefits of between 20 and 40 basis points.

    Second the GSEs operate with less equity capital per dollar of debt than other financial institutions. On average the two, Fannie and Freddie, have about $32 of debt for any dollar of equity capital and the Home Loan Banks have about $19 of debt per dollar of equity capital. This compares to other financial institutions where banks and thrifts tend to have about $11 or $12 of debt per dollar of equity and securities firms that are more highly levered at about $25 of debt per dollar of equity capital.

    Third, the GSEs receive direct cost savings as a result of exemptions from SEC registration fees and State and local taxes.
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    These advantages are significant in the marketplace in which the GSEs operate. And, again, the U.S. capital markets are the most competitive and efficient in the world. Relatively small advantages, even measured in single basis points, can allow firms to earn higher returns and potentially dominate their markets.

    The GSEs now control a central position in the mortgage market and an increasing share of U.S. debt markets. The three housing GSEs' debt was $1.4 trillion at the end of last year. This is large on any relative scale. It is roughly the size of the entire municipal bond market, which includes the debt of all 50 States and all localities in this country. It is now more than half of the $2.7 trillion of outstanding, privately-held marketable Treasury debt.

    If one added the $1.2 trillion of GSE guaranteed mortgage backed securities, GSE's involvement in the credit market approach is the size of the Treasury market. Based on recent trends and growth forecasts of the companies, GSE debt is likely to double in the next five years, approaching $3 trillion by 2005. This would surpass the Treasury debt market some time in the next three or so years.

    The GSEs have become the dominant institutions in the secondary mortgage market. As of year end 1999, Fannie Mae and Freddie Mac owned or guaranteed roughly 63 percent of all outstanding conforming conventional mortgages. GSE debt is also a significant portion of banking assets. As of mid-1999, banks held over $200 billion of GSE debt and also had approximately $350 billion of mortgage-backed securities guaranteed by those GSEs.

    Banks' holdings of GSE debt represent over one-third of their total capital. While banks are not permitted to hold more than 10 percent of their capital in any corporate bonds or not more than 15 percent lending to any one borrower, GSE debt is exempt from these various restrictions. And as you can see from the numbers, it is likely that many banks' exposure to any one GSE have that is beyond those limits. As the GSEs continue to grow, issues of potential systemic risk and market competition become more relevant.
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    Treasury's general approach to mitigating systemic risk and capital markets emphasizes the role of the private sector. The public sector does have various roles. I would like to identify three that are consistent with long-standing Treasury views. First, we must create an environment in which market discipline can work effectively. Promoting market discipline means crafting Government policy so that creditors do not rely on Government intervention to safeguard them against loss.

    Second, promoting the maximum degree of transparency, and, third, maintaining the competitiveness of the system itself. Promoting competition lessens systemic risk in any sector of the financial market, and the dominance of one or two firms can lessen competition and the efficiency of the market pricing mechanism.

    Mr. Chairman, I appreciate your efforts to highlight these issues. I now turn in summary to the legislative proposal. H.R. 3703 promotes private market discipline by repealing the housing GSEs' conditional line of credit with the Treasury. The dollar amount of these lines of credits are now a mere fraction of the GSEs' actual borrowings. For example, since its line of credit was established at its current level in 1957, Fannie Mae's mortgage holdings have increased over 300 times.

    Therefore, any function the lines of credit perform at this point is purely symbolic. Repealing the lines of credit would be consistent with the Congressional requirement that GSE securities clearly state that they are not obligations of the U.S. Government. The bill will also promote private market discipline by authorizing the appointment of a receiver to resolve a troubled institution, the same authority that other Federal regulators have, and by repealing the Home Loan Banks superlien authority.
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    The bill contains provisions that increase transparency, which we believe would increase the efficiency of markets. We also believe that the provision calling for the GSEs to be annually rated by an independent rating agency is an improvement over current law.

    The bill contains provisions promoting market competition as well. Limiting new activities of GSEs could limit their scale, increase their focus on mission-related activities and decrease the risk exposure.

    The bill also highlights an important issue, the potential for problems at one financial institution to cause instability in markets or to cause problems for other institutions. As I noted earlier, GSE debt obligations are exempt from the banks' investment security limits or banks' loan to one borrower limits. We believe that Congress should seriously consider the best way to repeal such exceptions with sufficient transition periods to prevent any market disruption.

    The bill also addresses the regulatory structure for the GSEs. We believe that the standard for regulation and the tools available to the regulator are issues of primary importance. But the identity of the regulator is important as well. And we agree with you, Mr. Chairman, that it may be appropriate to have common regulators for the three housing GSEs. We also believe that the supervision of the GSEs should be the duty of the Executive Branch of Government, which is charged with economic policy, both banking and housing policy.

    Responsibility for regulating financial condition could be placed with an agency responsive to those in the Executive Branch who oversee the soundness of the financial system. Experts in housing could supervise mission.
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    Mr. Chairman, if I may conclude, the economy and the financial markets are strong. The GSEs play a central role in the Nation's housing and debt markets. With no particular problems on the horizon, this is an ideal time to review the supervision and regulation of the GSEs.

    Thus, your subcommittee is providing a valuable service by thinking through the best framework for overseeing these enterprises. These are important matters of public policy that require balanced, thoughtful review by all interested parties.

    Chairman BAKER. Thank you, Mr. Secretary. I really appreciate your testimony. Mr. Kanjorski and I will make sure every Member gets the summary of your observations. I think anyone listening understanding the scope of obligations the GSEs now represent in the current financial market and fully understanding our current regulatory capacity, would have to have some concerns, not about today, but about tomorrow. Some have characterized H.R. 3703 as a ''solution looking for a problem'' or ''if it isn't broke, don't fix it'' approach.

    I would like to respond to those observations with this question. What was the financial condition of Fannie Mae from 1979 to 1984?

    Mr. GENSLER. Mr. Chairman, as I said in my written testimony, there was a time in the early 1980's when Fannie Mae found, based upon movements in interest rates, that on a mark-to-market basis they were insolvent. Again at this point in time we don't see particular problems on the horizon, but we do think it is appropriate to consider the balance of public benefits that these GSEs provide to the market and at the same time consider the risk to the financial system as a whole.
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    Chairman BAKER. I share that view exactly. I was merely pointing out that to understand the future one must look at the past. It is not something that is impossible nor altogether improbable and to act without some concern about future business cycles is, in my view, somewhat irresponsible. Looking to the future, we have a chart to your right, Mr. Secretary, which describes in graphic form what you said in your testimony with regard to the potential future GSE debt growth as opposed to the publicly-held Treasury debt.

    I think your testimony was a bit more progressive than our chart as it turned out. I think you indicated that it would be about 2003 when the GSE debt would surpass that of the Treasury. If you were to make some very large assumptions and that you were Secretary of the Treasury five years from this date and you were sitting in this committee room responding to questions from some troublemaking Congressman and look at these numbers that are represented by that chart where GSE debt would have not only surpassed, but exceeded Treasury debt by significant measure, would that be cause for concern given current regulatory constraints?

    Mr. GENSLER. I think that the chart that you have, which compares housing GSE debt versus publicly-held Treasury debt and includes some forecast into the future, is illustrative of the central role that the GSEs have come to be not only in the housing finance market, but in the debt market as a whole. And with the very good fortune of the economy and the fiscal discipline that this Administration and this Congress has been able to share, the Treasury debt is declining.

    On the chart I presume, I can't see the small print, that it is based on our publicly-disclosed——
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    Chairman BAKER. That is correct.

    Mr. GENSLER. ——Administration's forecast, publicly-held debt today is about $3.6 trillion and would be declining along that path. I was referring in my testimony to privately-held marketable debt, which we do not forecast publicly. Privately-held marketable debt does not include debt that is also held as savings bonds that is not marketable and is held by the Federal Reserve. So in my testimony, I was referring to the about $2.7 trillion in privately-held marketable debt and what might likely occur, which is why GSE debt would cross that line maybe a year or so before.

    But I think this is an illustration of the central role that these GSEs may come to be and why it is appropriate from time to time for this subcommittee to look at their supervision and regulation. It is also why we look at certain aspects of your bill in the context of how to mitigate systemic risk. We think it is appropriate to look at ways to mitigate that risk by promoting private market discipline, promoting transparency, and promoting competition.

    Chairman BAKER. Thank you. Another question with regard to potential systemic risk relating to loans to one borrower. As I understand it today, a bank cannot extend to one individual or corporation credit which exceeds 15 percent of capital and that in some instances there are financial institutions, credit unions, for example, with old agency paper as part of their tier one capital in the case of a bank. I am told that there are financial institutions of which in excess of 70 percent of that portfolio is agency debt, that there are significant numbers of institutions, perhaps as many as 30 or 40 percent, which have over half of that portfolio in agency debt.
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    How do we reconcile the concerns that regulators must have had when the 15 percent loan to one borrower limit was set as against the GSE's ability without constraint to occupy that level of concentration in a bank portfolio? Isn't that a terrible oversight on our part?

    Mr. GENSLER. Mr. Chairman, I think you have done a valuable service to highlight this issue in your bill. We think that in promoting private market discipline it would be appropriate with sufficient transition periods so not to disrupt markets, to repeal these exemptions. These limits were put in place to promote the safety and soundness of the banking system, there are various limits, but 15 percent loan to one borrower limit is for the banks.

    And we think it would be appropriate as there are numerous banks and credit unions, even though we don't have as good statistics on the credit unions, that do hold in excess of that 15 percent limit, and there may be some, as you say, that hold as much as—I think your number was 70 percent—of their capital in GSE debt.

    Chairman BAKER. One last question, because I am already well over my time. Can you tell me this morning that the United States Government does not extend its full faith and credit to GSE debt?

    Mr. GENSLER. I think that Congress has actually stated that GSE debt is not guaranteed by the U.S. Government and such a statement is actually contained in the prospectus and on the face of the debentures of all GSE debt.
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    Chairman BAKER. If we were concerned about the failure of LTCM and systemic risk, which caused the intervention of the Fed some months ago, am I to believe that if we had an agency difficulty that would not be a similar response?

    Mr. GENSLER. I think from Treasury's consistent philosophy, we think it is best to promote private market discipline, and that private market discipline means that investors and creditors should not only bear the fruits of their investments, but also bear the risk of those investments. And Government policy should be crafted in such a way that private creditors do not come to believe that the Government would in any way bear for them the losses that they may take from their decisions in the private markets.

    These are private sector firms and we look at this consistent with other financial institutions.

    Chairman BAKER. I appreciate your testimony and all your courtesy. Thank you.

    Mr. KANJORSKI. The market for GSE paper is rather, I think, secure, relative to the unsecured paper market. If we were to discourage further debt in mortgage lending by the GSEs, where would that investment money flow? Is it going to purchase back Government securities, in your opinion? Would you rather see it flow to credit card notes as opposed to mortgage money?

    Mr. GENSLER. Congressman, I think you are absolutely right. Part of that chart, the Treasury debt line is very much good news. It represents the shared view of the Administration and Congress that contributing to net national savings and preparing for our future by paying down the debt is very positive for the economy. The GSEs contribute to a very strong housing finance market and we share your view that it is important for that finance to continue and the markets to be strong.
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    I think that this chart is just highlighting that over time the GSEs may come to be even more central to the capital markets.

    Mr. KANJORSKI. Mr. Secretary, the point I am trying to make is that eventually if we carry that line out, we hope that around 2013, if the President's projections are correct, there will be no publicly-held Treasury debt. So at that point, all other debts are going to look like they are terribly expansive. But on the other hand, if we apply the formula that if the market is held relatively tight in its growth potential from this point on to 2013, actually before that, 2008, the domestic product of the United States would double, and the amount of money available for securities is going to more than double, so these funds are going to have to flow somewhere.

    The question is whether we are leaning towards hysteria when shown two lines, one coming down, and the other one going up, and not realizing that the policy discussions that we have to have here is where would the preference of the country and public policy be as to the placement of funds available in the marketplace? How much can flow into venture capital? What can go into product and investment? What can go into consumer credit? I for one, if given the choice of increasing my credit line and being sure that the consumer credit will be similar at the GSE line, I would prefer to take the GSE line over the consumer credit.

    Mr. GENSLER. I think that it is a very positive step in paying down the Treasury debt and that will free up money and credit for all sectors of the economy. Our general approach is really that the private sector is best to price and allocate that capital and certainly Congress has noted with regard to the GSEs that it is appropriate to have Government sponsored enterprises to facilitate credit in the housing markets and the housing GSEs have contributed significantly to the housing markets. I share your view that it deserves thoughtful and balanced consideration over time as this discussion goes forward.
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    Mr. KANJORSKI. Concomitantly with that problem, of course, is the consumer debt, and a lot of consumer debt is being consolidated in equity loans. I just came from a bankruptcy course given at the Congressional Research Service, and heard some of the financing rearrangements being made of interest charges as high as 20 and 25 percent on home equity loans for lower-income people who are in financial difficulty. If the GSEs carry on with their process of maximizing home ownership, at what percentage point would you think is our maximum level of home ownership? And finally then, is there perhaps another method to discipline the private market as to prevent overcharging and allow support for home equity loans?

    Mr. GENSLER. Administration policy has been that, again, it is best to promote private markets only where there is clear market failure, might it be appropriate to consider new activities for these GSEs or for even potentially new GSEs. And I think that is what Congress did when they created these GSEs many years ago, address clear market failure. We think there should be a high bar before moving to new activities beyond the ones already articulated in the charters.

    Mr. KANJORSKI. So part of the undertaking of this subcommittee should be to re-examine all those underlying formulas as well as what products can be developed.

    Mr. GENSLER. We think it is, from time to time, appropriate to look at the missions of any GSE so that they are focused, because it really is in a sense an exception to an overall philosophy we have in the capital markets and in this country of promoting the private sector. While recognizing that the GSEs have a mission, we think it is appropriate for Congress to look at it from time to time and to have a regulatory function that allows innovation on a real time basis. We think it is important these firms be able to innovate and be flexible with regard to their mission, and we share that view, because I think they have provided a great service there.
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    But, also, from time to time, look at assessing ''is this mission the appropriate mission?'', or, as you suggest, maybe possibly broadening it, or maybe doing something in the other direction. But that is really for Congress to decide.

    Mr. KANJORSKI. There were proposals. Regarding one of my earlier questions on the interest rate for refinancing packages, sometimes I think just getting users 20 or 25 percent. Does the Administration have any policy as to whether we should re-examine the Bush-D'Amato proposal of limitation of interest rate at some point in the future if unfeddered activity in the market occurs? I mean, there is an abundant sum of money out there and if we limit GSEs from concentrating on the housing market, that money will flow somewhere and it could very easily start channeling itself into consumer debt, particularly opening up the underserved market. The least-able to sustain that level of debt in our society will experience extremely high rates.

    I suspect anyone will lend money if the interest rate is high enough. Are we getting ourselves into a control mindset where Congress is going to have to start dictating limitations? And should we?

    Mr. GENSLER. I think in terms of access to capital, we think our economy is strong, but we should always be focused to make sure that all Americans are able to access the capital markets or access the banking system. We have done much in the Administration to try to broaden access and information. And I would also say competition, and as you have noted, sometimes the low-income or moderate-income Americans don't have that same access, but if we can promote access to the banking system and access to competitive capital markets, that would be a very good thing to move forward.
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    Chairman BAKER. Thank you, Mr. Kanjorski. Just to clarify, I am not concerned about the fantastic enhancements in housing markets. As Capital Markets Chairman, I am only worried about concentration of assets in one industry and concentration of investments by banks. If you took GSE off that chart and put the word ''Microsoft'' or put ''Chase'' or put ''IBM'' and you saw the amount of dollars held by that institution. I remember persuasive arguments made by the gentleman and others about how big banks are going to run everything in the United States if we do this modernization proposal in some form or fashion.

    And my point here is that we do not have the regulatory competency, in my view today, to fully comprehend their market risk and that is all that this is in pursuit of. I don't want the GSEs nor anyone else to take this hearing as what they are doing is bad or they are doing it poorly. That is not it at all. This is a forward look down the road and do we have the ability if that chart comes to reality to understand our exposure, and I honestly don't think we are there.

    Why don't we recognize Mr. Sweeney. We will have him for his comments and then we will recess for the vote and come back.

    Mr. Sweeney.

    Mr. SWEENEY. Thank you, Mr. Chairman. I will have a very brief question in an attempt as a new Member of this subcommittee to try to understand better capital markets. In boiling this issue down, Mr. Secretary, the question is what are the risks and do they rise to the level that we need to act? In light of that, and in light of Mr. Baker's point that some institutions hold agency debt as over half of their capital, could you play out a scenario for me reluctantly, as I guess you would be, on what those risks are and explain to me where the private sector risks are the greatest?
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    Mr. GENSLER. I think it would be best not to try to deal with a hypothetical, but what I think is all financial institutions, banks, security firms, insurance companies, GSEs, as part of their mandate in the private sector, seek to hold and manage risk. The GSEs do that and do that well, but still the nature of the financial system is that there is risk by the holding and managing of risk in financial institutions.

    Our general approach to managing—or I am sorry, our general approach to mitigating risk, is to promote transparency, to promote market discipline, promote competition. It is only in that light, that general light, when these issues have been raised by Chairman Baker's bill, that we have looked at some of these issues and found some of the provisions of the bill we believe help promote transparency or help promote the private market discipline.

    And while the economy is strong and housing finance is strong to take a thoughtful and balanced discussion of this at this time is appropriate as was done in years past in this subcommittee and may well be in years in the future.

    Mr. SWEENEY. The economy is strong and stable at this point, but if we were to undergo market changes, specifically, market changes in interest rates, explain to me what you would foresee occurring within the GSEs and within the overall market.

    Mr. GENSLER. I couldn't speculate on any one GSE, because it may not relate to interest rates rising or falling. These are very complex financial institutions as are banks and as are security firms. Very large sophisticated financial institutions are subject to a number of risks. Interest rate risk is one, as you have identified, credit risk is another. Something that is also true of large financial institutions is liquidity risk, the risk of when markets adjust, can you sell or buy your portfolio.
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    The history of markets has shown that there is also an intersection of these risks which relates to scale and liquidity. So for all financial institutions it is appropriate for regulators to look at how we mitigate some of those systemic risks through appropriate supervision and regulation.

    Mr. SWEENEY. I thank you, Mr. Chairman. I will yield back my time knowing that we have to go to vote and I have to go to another meeting. I again thank you for the hearing.

    Chairman BAKER. Thank you for your participation. The hearing will stand in recess pending the vote. We will return as quick as we can, Mr. Secretary.


    Chairman BAKER. When the hearing recessed, Mr. Sweeney had just completed his remarks and Mr. Weygand, you would be up next if you would like to be recognized for comment.

    Mr. WEYGAND. Thank you, Mr. Chairman. I would like to ask the Secretary just a couple of brief questions more on philosophy and direction that was probably an echo of my colleague, Paul Kanjorski's, Mr. Secretary. The chart that you have provided us, the chart on our left, indicates a change in direction with regard to debt. I apologize for coming in late. We had a previous meeting, but is it your position that this is not the direction we should be going in philosophically with respect to the Treasury regarding our debt?
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    Mr. GENSLER. With regard to Treasury debt it is very much the philosophy of the Administration that we want to bring down Treasury debt, our national debt, and contribute to net national saving and contribute to the economy.

    Mr. WEYGAND. And isn't it true that we have been working toward and talking about reducing the debt, not only Treasury debt, but overall Government debt, which provides more liquidity, more money in the marketplace for private investment in other ventures and that has been our goal. So isn't it philosophically the direction the Administration and most of us here have been taking anyway?

    Mr. GENSLER. I think that it is very much the philosophy of this Administration and shared with the Congress that paying down the national debt contributes to the economy through freeing up, and as we might say crowding in the rest of the market. I think that the context of—this was actually the Chairman's chart—is just that we think that it is appropriate from time to time for Congress to look at the balance, the balance of promoting housing, which we do very well in this Nation, and the benefits that are given to the GSEs, the various statutory benefits.

    That balance should consider on the other side issues of the risk to the financial system and issues of market competition. And it is best to do that when the economy is strong and when housing finance is strong. That is why we appreciate the opportunity to talk here today.

    Mr. WEYGAND. I do not disagree with the concept of periodic review to see if the balance is proper, the diversity is proper, and that things are not going wrong, but isn't it true that our philosophy has been that by reducing the debt we allow for more money to be in the marketplace to be used for mortgages with regard to home improvement loans and a host of other things, so we therefore have encouraged this philosophy that is illustrated on the Chairman's chart?
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    Mr. GENSLER. We have encouraged the top line for sure, and in ways we have encouraged the bottom line, but I just noted in my testimony earlier there are various benefits, funding advantages and leverage advantages and cost advantages that the GSEs have. And in our capital markets they are so efficient that even modest advantages can allow financial institutions to come to dominate their markets, and I think that is just what is highlighted on the bottom line.

    Mr. WEYGAND. Again, excuse me for not being here earlier, and I haven't read your full statement, but are you taking the position that the bill before us, H.R. 3703, is something that you are endorsing and promoting?

    Mr. GENSLER. We have really looked at the bill in a context of Treasury's general philosophy of mitigating systemic risk, promoting transparency, promoting market discipline and competition. There are a number of aspects of the bill that we think help in that regard. We think it is appropriate for the subcommittee to have a thoughtful review of this and really bring in all the parties who have an interest collectively of mitigating systemic risk.

    Mr. WEYGAND. And, last, in today's situation, today's conditions, today's marketplace looking toward the future, five or ten years down the road, are the regulators currently overseeing GSEs doing an inappropriate job or do you feel that there are presently problems within the existing regulations that would warrant a more immediate change toward H.R. 3703, or should there just be an ongoing discussion of how we can best make sure the market is not only competitive, but also promptly secured?

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    Mr. GENSLER. I think that there is not a problem on the horizon, but I think because of the significant change in the scale, scope, and centrality of the GSEs to the capital markets, it is appropriate to assess the balance moving forward.

    Mr. WEYGAND. And you think they, the GSEs, are getting too big and too central for your preference?

    Mr. GENSLER. No. I just think that there are aspects of promoting the markets in the financial system that from time to time are appropriate to look at. We think that the Chairman's bill highlights a number of those that may be worthy to move forward on. Also, we do think that it is very important that the regulator should finalize the risk-based capital standards and get those out promptly.

    Mr. WEYGAND. Thank you, Mr. Secretary.

    Chairman BAKER. Thank you, Mr. Weygand.

    Just to clarify on one of Mr. Weygand's questions and your response, this is not a trick question seeking an endorsement, but it is a clarification of points of concern. I recognize there may be concerns by HUD and others about the mechanism of the regulatory structure. Put that aside for the moment. Are there any other suggested aspects of H.R. 3703 that are a problem to Treasury at this point?

    Mr. GENSLER. Mr. Chairman, we have identified in our testimony a number of attributes that we support, some that we think are worthy of further and serious consideration to help mitigate systemic risk. I think that in terms of the regulatory structure we share some of the attributes. We think that mission regulation could be best served by being within the aegis of the experts on housing, and the financial condition regulation could be under some other oversight. So I think with regard to that we do have some different thoughts. We did not actually catalog each and every aspect of the bill.
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    Chairman BAKER. Let me follow up to make it clear for Members. I will transmit to you a formal request recognizing that the HUD mission governance issue is not a subject of debate. We understand the position there. But on the regulatory safety and soundness aspects of the legislation, I will write and ask you for a response if there are any aspects of that with which Treasury has difficulty, and you will be prepared to respond to that.

    Mr. GENSLER. As always, as Congressional requests come in, we respond to them. Absolutely.

    Chairman BAKER. For the subcommittee's benefit, I want them to know that is on its way. Thank you.

    I am going to try to do this in recognition of those who came first. Mrs. Roukema has been very patient here for most of the hearing and she would be next to be recognized.

    Mrs. ROUKEMA. Thank you, Mr. Chairman. I appreciate that, but you just asked my question. You and I have been thinking about the same issues. I want to ask Mr. Gensler if he would be more specific in terms of his evaluation of this regulatory structure. It appeared to me that you neither support nor oppose this regulatory proposal. You rather talked around it.

    I don't mean that you are trying to avoid the issues. We all recognize that there is a complexity to this. I would join Mr. Baker in submitting that question to you for a specific answer. Do you want to comment further now?
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    Mr. GENSLER. If I might. We believe the standard of regulation and the tools available to the regulator are issues of primary importance. The identity of the regulator is important as well. We focus much of our thoughts on the standard and the tools. With regard to the bill, we think that it may be appropriate to have a common regulator for the three GSEs, but have mission regulation led by those in the Executive Branch who are expert on housing and to have financial condition regulation, at least be responsive to those in the Executive Branch that have responsibilities with regard to the soundness of the financial system.

    We look forward to any review of this. We think any review of this should be thoughtful and balanced and bring in all the interested parties. These are important broad matters of public policy, and we have tried to lay out broadly what we think on the combined regulator issue.

    Mrs. ROUKEMA. Well, let us use your answer as the vehicle for further questioning. A little more amplification would be appreciated and would be the basis for our future inquiries and working together with Treasury on this subject. I have heard what you said about mitigating systemic risk. I certainly have recognized the importance of addressing systemic risk as well as recognize that there has to be promotion of competition, private market discipline, and increasing transparency. Can you spell out how do we do that in a couple of those areas?

    Mr. GENSLER. The bill suggests in terms of transparency that we could call for having independent rating agencies annually rate the GSEs. We think that this could be an added benefit, not only to promote the private sector market discipline, but also to provide regulators with an independent view as to the financial condition of the GSEs. There are also various flexibilities built in to the bill with regard to making public disclosures with regard to the GSEs. We think that though——
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    Mrs. ROUKEMA. Are all these adequate or would you go further?

    Mr. GENSLER. Well, in two cases we have actually have suggestions. One is with regard to what was earlier referred to as the banking system's exposure, credit exposure, to GSEs. It might be appropriate to work with Congress to have a sufficient transition period to find a way to bring the GSEs into the consistent scheme that we have for the banking system under those loan to one borrower and investment limits. Also, in a much smaller point, we have made a suggestion about bank exam fees.

    Mrs. ROUKEMA. All right. Well, we will look forward to further in-depth discussions on these issues. As I said in my opening statement, and I repeat now, that safety and soundness and the mitigation of systemic risk is essential. We can't, however, be just talking in generalities. We have to be quite specific. I look forward to your specific comments. There are other questions that I might bring up at another time. Thank you.

    Mr. WEYGAND. If the gentlelady would yield.

    Mrs. ROUKEMA. I would be happy to yield.

    Mr. WEYGAND. I would just like to follow up with the gentlelady from New Jersey's first questioning about detail and specificity regarding recommendations from the Treasury. I think it is extremely appropriate in this discussion that we are having about regulation. As I hear from you, Mr. Secretary, you are talking about a body that would actually oversee the development of mission. It would be that body who would oversee policy with regard to safety and soundness and then regulators.
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    This leaves a lot of unanswered questions about what you are actually telling us you would recommend with regard to H.R. 3703. I would truly hope that you could come back to us as quickly as possible with specific suggestions. If indeed you don't have a form or a structure that you would heartily endorse, but only a discussion about the possibilities, we would like you to be specific about those as well. It would be extremely helpful to us, because I think the Chairman is trying, in this legislation, to streamline or simplify the regulation, but what you have just outlined is indeed three different bodies or entities overseeing them all over again.

    And that would be, I think, some concern to the Chairman. Not necessarily to me, but perhaps to the Chairman and I think we as a body should know what direction you are suggesting we follow.

    Chairman BAKER. Thank you, Mrs. Roukema, for yielding to Mr. Weygand.

    Mrs. ROUKEMA. Thank you, Mr. Chairman.

    Chairman BAKER. I think Mr. Bentsen is next. I am not sure. I don't know the order of Members' arrival on the Democrat side. I will just proceed in order if that is OK unless somebody objects.

    Mr. Bentsen.

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    Mr. BENTSEN. Thank you, Mr. Chairman.

    Mr. Gensler, I have a couple of questions. I think, first of all, this is a rather broad bill that the Chairman has introduced and it raises a lot of questions. I don't think we can take this bill lightly at all. But I have some questions about your testimony. First of all, and I know this is just for comparison purposes, but I have got to tell you that I think the comparison of U.S. Treasury debt to the debt of the GSEs is really apples and oranges.

    You are talking about debt that is used for operational purposes in terms of the U.S. Treasury debt. It certainly has been for the last eighteen or twenty years. And it is sovereign debt, as well, compared to debt that is used arguably for capital formation purposes in the acquisition of mortgages for portfolio purposes. And so I am not sure that there is a comparison there to be made. Now the question may be that you are trying to get at is have the GSEs just become too big, given all of the benefits that they have.

    And that may be more where our topic should be, but I think this, and I know the Chairman has made this debate as well, I just think this is apples and oranges. And it may look good, but I don't think it is comparable. I think your comments with respect to equity to debt are reasonable, although the GSEs arguably have a different portfolio than banks would have. They have a different portfolio, because they are not carrying commercial loans in their portfolio and they have a different portfolio than securities firms would have, because they carry marketable securities, securities firms and marketable securities, as you know, some are more marketable than others given what is going on.

    But I am particularly surprised by the Treasury's comment, and I think this is new, that you believe that we ought to repeal the line of credit that the GSEs have with the Treasury, and even though it is only a small amount, $2 billion or $2.5 billion compared to their overall capital, it seems to me that it is still a rather significant statement that the Treasury is making about that. I mean, in my mind, and I think you would agree with this, that is the whole essence of their AAA rating that they enjoy right now.
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    In the past, when this subcommittee has looked at it and when rating agencies have looked at it, I think we have come where Moody has finally said that they thought on their own Fannie and Freddie would have probably a AA-minus rating, which is not a terrible rating, but certainly a far cry from a AAA rating. And your own testimony says it is worth 30 to 40 basis points, I think, or certainly some spread there.

    And you raise questions about the concentration of GSE debt held as assets by commercial banks and whether or not that is something that ought to be looked at as well. But at the same time that you are saying that there would certainly be some fallout if we were to repeal, in effect repeal Fannie and Freddie's market rating and that would put pressure on them and put pressure on banks that hold their bonds in their own portfolio.

    So I think we need to think about this and I think that we really ought to let Mr. Falcon and OFHEO do their job and let us see what happens and then come back and look at this. So I don't really have a question for you, but I guess it is more of a comment, but I would hope we wouldn't move too fast and I would hope the Administration or the Treasury Department would not push too hard on the Chairman's legislation at this time until we see what OFHEO comes up with on their risk analysis that they are doing and then perhaps come back.

    But I think also that Treasury might come back to us and tell us whether or not you think the GSEs have gotten too big and there is a need to completely restructure the secondary mortgage market. That is all I have, Mr. Chairman.

    Chairman BAKER. I don't think I will ask you to co-sponsor it, but we will keep an open mind. The only thing I would like to point out on the chart, you are correct, it is apples and oranges, but the problem is the GSEs will make it apples and apples. As there is less Treasury debt for people to invest in, they have to have a place for liquidity and safety to park that money. It will either be Fannie benchmarks or Freddie reference notes.
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    And I can't tell you today, and I don't think anybody in this room can tell you with great certainty, that we have an objective criteria to assure taxpayers of the agency's financial adequacy. I am not suggesting there is a problem. I am just saying we don't have the tools to do that properly and that is what H.R. 3703 is about. So it is not to preclude that chart from happening. It is to make sure when it does you can tell your constituents you know what is going on. That is really what it is about.

    Mr. Cook, you were next, I think, in arrival.

    Mr. COOK. Thank you, Mr. Chairman. I want to thank Mr. Gensler for his informative testimony. And again looking at the chart of GSE debt versus Treasury debt and the fact that in just a couple of years it is going to probably be larger than Treasury debt and if we project that out to even 2010 it might be massively larger. And I would like to get your opinion as to whether GSE debt is going to replace Treasury bills and Treasury debt as the benchmark for investment in bond markets. And, if so, doesn't that really imply some need to really look at this whole regulatory question?

    Mr. GENSLER. The U.S. financial markets are competitive, the most innovative of the world. We think that as Treasury debt declines it is very good for the economy as a whole, and it promotes many sectors of the economy as Congressman Kanjorski and others were mentioning earlier. We think that markets are innovative and will find a smooth transition to other referenced securities and derivatives. They have already done that to some regard.

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    And many other large corporate issuers beyond the GSEs are also assessing and looking to promote their securities as benchmarks. We believe the financial markets will sort that out in a smooth way over a long transition.

    Mr. COOK. At the same time, I do think that one of the hazards of a whole lot of new regulation is the fact that each one of these GSEs is different. Freddie Mac is different than Fannie Mae and it is certainly different than the Federal Home Loan Bank in terms of the rules and even the purposes and the conditions and functions and so forth. And I guess what I am asking is if there needs to be significant and new regulation how do we take care of those differences? If you could comment on what the major differences the regulators would have to be concerned with in terms of those two or three major GSEs.

    Mr. GENSLER. I think you raise a good point. We stated in the longer prepared remarks that we think that Congress has laid out different charters for particularly the Home Loan Bank System and the other two housing GSEs and if one were to move forward in consolidating or combining these regulators that it would be important for Congress to be very specific as to the mission of the various GSEs and to focus that mission on the intent of Congress.

    The Home Loan Bank System pursues its mission more through lending to banks and thrifts and the other housing GSEs pursue their mission differently. And those distinctions, even if one brings together the regulators, may be appropriate to maintain as they have been in the past.

    Mr. COOK. And then just kind of one final technical question. Is the Federal tax treatment both for corporations or individuals pretty much the same in all the different GSE debts and compared to Treasury or what are the—if you could just maybe outline the significant difference, if any, between how they—a holder of the debt, how the tax—certainly Treasuries are not taxed at State levels and so forth. I just wonder does that apply also to the——
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    Mr. GENSLER. Let me make sure I get this technically right. I think this will answer the question. The interest on the bondholders Federal Home Loan Bank debt is tax exempt at the State and local level. That is not the case with the other GSEs.

    Mr. COOK. I think more evidence of probably the difference in terms of regulations. Thank you.

    Chairman BAKER. Thank you, Mr. Cook.

    Ms. Waters.

    Ms. WATERS. Thank you very much, Mr. Chairman. Let me perhaps ask some questions that may have been asked before, but I need a little bit of clarification. Are the GSEs sound? Are we faced with GSEs presenting a particular kind of risk that I don't understand? Would you describe for me or answer for me is there a problem with the GSEs in terms of their management at this time?

    Mr. GENSLER. Congresswoman, we don't see a problem on the horizon. The economy is strong and the housing finance market is strong. These entities have, as we can note in the testimony, strong performance and strong growth, and they manage their risks as other financial institutions manage risks in a sophisticated manner. I think that all that we have noted in our testimony is that a lot has changed since 1992 when Congress last took these issues up in a broad legislative package.

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    Ms. WATERS. Before you go on, I just wanted to get that on the record and to have that understood. There is no problem and that they are managed well. As a matter of fact, since I have served on this subcommittee I have come to understand that they are admired, because of the way they have managed these GSEs and the way that they have been able to demonstrate that they can manage them well, they can provide the product, and they can make money for the investors. That is kind of the American way, isn't that right? Isn't that what everybody, all businesses, would like to do?

    Mr. GENSLER. All businesses would like to have the performance that these entities have had. These entities also pursue a public mission that this Congress and prior Congresses laid out, and they have certain Government benefits that help in their performance.

    Ms. WATERS. We understand that. We understand the reason for their existence. And one of the things I have come to appreciate about them is the access that we have in trying to work with them to meet the needs of our constituents. I just had a big hearing in my district by ACORN. Are you familiar with ACORN?

    Mr. GENSLER. Yes.

    Ms. WATERS. And it was about predatory lenders and subprime lenders and what is happening in communities such as part of my district where many of the subprime lenders are taking advantage of my constituents and I am working with Fannie Mae in particular to really strengthen and expand opportunities to support these mortgages. So I don't see any problem. We have access to them. They are managed well. And I just don't want anyone to listen to this hearing or to go away thinking that there is a problem or there is some kind of risk that exists at this time. Now let me ask, are you familiar with FM Watch?
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    Mr. GENSLER. Yes.

    Ms. WATERS. Do you know who they are?

    Mr. GENSLER. Yes.

    Ms. WATERS. You know they are worried about competition?

    Mr. GENSLER. I am not familiar with all of their worries, but I have read some of their papers.

    Ms. WATERS. Well, why do you think they are in existence and what do you think their stated mission is?

    Mr. GENSLER. I haven't read their mission.

    Ms. WATERS. You have got to know. I mean this is your business. This is one of the most talked about attempts to limit the abilities of the GSEs to expand or to do what they do and that is why this is something I think we should concentrate on today. You know, increasingly I find myself in a position here in Congress in the middle of fights.

    On the one hand, we have those who tout the American way and let the marketplace work and tout what competition is all about, but then we have those entities that when they find that they are not doing as well, they come to Government and they ask for more regulations so that they can place themselves at a better advantage. Now I know I sound like a Republican right now talking about these regulations. I can't imagine having to take up the Republican arguments about the marketplace and about getting rid of regulations that attempt to create some advantage for one side or the other, but that is what this seems like to me.
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    Mr. GENSLER. Well, I think, Madam Congresswoman, if I may, the GSEs have significant benefits in funding advantages, capital advantages, and cost advantages. Treasury looks at all financial institutions to determine how can we help promote the financial system by promoting transparency, private market discipline, and competition. And it is in that context of how we mitigate systemic risk. And there are times when we can benefit the system by mitigating systemic risk through prudent steps that lessen uncertainty and promote the economy.

    Ms. WATERS. But it is impossible to mitigate what does not exist and so we are talking about anticipating possibly something that may happen in the future that we have got to design mitigation for. And, you know, it seems to me that when we talk about transparency, just last week in the subcommittee we approved the Hedge Fund Disclosure Act that specifically refrained from requiring hedge funds to submit such information based on the notion that it is proprietary information. We put the hedge funds at a competitive disadvantage.

    Nobody wants to give away its formula for success. People don't just give it away. And if those who want to compete with them want to compete with them, they got to come up with a better mousetrap and I don't want to be used to do that. So I guess what I am saying to you is I appreciate the role that you play and the concerns that Treasury must have, but we don't have a problem here.

    Chairman BAKER. Would the gentlelady yield?

    Ms. WATERS. Yes, I will yield.

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    Chairman BAKER. Thank you. We have a series of votes and I want to ask for a response, if I may, before we recess, I just want to make sure I understand the gentlelady's concerns. We from time to time disagree on policy.

    Ms. WATERS. Yes.

    Chairman BAKER. Are you suggesting——

    Ms. WATERS. To say the least.

    Chairman BAKER. Sometimes we work together. Are you suggesting that my legislative effort is in some way tied to Fannie Watch?

    Ms. WATERS. Well, here is what I am suggesting.

    Chairman BAKER. If you can just give me a yes or no.

    Ms. WATERS. I am suggesting that it may be and you may not know it.

    Chairman BAKER. Well, I can fully assure the lady I have worked on this proposal for about a year with representatives of every financial regulator, the GAO, the CBO, and at no time have I vetted this proposal with any representative of Fannie Watch nor am I a dupe of Fannie Watch nor do I appreciate the lady's——

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    Ms. WATERS. I have not accused you——

    Ms. JONES. Will the Chairman yield?

    Chairman BAKER. It is not my time. It is the gentlelady's time.

    Ms. WATERS. It is on my time. Reclaiming my time.

    Chairman BAKER. I would point out her exceeded time, but she may continue.

    Ms. JONES. Will the gentlelady yield for a moment?

    Ms. WATERS. Yes, I will yield.

    Ms. JONES. Mr. Chairman, we are not suggesting that you are connected, but I would wish that you would have one of your staff people turn on the web page of FM Watch and read what it says on the web page about your legislation. You may not think it is connected, but I suggest you read it.

    Chairman BAKER. If the gentlelady will continue to yield, I would suggest she read the Treasury testimony of this morning, which is your Administration, which says this proposal is well-founded and reasonable, and I thank you for both your comments.

    Ms. JONES. You asked were you being connected with FM-whatever-it-is, and I am just suggesting that you read the website.
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    Ms. WATERS. Now reclaiming my time.

    Chairman BAKER. No, your time is exhausted. We are down to——

    Ms. WATERS. Unanimous consent for one additional minute.

    Chairman BAKER. The gentlelady is recognized.

    Ms. WATERS. Thank you very much. I am suggesting—first of all, let me be clear. I am not suggesting that you are a dupe. I am not suggesting that you are carrying the water for, I am not suggesting that you have met with them and you have worked out a deal, I am not suggesting any of that. But what I am suggesting is FM is out there and it is formed and organized for one reason, it wants to limit the competition so that it can be at better advantage to seek some of the same markets that these GSEs have. That is a fact of life.

    And so we don't have any risk. We don't have any unsoundness. We don't have GSEs that are unstable. We only have them that are performing, performing well, and doing a pretty good job. Now I want to tell you I have my differences with them from time to time and I am pushing them and I want them to expand to be able to provide more mortgages for poor people.

    I am not saying that they are everything that I want them to be, but what I am saying to you is that in a time when we should all be worried about spreading out this wealth and making sure that all communities have access to the opportunities so there can be more mortgages, more capital flowing. We should be dealing with that and not doing the business that will enure to the benefit of the FM Watch, because that is all that this does.
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    Mr. KANJORSKI. Will the gentlelady yield?

    Ms. WATERS. Yes, I will yield.

    Mr. KANJORSKI. I know that the gentlelady was not here for all the opening statements and comments, and I would just say that I guess if we look around this room and read some of the web pages, we probably could conclude that this is a battle of the Titans. But in reality, I think it is an opportunity to slowly examine these issues and that commitment has been extracted from the Chairman, and that this is not something that is going to move very quickly, and probably not in the form that it has been drafted. This hearing is merely a platform to examine issues.

    Ms. WATERS. Well, reclaiming my time, yes.

    Mr. KANJORSKI. I am very supportive of the distressed communities in the need for fairness.

    Ms. WATERS. Sure.

    Mr. KANJORSKI. This may give us an opportunity to use the GSEs to accomplish just that.

    Ms. WATERS. Reclaiming my time, if I may, and you have been very generous, Mr. Chairman. I really do appreciate it.
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    Chairman BAKER. Just remember.

    Ms. WATERS. I will. But reclaiming my time, why don't we have a series of hearings, why don't we take them out into the country, why don't we have legislation that is now being produced to anticipate——

    Chairman BAKER. If the gentlelady will give me just a moment.

    Ms. WATERS. OK. All right.

    Chairman BAKER. We are getting close to our vote time here.

    Ms. WATERS. OK.

    Chairman BAKER. If I had suggested reform and didn't have a specific proposal, criticism would be leveled. It is a generic hodge podge of unformed suggestions that make no sense cobbling together, and how can we give you a response if you don't have a specific idea? What I placed before the Treasury and the other regulators, from whom eventually we will hear some time in this coming week, is a specific proposal for their review and comment.

    I even circulated it to the CEOs of Fannie, Freddie and the Home Loan Bank. We have visited with anybody who said, ''Baker, what are you up to?'' This is not a sneak attack. It will not move fast, but I want to assure the lady I am going to do everything possible to see this proposal move forward in some fashion, because whether you agree with me or not, the ultimate end game of all of this is to continue the GSEs to perform their public mission, which, by the way, I don't think you think they do all that well, based on what I read in the paper recently.
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    Ms. WATERS. They are doing better than these predatorial lenders.

    Chairman BAKER. I got information that might surprise you. But, second, that they do not engage in activities which present unknown risk to future taxpayers without at least us asking the questions. Am I to understand that we are to let any business enterprise engage in such massive scale of activity and not ask the questions? We may not like the answers. We may not agree at the end of the day. But what is being presented here is merely a mechanism by which competent regulators can inform you and me as to what actions we may need to take in the future.

    So, understanding that the gentlelady is not suggesting that I am being manipulated by the free market forces and understanding——

    Ms. WATERS. I would not ever suggest that.

    Chairman BAKER.——that the lady suggested additional hearings, which we certainly will have. I think Members will be probably quite tired of hearings by the time I get finished. I just want you to understand when this is at the end of the path, your Administration is finding some merit in this proposal, and I intend in some manner to offer it for your consideration.

    Ms. WATERS. If I may, and I know that my time has——

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    Chairman BAKER. Everybody's time has expired. We are really——

    Ms. WATERS. Mr. Chairman, Mr. Chairman, you just supported the bill that restructured banking——

    Chairman BAKER. I actually wrote that bill.

    Ms. WATERS.——that handed the opportunity for banking to get into every business that it wants to.

    Chairman BAKER. With regulation.

    Ms. WATERS. You took down the walls.

    Chairman BAKER. With regulation.

    Ms. WATERS. You did all of that, and I remember your arguments were quite different.

    Chairman BAKER. No, they weren't. No, they weren't.

    Ms. WATERS. In relationship to banking and modernization than they are now when you talk about the original mission. I can tell you what the original mission of banks was.
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    Chairman BAKER. The gentlelady is raising an issue which we clearly have differences on. My policy on Government regulation for enterprise, GSEs is consistent. We will debate this ad finitum for coming months. We should stand in recess pending the vote and reconvene.

    Mr. Under Secretary, I appreciate your continued patience. We will return.


    Chairman BAKER. Mr. Secretary, while we are awaiting the return of Members, I am told we will have about thirty minutes to an hour likely before the subcommittee is interrupted again for votes. I would just like to revisit some of the ground that has been plowed haphazardly this morning.

    The principal concern prospectively is concentration in individual institutions, concentration in the broader capital market, and insuring regulatory capacity to assess potential consequences of that concentration. Is that a fair statement?

    Mr. GENSLER. I think so, sir. I think also that it is the balance of the benefits, the benefits of promoting the public missions that these institutions do, and as many Members have said, do effectively. And the balance vis-a-vis the risk that you have just identified to the financial system either as articulated by systemic risk or by the risk to market competition. And as time changes and financial market changes, the appropriateness of reconsidering that balance.
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    Chairman BAKER. And with regard to, I call it loan-to-one-borrower limit, from my perspective, that is the most immediate and concerning issue. Would it be appropriate for us to look beyond studying that case, either make the current loan limits to one individual applicable to the GSEs, do we do that over a period of time or do we simply give the regulator the authority to continue to monitor and make recommendations in the future? How on that scale of progression are you suggesting we should move today?

    Mr. GENSLER. The exposure limits or loan to one borrower limits are one of the important protections of the safety and soundness of the banking system. We think that it is appropriate to take a very serious look and actually bring all borrowers, including GSEs, under those same consistent limits to help mitigate risk in the banking system. We think you would want to take that step over sufficient time and transition, make sure to thoroughly consider all points of view, and have all parties comment on it, but we think it is an appropriate goal.

    Chairman BAKER. Thank you.

    Mr. Hill has returned and he was next for recognition.

    Mr. HILL. I presume, Mr. Chairman, it is for the customary thirty minutes as the last exchange was?

    Chairman BAKER. Absolutely, as long as you have a slightly different perspective on the circumstances.

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    Mr. HILL. Thank you, Mr. Chairman.

    Mr. Gensler, I am trying to—I guess I would say that this bill contains lots of good ideas, probably some not-so-good ideas, and I think the Treasury's testimony seems to suggest that it supports some of them, perhaps not all of them. I am trying to get a sense of what the problem is here and then focusing on what the solution ought to be and what the goal ought to be as a consequence of that.

    And it seems in your testimony what you said was that in essence, because of the size of the GSEs now and their dominance to the market or the extent of their market share that there is greater systemic risk and there is greater risk to them as a consequence of that.

    Mr. GENSLER. I think, Congressman, that is right. I would add that our capital markets are so efficient that with good management small advantages can be used to dominate markets and to grow rapidly. And so the advantages that Congress has bestowed upon the GSEs in pursuing their mission has both promoted that mission, but at the same time, those advantages would suggest that the GSEs growth would continue and that their growth would be faster than the economy and faster than the markets themselves.

    Mr. HILL. Those are two separate issues as I would see it. One is are these risks so large that they are not manageable or are we not adequately managing them or are we not regulating them sufficiently that they are adequately managed. That would be question one. And then the other question is are these advantages such that it either stifles competition or limits competition that will cause a greater concentration of market share in the GSEs.

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    I presume from what you just said that you believe that those advantages will further give them further advantage and increase market share.

    Mr. GENSLER. I think that has been the history of capital markets, particularly with good management, that those advantages will lead to increased market share.

    Mr. HILL. Are there some costs associated with this mission too? Are there some disadvantages that go with the mission that Congress has given to these GSEs?

    Mr. GENSLER. I think it is. I have chosen to use the word on behalf of the Administration of balance, because there are benefits provided to the GSEs, and there are benefits in our housing finance market and great innovations that have come forth from these GSEs over many decades. But at the same time the balance of what the scale of these institutions will be and what it does to market competition should be considered.

    Mr. HILL. But the goal here is to maintain some balance. Perhaps you are suggesting it is imbalanced now. Are you suggesting it has to be rebalanced, is that what you are saying?

    Mr. GENSLER. I think that thoughtful consideration is appropriate from time to time. As I understand it, the last time that Congress took this up was in 1992 and since that time the GSEs have close to quadrupled in size. They now are about 63 percent of the conventional conforming mortgage market. And so it is appropriate to look at it as I am sure you will be wrestling with for years to come.
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    Mr. HILL. Going back to the chart that everybody has made reference to, we are not arguing here that we want to have fewer mortgages. You are arguing here just simply that the amount of GSE debt is going to grow faster in proportion to the overall economy.

    Mr. GENSLER. Let me speak as a technical matter, if I might for a minute, because I had a chance at one of the breaks to read the footnotes on the Chairman's chart. The debt represents here is the debt of the three GSEs. In addition to this and somewhat separate from this they guarantee mortgage-backed securities in the marketplace of about $1.2 trillion.

    This debt is growing. As they purchase mortgages and hold them within their portfolio, and as the dialogue continues, I think this chart should not suggest something about their guarantee business. This is more, this chart here, about their portfolio business.

    Mr. HILL. Mr. Chairman, if you can indulge me one last question. Going to this line of credit question, and I think that it is an admirable goal to make clear to investors that the securities backed by the GSEs are not guaranteed by taxpayers, but this line of credit isn't the typical kind of line of credit. I mean the GSEs can't just draw upon this line of credit any time they want to on the basis of what they think their need is. Is that a correct understanding?

    Mr. GENSLER. That is correct, sir. It is actually written into statute that the Treasury Secretary has authority to purchase securities.
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    Mr. HILL. The question I have with respect to that if we were to repeal that is simply this: are there circumstances under which you think that it may be an advantage for Treasury to be able to add liquidity to the system through the GSEs that would be prohibited if we repealed that provision?

    Mr. GENSLER. The line of credit, at least for Fannie Mae, was put in place actually when Fannie Mae was part of the Government and kept in place as they were put out into the private sector. But it is really at this stage such a small number. As we said, these institutions have grown so significantly since their lines of credit were put in place that it has, at this stage, not a true ability for Treasury to use.

    I would also note Treasury does not have such ability with any other financial institution, so our consistent approach is to look at financial institutions similarly to promote private market discipline and promote private markets to be a moderator on risk-taking as best they can.

    Mr. HILL. So eliminating this provision isn't going to weaken the system in any way in your view or weaken Treasury's ability to respond to a crisis that might occur? It has not ever been used, is that correct?

    Mr. GENSLER. It has not ever been used in a crisis. There was one time as I understand it in the 1970's that it was used with regard to Freddie Mac in a small proportion, I think at that time actually to promote a mission goal, but I haven't researched that well enough.
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    Mr. HILL. Thank you very much.

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Hill.

    Mrs. Maloney.

    Mrs. MALONEY. Thank you, Mr. Chairman, and welcome, Mr. Gensler, and thank you again for all your diligent work with all of us on the financial modernization bill. And, Mr. Baker, I look forward to working with you on this bill although I do have some questions. The GSEs actually have played a very important role in the city that I represent, New York, and as my colleagues are aware, home ownership in the United States is extremely strong, and the GSEs have played a role in that.

    We are now at over 70 million families owning their own homes, yet at the same time we have room for a great deal of improvement. Home ownership rates for minority groups trail those of whites by more than 20 percent and as the mission regulator of Fannie and Freddie, Secretary Cuomo's recent decision to increase their affordable housing goals I believe is a tremendous step forward in addressing this serious problem and disparity.

    The Secretary's decision and action demonstrates one of the achievements of the 1992 GSE Act by splitting regulatory oversight of the GSE's public mission and oversight of safety and soundness between two regulators. The Act seeks a balance between the two objectives. I support the Chairman's objective of simplifying and strengthening regulation, but I think we have to be aware of unintended consequences of a sweeping rewrite of GSE, particularly in light of OFHEO's finally completing their risk-based capital standard.
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    And just last year, as part of modernization, we passed significant reforms to the Federal Home Loan Bank System for which substantial credit is due to the Chairman and the Ranking Member. And I agree with Mr. Bentsen that it might be more appropriate to see how the new risk-based capital rule and the post financial modernization of the Federal Home Loan Bank System operates before we redraft their total regulatory structure. But I have some specific questions on the bill. Do you believe there would be any impact on mortgage rates from H.R. 3703?

    Mr. GENSLER. Congresswoman, I just want to start and thank you also, because the experiences that we had with this entire committee, and I know that we talked a lot on financial services legislation, was productive and it is good to be back together.

    Mrs. MALONEY. You were terrific at 9:00 in the morning and at 4:00 in the morning, all those meetings, but it is good to see you again.

    Mr. GENSLER. Good to see you. Thank you. I think that you are correct to say that housing finance has been benefited in this country by the GSEs pursuing their mission. The issues that we are discussing here today—how to lower risk, and how to lower uncertainty—are always part of the sound promotion of our financial system. I think that that is what is important. To the extent that we can lessen risk and lower uncertainty in the markets, that tends to lower interest rates.

    Specific provisions in the bill that are consistent with Treasury philosophy of lowering risk should be better for the markets as a whole. I could not predict what it would do for particular markets or particular segments, but I think overall that it is good for the system.
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    Mrs. MALONEY. So you think it may lower mortgage rates?

    Mr. GENSLER. I don't know, and as a Treasury official we are schooled not to predict what will happen in specific markets, but in terms of the soundness of the financial system our overall approach has been promoting transparency, market competition, and private sector discipline. History tells us as we promote those, we tend to lessen uncertainty for the overall system whether it be one sector or another.

    Mrs. MALONEY. The bill would require GSEs to gain approval from the newly created regulatory board for any new program. It is beyond argument that the new regulator would therefore be more intimately involved in approving programs than is the case in the current system where there actually is no approval system. Is there a danger that the Government's increasing involvement in GSE's daily business that the markets could perceive a Government guarantee to be explicit, which would increase a systemic risk?

    Mr. GENSLER. I think that it is important that the GSEs be able to pursue their mission in an innovative and competitive way, but at the same time they should stay focused on that mission as Congress clarifies what that mission is to be. There are benefits in funding and leverage and other benefits that the GSEs have and so I think that Congress has been careful to only provide those benefits to accomplish a focused mission.

    We do think that we would want to make sure that people can be innovative and focus on the mission, but at the same time not to be able to use those benefits beyond the mission. And I think that that is an appropriate role for the mission regulator, to be helpful that people are focused on mission, not beyond the mission.
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    Mrs. MALONEY. But have they had examples in the past of programs that are beyond the mission? I am not aware of any.

    Mr. GENSLER. The challenge, it is a good, but hard challenge, is as a private sector firm maximizing one's opportunities. If one has advantages by the Government, these various advantages of being able to borrow at cheaper rates with higher leverage ratios, that the motivation will always be to maximize the opportunities and that is what we want the private sector to do. But as Congress has bestowed certain advantages, even small advantages can be used in many other markets and so I think Congress has spoken that you would want it to be focused on the mission, not in other markets beyond the mission.

    Chairman BAKER. Can you wrap up, Mrs. Maloney?

    Mrs. MALONEY. Pardon me?

    Chairman BAKER. Can you wrap up?

    Mrs. MALONEY. OK. My time is up.

    Mr. GENSLER. Oh, I am sorry.

    Chairman BAKER. Ms. Hooley.

    Ms. HOOLEY. Yes, thank you. Mr. Secretary, I apologize. I have been in and out today, but part of my problem as I am sitting here listening to this is I guess I need to understand the problem. You know, what are we trying to do? Are we trying to reduce the risk? Are we trying to—there was a chart up earlier, are we trying—or maybe the same chart is up. I just don't have my glasses on. Are we trying to reduce the debt? Are we trying to rein in GSEs? What are we trying to do? What is your perception of what we are trying to do in this particular piece of legislation?
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    Mr. GENSLER. I think to lessen the risk of the financial system, recognizing that the GSEs have bestowed upon them from Congress certain benefits, and that those benefits in the very competitive capital markets we live in can be and generally will lead to increased market share and increased dominance. Now the history of the GSEs is they performed well. Housing finance in this country is very strong.

    At the same time there is a balance of bestowing these Government benefits and recognition that growth and scale itself can raise issues of risk to the financial system and risk to market competition. We have looked at it through the lens of mitigating risk, mitigating systemic risk, and that is through the same way we look at it for other financial institutions.

    Ms. HOOLEY. Do you think the current arrangement actually adds to the riskiness of the GSEs?

    Mr. GENSLER. I think by bestowing Government benefits on any financial institutions you add to their ability to grow and dominate markets, that in and of itself, when one or two firms come to dominate a particular sector of the financial markets the pricing mechanism is at risk, the pricing mechanism within that capital market. Also other financial institutions who do not have those advantages can tend to take on risk themselves.

    Taking on risk is sort of left to less profitable businesses as they do not have the advantages that the Government bestows. Still though, as I say, if we focus and as you focus on the mission, we want people to be innovative in that mission and manage their risks within that mission.
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    Ms. HOOLEY. Just a quick follow up. There are agencies where they have come under one regulator, but have two totally different missions that have gotten into trouble, because it is hard sometimes to serve both of those missions under one regulator. Do you see that as a problem occurring under the proposal in this legislation?

    Mr. GENSLER. I think that the challenge that you highlight is one that we do address in the testimony a bit. We think it would be, if there are efficiencies to bringing the regulators together, beneficial that Congress clearly lay out the GSEs' specific missions as it was earlier said the Home Loan Banks pursue their housing mission differently today than Freddie Mac or Fannie Mae. We must also make sure that the GSEs stay focused on their intended mission, particularly because Congress has provided Government advantages to achieve that mission.

    Ms. HOOLEY. So you think under the new regulation it is going to bring down the debt?

    Mr. GENSLER. I am sorry?

    Ms. HOOLEY. Under the new regulator, do you see that bringing down—I mean if you look at those lines, do you see that bringing down the debt?

    Mr. GENSLER. We really focused on recognizing there is this growth and how can we help mitigate risk. I don't know whether this line will be higher or lower than that line, but regardless of where these lines are, I think our duty at Treasury is to highlight those ways to mitigate risk such that regardless of whether this line is a little higher or a little lower there is less risk in the system.
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    Ms. HOOLEY. Can there be less risk under the current system?

    Mr. GENSLER. I think that again reconsideration is appropriate. It should be thoughtful and balanced, and all parties should be involved, but reconsideration is appropriate from time to time as financial conditions change. Since the early 1990's, the size of the GSEs has quadrupled. It is likely to double in the next five years and so just that in and of itself makes it appropriate to take these matters up in times when the economy and housing finance is strong. This is the time that I think we would all rather be discussing this than if the opposite was true.

    Ms. HOOLEY. Thank you.

    Chairman BAKER. Thank you, Ms. Hooley.

    Mr. Kanjorksi wants a minute.

    Mr. KANJORSKI. Mr. Secretary, because we are expanding some of those missions to take into consideration economic development, community development, infrastructure development in distressed communities, it is only reasonable to assume that we can look forward to the cooperation of Treasury in revisiting the issue of economic development and the use of GSEs toward that end?

    Mr. GENSLER. We look forward to working with you and the whole committee on discussion of these important matters of public policy. I know that Assistant Secretary Apgar also from HUD is going to talk about the mission and the regulation in that regard as well.
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    Mr. KANJORSKI. Thank you very much, Mr. Chairman.

    Chairman BAKER. Ms. Waters.

    Ms. WATERS. Unanimous consent to submit my statement for the record.

    Chairman BAKER. I wouldn't object to a thing.

    Ms. WATERS. Thank you.

    Chairman BAKER. You are quite welcome. Without objection all Members' statements will be made part of the record.

    Mr. Secretary, I thank you for your long-suffering patience. We are going to recess. I notify the panel members of the second panel we will reconvene as soon as we return from this vote.


    Chairman BAKER. The hearing reconvenes, and we welcome our second panel of witnesses to the subcommittee hearing this morning. I am told, although I don't know how reliable the information is at this point, we have an hour before we can expect to vote, and I would hope if we continue on we might be able to conclude the hearing within that hour period.
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    Our second panel is composed of William Apgar, Assistant Secretary for Housing, Department of Housing and Urban Development; Armando Falcon, Director, Office of Federal Housing Enterprise Oversight; and Bruce Morrison, Chairman of the Federal Housing Finance Board. I welcome all three of you gentlemen here this afternoon and look forward to your remarks.

    Secretary Agar, would you care to proceed?


    Mr. APGAR. Thank you, Mr. Chairman, Representative Kanjorski when he returns, other Members of the subcommittee. I am pleased to be here today on behalf of Secretary Andrew Cuomo to testify on the effect of regulation of the Government Sponsored Enterprises or GSEs. The Secretary has delegated to me much of the responsibility for insuring that Fannie Mae and Freddie Mac, the two GSEs, are fulfilling their public mission responsibilities.

    As we have heard, these two enterprises enjoy considerable advantage over their private sector competitors and HUD is committed to achieving their public responsibilities. The intent of my testimony today is that HUD is doing its job and has proven to be an effective regulator of the GSEs, yet we believe regulatory oversight of the GSEs can be enhanced and to the extent the provisions in H.R. 3703 strength and regulatory oversight they merit careful attention.

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    Before providing some specific comments on the bill, let me review our current regulatory initiatives. First, of course, I would like to comment on our regulation relative to the affordable housing goal. As you understand, last year Secretary Cuomo announced plans to substantially increase the Congressionally mandated affordable housing goals that will require Fannie Mae and Freddie Mac to purchase as many as $2.4 trillion in mortgages over the next ten years providing affordable housing opportunities to 28.1 million low- and moderate-income families.

    So this is an aggressive expansion of the affordable housing goals and we think that merits serious attention by all Members. Substantially higher goals will require that beginning next year a large share of the activity of Fannie Mae and Freddie Mac will benefit families of low- and moderate-income. The new goals will substantially increase access to housing capital in many of our Nation's underserved communities and underserved groups.

    Additionally, the department has been active recently in mounting the most extensive fair lending review of the automated underwriting systems of the two GSEs. HUD initiated this first review in the fall and it is now well underway. In light of the importance of the GSEs' underwriting standards and growth of their automated systems in determining whether families realize the dream of home ownership this review is timely and essential.

    After much discussion and recognizing the need for protecting important proprietary information, Fannie Mae has provided requested information and negotiations are still underway with Freddie Mac. We think this information that we are receiving will allow us to effectively evaluate these important automated underwriting systems. Unlike other areas of HUD regulations, where I have chief responsibilities, the automated underwriting review is the responsibility of the Assistant Secretary for Fair Housing and Equal Opportunity and she shares that duty with our general counsel.
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    We have other areas of regulatory oversight that I would like to highlight. We are also active in the review of new program activities. Recently HUD requested information on a number of GSE initiatives including their mortgage insurance initiatives and their various Internet activities to see if they are operating within the context of the charter, in the public interest and with an eye to safety and soundness.

    Finally, we are active in reviewing their non-mortgage investments. We know this has been a particular concern of Chairman Leach. HUD issued an Advance Notice of Proposed Rulemaking on this topic and we have a major study underway to guide us in how to effectively monitor the GSEs' activities and non-mortgage investment arena. And last, but not least, we are busy trying to insure that there is availability of public information on GSE activities. We maintain an extensive public use database containing information about GSE activity and we begun to release additional tabulations of GSE activity to better inform the public of the activities of these two entities.

    With respect to the specific legislation, it is our general feeling that the existing structure works well and we believe that is backed up by our record of achievement in oversight activities in recent years. But at the same time, we believe that it can be improved upon and we welcome the opportunity to work with the subcommittee on enhancing overall GSE oversight. In creating the structure, Congress recognized the importance of establishing Cabinet level emphasis on GSE oversight and insure that there was consistency with respect to GSE oversight and its link to overall housing policy.

    At the same time, the recognition of the separate and important role of safety and soundness regulations through OFHEO, we think, was well taken. H.R. 3703 includes a number of helpful comments to enhance GSE regulations that we believe are worthy of careful consideration. These include the authority to assess GSEs; the full cost of the regulation, including mission regulation; clarifying and strengthening HUD's existing authority to review new program activities; and further Congressional directions for limitations on GSE non-mortgage investment.
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    In my written statement, I outline these in more detail. We think in each area those elements of the bill that can enhance overall GSE oversight are well taken. In addition, my written testimony addresses some issues relating to fair lending enforcement. H.R. 3703 would have HUD retain its general authority in this area over the GSEs. However, as we read the bill, the enforcement activity for this authority, which currently resides with OFHEO, would be transferred to the new entity and we are concerned that this would fragment our regulatory oversight in this important area of fair lending and think we need to continue to work to clarify that aspect of the oversight of the GSEs.

    In conclusion, we believe that HUD is providing strong and effective mission regulations of the GSEs. The current structure is working well and it is having a valuable impact on affordable housing markets. At the same time we readily acknowledge that, given the changing market conditions over time, there may be a need for revision to the existing GSE regulatory oversight structure as was suggested by Secretary Gensler.

    So, in the meantime, Secretary Cuomo and I look forward to working with the subcommittee as we build on the strengths of the current system and make the needed adjustments to make it work better in the future.

    Chairman BAKER. Thank you, Mr. Secretary. We appreciate your testimony.

    Our next witness is Director Falcon, who I understand returns for the first time since your appointment to your old banking haunts, so welcome back.
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    Mr. FALCON. Thank you, Mr. Chairman. It is indeed a pleasure to be back here in the room of the House Banking Committee. I do have nothing but fond memories of my time here serving on this committee. I must say I appreciate the opportunity to appear before you today to discuss H.R. 3703, the Housing Finance Regulatory Improvement Act. Mr. Chairman, I first want to commend you for your ongoing commitment to ensuring the best possible oversight of the GSEs and reiterate my support toward achieving these things.

    You and Representative Kanjorski have brought real leadership to GSE issues in general, and I look forward to working with you and your colleagues on the full committee to ensure the best possible oversight structure for the enterprises. As you know, since OFHEO began operating in 1993, Fannie Mae and Freddie Mac have doubled in size to over $2 trillion in assets and mortgage-backed securities guaranteed. The need for strong oversight is more critical now than ever before.

    As Congress considers the changes you have proposed, I want to assure you that there is a very strong regulatory system already in place. OFHEO works well as a safety and soundness regulator for Fannie Mae and Freddie Mac. The only major shortcoming, which I will address later in my testimony, is OFHEO's lack of financial independence.

    OFHEO's top-notch examination program consists of an annual comprehensive risk-based assessment of the health and management of the enterprises.
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    Also, as I am sure you are aware, we are moving expeditiously to implement a final risk-based capital rule. Mr. Chairman, I take your comments in your opening statement to heart. The risk-based capital rule is unacceptable and I make no excuses on behalf of OFHEO. I only want to assure you that my focus here is to get the job done and that is my number one priority at OFHEO to finalize the risk-based capital rule.

    OFHEO also conducts sound and authoritative research and analysis which enables us to become even more proactive in our oversight of the enterprises. While the current system is working well, that doesn't mean it can't be improved. Consolidation of the safety and soundness regulation of the housing GSEs could lead to even stronger oversight, if done properly. However, the consolidation of mission regulation with safety and soundness regulation is not essential for OFHEO or its successor to properly fulfill its safety and soundness responsibility.

    The lack of mission oversight does not hinder OFHEO's effectiveness or ability to do its job. Any need OFHEO may have to be informed about developments in mission regulation can be satisfied through the open lines of communication that exist between OFHEO and HUD. Nor has mission regulation suffered. Secretary Cuomo and Assistant Secretary Apgar have demonstrated their strong commitment to fulfilling HUD's mission oversight responsibility.

    I have several comments to make on H.R. 3703. The structure and authorities of the regulator created under the bill would maintain and, in some ways, even improve oversight of Fannie Mae and Freddie Mac. As provided for in your bill, more disclosure and transparency of the enterprises' activities would serve to increase the efficiency of the secondary mortgage market.
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    OFHEO already contributes toward this goal by disclosing the results and conclusions of our comprehensive annual risk-based examinations. In addition, the bill would require the regulator to obtain annual credit ratings for the enterprises from rating organizations. OFHEO obtained such a rating in 1996. With adequate funding, regular updates of this type could provide more information to investors about the enterprises' financial condition.

    The bill also reflects prudent public policy by providing for an appointment of a receiver for a GSE when necessary. The absence of such provisions serve to weaken market discipline by reinforcing the market's perception that the enterprise securities are implicitly guaranteed by the Government.

    I would like to address the regulatory structure contained in the bill. I believe that a single agency head is preferable to a board. This structure has proven effective and efficient for OFHEO.

    First, the single agency head focuses accountability on one individual rather than on diffusing accountability among numerous board members. Second, a single agency head unifies day-to-day management of the agency in one person, which avoids the confusion, dissension, and gridlock, which might sometimes be associated with boards. Also, a single agency head allows the agency to move quickly in reacting to the risks of the companies that it regulates.

    Whatever Congress decides on the final structure of the new agency, I know you will agree that the bill should do everything possible to ensure the success of the new agency. To that end, I strongly believe that the bill's transition period needs amending. First, the nine-month period, I believe, is far too short. I would recommend that the bill include a longer, more practical transition period.
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    During this period, the duties and functions of the existing agencies could be combined, allowing the integration of the agencies before the management assumes responsibility. This is especially critical if the new agency is set up under a board structure, because it would allow the new board to inherit a fully integrated agency. Finally, this longer transition would accommodate a more orderly merging of the technological and regulatory infrastructures of the agencies.

    Mr. Chairman, I would like to end with one final point, which I believe is critical to the success of OFHEO. I share your view that safety and soundness regulators need to be free of the uncertainty and inflexibility of the annual appropriations process. This is why I wholeheartedly support the bill's funding mechanism. I feel very strongly that the current situation of subjecting OFHEO to the appropriations process is simply bad public policy.

    That is why I ask this committee to remove OFHEO from the appropriations process. This would put us on par with all other safety and soundness regulators. I want to be clear that this change would in no way remove OFHEO from appropriate Congressional oversight. OFHEO would continue to be subject to the oversight of this committee and would still have to meet all annual statutory reporting requirements. Removing OFHEO would simply provide me with the flexibility I need to respond quickly to changing conditions, especially a deteriorating one, of the enterprises or the market.

    I want to thank you for your support of our previous budget requests as well. I want to also thank you for taking the lead on this appropriations issue. I hope that with our combined efforts we will achieve this goal this session. I would like to end by thanking the subcommittee again for the opportunity to testify this morning. As I stated, OFHEO is adequate to the test, but that does not mean that improvements cannot be made. I am committed to working with the Congress and this committee to ensure that the system for regulating the Government Sponsored Enterprises is as strong as possible.
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    Chairman BAKER. Thank you very much. We appreciate your presence here today.

    Returning again after many visits and as a former Member, welcome, Bruce Morrison.


    Mr. MORRISON. Thank you very much, Mr. Chairman, and to you, Mr. Kanjorski, as well and to other Members of the subcommittee. It is my pleasure to be here and I look forward to sharing some viewpoints on H.R. 3703 and related topics, but let me start by asking that my written testimony be included in the record and that that testimony also include my prior testimony in 1997, which addressed this subject as part of the subcommittee's earlier consideration of regulatory structure.

    Chairman BAKER. All testimony of all witnesses will be made part of the official record without objection.

    Mr. MORRISON. I also want to thank you, Mr. Chairman, and Mr. Kanjorski, in particular, for your leadership that led to the enactment of the Modernization Act for the Federal Home Loan Bank System last fall. As you know, this was a project with a long time in preparation and the success which was achieved last fall is due to both of you and your cooperation and your diligence in pursuing it, and it is very much appreciated.
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    I want to report to you that the Finance Board has taken very seriously the job of implementing that legislation. We have in process all of the regulatory changes that are required. Many of them have already become final. By April 12, we will have proposed regulations or issued final regulations for all aspects of statutory change in that legislation except for the capital provisions. The capital provisions will be proposed in regulatory form toward the end of May and we expect to meet the statutory deadline in November for final regulations.

    As I committed in a letter to the Congress—to the Chairman of the House and Senate conferees—at the time we had been consulting with Members and Member staff in that process, we welcome any input from Members of this subcommittee as we go through this regulatory process. In particular, I want to point out that we are about to propose regulations modifying the collateral that can be accepted by the Federal Home Loan Banks.

    This is important for two particular reasons. One, it will allow small institutions a much broader access to the advances of the Federal Home Loan Bank System and it will allow all banks greater access to advances to support economic development lending, because real estate collateral much more broadly than previously will be available to support advances. So in both of those ways the goal of the Congress in expanding the reach of the Federal Home Loan Bank System to Main Street credit needs will be benefited, and we are moving as expeditiously as possible consistent with safety and soundness to implement those changes.

    Now with respect to H.R. 3703, I think the most important thing to be said is that I very much support the goal that I know you, Mr. Chairman, have and I think that is shared by your colleagues regardless of what their views are on the details. That goal is that the regulation of GSEs needs to be efficient and effective. It should not be so intrusive as to interfere with their accomplishing their mission. It should make sure that they are safe and sound and it should also make sure that they are accomplishing the mission that Congress intends on behalf of the American people.
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    There can be focuses on individuals in particular roles and individual administrations in talking about this issue. I think we should separate ourselves from those kinds of discussions. Any individual can make the best of a particular structure, but the structure should be refined to maximize the ability of whomever may come and go through these positions to see to it that effective GSE regulation results.

    In my experience in five years as Chairman of the Finance Board, I must say that the challenges of mission regulation are great. This is not a popular subject with the regulated entities. The regulated entities think of themselves as private corporations and they find regulation of their mission to be intrusive no matter how efficiently it is done. It is also the case that safety and soundness needs to come first, and that mission regulation has always to be consistent with safe and sound operation.

    For that reason, I am a supporter of the kind of regime that we have at the Finance Board where safety and soundness and mission are conducted by the same agency. That is not to say that HUD is not pursuing mission aggressively in its current structure nor that OFHEO is not sensitive to mission when it regulates safety and soundness of Fannie Mae and Freddie Mac. It is just that either there are conflicts and they need to be resolved and they are harder to resolve in separate agencies or there aren't conflicts and therefore there is no reason to have them separated.

    Mission itself is the touchstone of what makes a GSE different from ordinary private corporations. They don't have different incentives from other corporations in terms of seeking profit. They do have different responsibilities in exchange for their public benefits. It will never be easy for a Government regulator to urge that these kinds of institutions do more than they are doing to accomplish the public purposes for which Congress organized them, nor will it ever be easy to draw lines around what they can and can't do. And yet, those are the distinguishing features of the existence of a GSE.
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    The stronger the regulator, the more respected by the Congress and by the regulated entities, the better we will do at that hard job. I must say that I think this is a relatively underdeveloped area of regulatory expertise and all of the agencies involved could be improved in that regard. So anything that can be done structurally, or in terms of attracting the very best people, or in terms of improving the tools, or in terms of clarity from the Congress, will all contribute to what I think we all share as the goal. When Government gives enterprises benefits, they want to see the benefits pass through to the American people and not see them stop along the way for shareholders.

    The fundamental difference between a GSE benefit and corporate welfare is that the benefit ends up with the ultimate consumer and doesn't stop along the way. That is our challenge. It is a structural one and it is a regulatory one. I think that this legislation is intended to work on that problem and I commend you, Mr. Chairman, for taking that on, as difficult as it is.

    Let me conclude by saying one other thing about GSEs and what the Congress is faced with. There has been a lot of discussion about the graphs. Some folks in this town want to do away with GSEs. They think that they are a distortion of the marketplace. I think they are a choice by the Congress to focus resources in areas that are important to the American people, and I don't think we ought to be pursuing a strategy to try to get rid of GSEs.

    I think what we ought to be pursuing is a strategy that sees to it that the American people get the benefits that come from the lower costs. Some of the things in your legislation and some of the additional things that have been talked about this morning have the risk of raising costs without really conferring any additional benefit. I refer for one particular to the repeal of the superlien enjoyed by the Federal Home Loan Banks.
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    The superlien is an efficient way in which the Federal Home Loan Banks gain a superior claim to collateral. If they didn't have that, they could still gain that superior claim by recording or physically holding each and every piece of collateral that they took as security. That would cost everybody a lot more money. It wouldn't change the fact that the Federal Home Loan Banks' claims were superior to FDIC's. So by doing that you would not advance the goal of changing the priorities in going after assets in a failure, but what you would do is raise the cost of advances and raise the cost of borrowing by member institutions.

    I don't think that is the right way to get at that kind of concern. There may be other ways to get at it, but I would avoid that. There are some who are proposing a step-by-step approach to raise the cost of GSE operations in the hope of leveling the playing field between GSEs and non-GSE private firms. If the goal is to reduce the risk to the taxpayer, I don't think it will accomplish the purpose. The risk to the taxpayer comes from the size and importance of these enterprises and that will not go away, because you take away some of the marketplace advantages.

    The loss of marketplace advantages will mean higher cost for consumers. That is not your goal, and I don't think that ought to be the goal. If you are concerned about too-big-to-fail, you should worry about how to scale down the size of the assets of the enterprises which can be done consistently with passing through the cost benefits to the consumer. If that is the concern, then that ought to be where the work is done.

    The last thing we should do is raise the cost for the consumer and still have the taxpayer on the hook, because that is a lose-lose proposition. And some of the proposals that are being made would lead in that direction. Thank you, Mr. Chairman.
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    Chairman BAKER. I thank all of you for your testimony. I would like to start with a question I asked Under Secretary Gensler.

    If we take regulatory structure off the table so that that is an unresolved issue; if we add to that list, for purposes of this panel, the question surrounding superlien status for Home Loan Banks, can each of you identify any other concerns as in your regulatory capacity that are contained in H.R. 3703 as either ill-advised; you feel should not be supported by the committee; or do you find the balance of the proposals basically safety and soundness recommendations to be an acceptable or constructive approach?

    Mr. Apgar.

    Mr. APGAR. With respect to the new program review, H.R. 3703 would require the regulator to make affirmative finding of the GSEs before they undertake new activity. We think that is good. HUD currently has the authority to review programs. What we are concerned about though is that the H.R. 3703 limits this review to mortgage-related programs and does not address the GSEs' pursuit of other activities that may or may not fall within their charter, so we think there needs to be some clarity.

    We do appreciate the fact that this expansion and clarification of the new program review authority, but we are worried about its limited nature specified in the bill.

    Chairman BAKER. On that point, has HUD ever declined a new product request of a GSE?
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    Mr. APGAR. We have done four reviews. In one instance our efforts were overtaken by Congress that explicitly acted overtaking our regulatory authority. We are currently doing a series of explorations about new activities. We have asked the GSEs to provide it and they have responded with information about their involvement in mortgage insurance-related activities, their involvement in Internet lending activities.

    In the case of Fannie Mae, we are asking them to provide us information about an initiative they have with Home Depot, a pilot program for home improvement loans, and with respect to Freddie Mac, we are asking about a new homestead buying center, which is a real estate brokerage effort, all of which we think at least on the surface posed the question of whether they are within the charter boundaries, whether they represent an effective public policy or whether they raise safety or soundness concerns, which is the three criteria we use for doing a new program review.

    Chairman BAKER. For example, on the Home Depot pilot, as I understand it, it is limited in scope today, but the constructive elements of it, I believe, is that Chevy Chase Bank would agree to finance home improvement items at the Home Depot store. If a fellow wants to add on a sunroom or put in a jacuzzi, Chevy Chase would extend the credit at the point of sale, and then the paper would be purchased by Fannie at the end of the line, is that correct?

    Mr. APGAR. Yes, that is a rough description of the pilot. In our mind, it raises safety and soundness issues and raises other issues of whether it is consistent with the charter.
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    Chairman BAKER. In some cases I understand that the extension of credit would not necessarily be secured by a home mortgage, it would just simply be a consumer extension.

    Mr. APGAR. Yeah, it is on that boundary of consumer lending which we are concerned about. Clearly, this is risky business. This type of lending can experience losses.

    Chairman BAKER. I just wanted to bring it to the subcommittee Members' attention as to the types of business expansion that are being considered. For example, two years ago there was a life insurance product that was suggested by Fannie Mae which——

    Mr. APGAR. Which was withdrawn.

    Chairman BAKER. Yes, but my point is that some have suggested that having any approval process would require disclosure of proprietary business activity that would be to the consumer's disinterest. Chairman Morrison, is it correct that Federal Home Loan Bank has a new product approval process and how does that work?

    Mr. MORRISON. Yes, we have had one for what we call pilot programs and that has worked in terms of both a submission process for legal authority and also a safety and soundness review before actual operations. We are expanding the scope of that as part of our collateral expansion process. So I certainly believe that a new activity approval process can work. It requires clarity of mission so you know whether it is inside or outside of the line. And it requires efficiency.
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    And I don't know whether the publication in the Federal Register is a good idea or not. That is in the bill. But such a process must require that things can move rapidly enough so that it is not a bar to innovation.

    Chairman BAKER. And to return to my original question, is there any other item in the legislation which you want to bring to our attention this morning that is problematic?

    Mr. MORRISON. I would identify the repeal of the Treasury line of credit in this way. As Mr. Gensler explained, this really just vests discretion in the Secretary of the Treasury to buy these securities. Therefore, it is not a compulsion to do so, and as he said, it is largely symbolic since the size of the credit line is wholly insufficient to deal with any real problem in any of the enterprises at this point.

    That being the case, this is about sending signals. So if the signal is that there is less connection between the Federal Government and the GSEs, then I would assume the markets would raise the price. I put that in the same category as the superlien. Before you raise the price, you ought to figure out where you are going and whether you are going to change the reality—which I say today is that the Federal Government could not stand idly by while one of these enterprises went bust. Anybody who believes that, you know, believes in the tooth fairy.

    That being the case, the last thing you want to do is be sitting with that potential risk and raising the price to consumers along the way. Then you are not getting the benefit of what the implied guarantee actually is delivering right now to the American people, which is a half to three-quarters of a percentage point lower mortgage rates than they would have otherwise.
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    Chairman BAKER. Thank you.

    Mr. Falcon.

    Mr. FALCON. Mr. Chairman, I view these issues through the lens of a safety and soundness regulator, so I would defer to my colleagues on commission issues. But there are some positive things in the bill, which deal with greater disclosure and transparency in the activities of the enterprises. I think those can only enhance the safety and soundness of the enterprises. There is an additional provision, which would remove the enterprises' line of credit with Treasury. They each have a $2.25 billion line of credit with the Treasury.

    Given that they are combined assets and not balance sheet assets over $2.1 trillion, that is largely a symbolic line of credit and so I don't think it would have a major safety and soundness impact. I think it is largely a question for the subcommittee to determine whether or not that symbolic role of that line of credit should stay or go.

    Chairman BAKER. Thank you. I do have a different view on the importance of that symbolic gesture and the pricing of that risk in the market explicitly for that reason to ensure that there is some measure of protection understood by those investors. But one other question——

    Mr. APGAR. Mr. Chairman, if I might.

    Chairman BAKER. Yes.
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    Mr. APGAR. I just wanted to make sure I was clear on our concerns about the fair lending provisions. The GSE oversight that we have gives certain authorities relative to fair lending. The way I understand the bill those authorities will remain with HUD, but the enforcement action would go to the new entity. We feel that that would divide our fair housing oversight function both on the GSEs and as it relates to other market players, then we need some clarification on how the fair housing piece of this would work.

    Chairman BAKER. That was understood, but I appreciate you for clarifying. We do have other Members and I don't want to go on at length. I have one just final thing that I would like to ask Mr. Falcon. With regard to the promulgation of the stress test, how far away are we? I have been asking now for eight years, and I hope that we are not going to extend the review period unnecessarily. Are we nine months away? A year? Eighteen months away?

    Mr. FALCON. Mr. Chairman, I can assure you you won't be asking for another eight years. I can say that safety.

    Chairman BAKER. I can assure you that too.

    Mr. FALCON. We are in the process of going through the comments we received on risk-based capital proposal and depending on the amount of work that is required in terms of adequately responding to each and every comment that we receive, and we receive thousands of pages of comments on this proposal, we will have to assess how much modification might be appropriate to the rule in response to comments in order to produce the best possible capital rule.
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    It is my hope, Mr. Chairman, that after going through these comments, I hope that we can get done before the end of the year. I say that at great risk, because I don't like missing deadlines and the agency has missed deadlines before. So, but that is my hope. It all depends on the nature of the comments and the amount of work that is required to modify the rule in response to the comments.

    Chairman BAKER. And let me for the record say all the reasons for delays and unmet expectations do not lie at the feet solely of OFHEO, and I certainly do intend to try to help with the appropriations resolution as best we can notwithstanding the outcome of this legislation.

    Mr. Kanjorski.

    Mr. KANJORSKI. Thank you, Mr. Chairman. Let me start at the very top.

    I think, Mr. Morrison, in your testimony you talked about some people in this town who do not like GSEs, and that there probably is some maturity level that a GSE gets to where it warrants privatization. Does anybody think that we should look at privatizing Fannie Mae and Freddie Mac as we did with Sally Mae? Are we at that level where they are mature institutions? And if we did privatize, would that lessen in any way the implicit full faith and credit support? In other words, would they be too-big-to-fail even if they were private institutions?

    Mr. MORRISON. Well, I am not a fan of privatization myself. First of all, we need to be clear on what true privatization actually means. Obviously, all the capital is privately-held today. There are many private aspects of GSEs to start with. But if you could ring out all of the public benefits that are different, you would have two problems.
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    One, you would also at the same time wring out all the benefits the consumer gets from those lower costs, so you would raise prices in this marketplace. Some people would say that is appropriate, because there is too much emphasis on housing. I don't happen to agree with that. But the other thing you would get is two enormously well endowed enterprises with enormous ability to dominate the marketplace. So you might end up with still having a kind of dualopoly power while you had given up any basis to require any public benefit. That wouldn't seem to be a very good outcome.

    So I think a much better approach than privatization is to focus on competition in the delivery of the GSE benefit. That is what we think we are doing with Mortgage Partnership Finance and other mortgage purchase programs: creating a third way of delivering the GSE benefit, which—by bringing a new form of competition—will mean the pricing will be as sharp as it can be, and, therefore, will be most likely to benefit the consumer.

    And I think there are other strategies one can pursue to make the ''too big'' part of the ''too big to fail'' equation less of a problem. The debt needs of the enterprises, including the Federal Home Loan Banks, can be made less of a problem. That is why we focus so much on the arbitrage issue, because we think that the balance sheet should be used for assets that actually deliver the goods to the consumer.

    So I guess what I would say that is the problems are worth considering. Privatization is unlikely to be the remedy that politically or economically will do the most good.

    Mr. KANJORSKI. Let me move to the next question then. If we do not privatize, obviously there is an importance with the mission and it seems to me as public policy is concerned, the mission statement of these entities are more than likely determined by who is President of the United States and who is in the majority of the Congress. If we were to create a single regulator and merge the mission control and safety and soundness regulation under one system, would we not be divorcing these entities from the representatives of the people or the President?
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    Mr. MORRISON. Well, I don't think so. First of all, the Congress ultimately writes the charters. By the same token, nothing Congress writes can ever be precisely tailored to everything that will come afterwards. So, there need to be regulatory interpretations. Whether you have a director or a board there——

    Mr. KANJORSKI. What about the independence of that charter?

    Mr. MORRISON. Well, if you are concerned—I think independence within limits is what you want. No entity should be independent from the byplay between the Congress and the President.

    Mr. KANJORSKI. Well, are we not talking about a structure similar to the Federal Reserve? Is that not somewhat divorced from the influence of Congress?

    Mr. MORRISON. I think what is in H.R. 3703 is very similar to the structure of the Federal Housing Finance Board. It is a five-person board. The only real difference is that the Secretary of the Treasury would be joined with the Secretary of HUD on such a board. That is very different from the Fed. We operate certainly under Congressional oversight and we have Executive Branch input today both from HUD and on an informal basis from the Treasury.

    Mr. KANJORSKI. I know we never have any difficulty filling these spots on the Board, because we have such great cooperation between the Administration and the Congress, but is competition not likely to happen if we create an independent agency?

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    Mr. MORRISON. There is no question that filling boards, certainly filling our board, has been an adventure throughout my five years on the board. And that very much might argue in favor of what Mr. Falcon had to say about the possibility of having an independent agency with a single head. All of these choices have up sides and down sides and I don't think any of them is perfect and ultimately it is the wisdom of the Congress that will govern.

    Mr. KANJORSKI. I take from your testimony, Mr. Morrison, that if we did not have the GSEs, particular Fannie Mae and Freddie Mac, the private sector would not have, and could not have, an entity as we do today for a real secondary market.

    Mr. MORRISON. Well, there is no question that the secondary market would never have been developed to the degree it has without the leadership that came initially within the Executive Branch. Fannie Mae was originally an Executive Branch agency. It was like Ginny Mae is today, a corporation within the Government. And the first securitization really came from there and then Freddie Mac when it was first developed was really very closely overseen by the Federal Home Loan Bank Board.

    So in all of these developments, and in what we have today, the private sector has gotten a marketplace with the assistance of the public sector. The question now is to make sure that the public benefit continues to exist from this very well developed market.

    Mr. KANJORSKI. I know my time has expired, Mr. Chairman. I just want to ask Mr. Morrison a question that Mr. Gensler answered. Will you cooperate with us as we get an opportunity to re-examine the expansion of the mission for the Federal Home Loan Bank System in taking larger roles in economic development, community development and infrastructure development in the distressed areas of the country?
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    Mr. MORRISON. Yes, as you know, I personally am very supportive of the Federal Home Loan Banks' taking a much more aggressive role with respect to that kind of economic development. I think the collateral change that you and Mr. Baker were very important in enacting will contribute greatly to their ability to do so.

    Mr. KANJORSKI. Thank you, Mr. Chairman.

    Chairman BAKER. Ms. Velazquez.

    Ms. VELAZQUEZ. Thank you, Mr. Chairman.

    Mr. Apgar, first I would like to thank you and Secretary Cuomo for the time that you have taken with the Hispanic Caucus to update us on your oversight of Fannie Mae and Freddie Mac. In conjunction with HUD's oversight, you have recently expressed concern about Fannie Mae and Freddie Mac's record in helping serve minorities. The housing GSEs argue that H.R. 3703, if enacted, will stifle the ability to develop innovative products and this in turn will hamper their ability to assist minorities in achieving home ownership. Do you think this is a valid argument?

    Mr. APGAR. No. I think that there are many opportunities today that exist within the confines of their charter to better serve minorities, low- and moderate-income folks, underserved communities broadly. We propose an aggressive new goal for them to meet and we think within the basic confines of the primary mortgage market and their role as secondary mortgage lenders, there are ample opportunities. We do not believe they need to reach out into new program areas. We do not believe they need to necessarily go into subprime lending or many other areas of expansion in order to meet these higher goals. It is a question of working hard.
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    I take the GSEs at their word that they have embraced these higher goals and I perceive that over the next couple of years we will see a substantial expansion of their involvement in underserved communities to the benefit of minorities across the country.

    Ms. VELAZQUEZ. Franklin Raines, the Chairman and CEO of Fannie Mae, recently stated that HUD's proposed rules, affordable housing rules, for Fannie Mae and Freddie Mac are tougher than CRA requirements for financial institutions. In fact, he referred to the proposed rules as ''CRA requirement on steroids.'' Obviously, you believe the proposed rules are reasonable and necessary. Could you explain to the subcommittee why that is the case, specifically how will the proposed rule help insure that Fannie Mae and Freddie Mac purchase loans in underserved neighborhoods?

    Mr. APGAR. Well, I saw the comment about the ''CRA on steroids.'' All I can say with respect to that is Chairman Raines has also stated many times, including at joint appearances with Secretary Cuomo, that these goals are doable and he welcomes the opportunity to push his company toward expanding their lending in this arena. Again, we have done a careful analysis of the marketplace and we have looked at the kinds of loans that private lenders are making and there is ample opportunity for Fannie Mae and Freddie Mac to increase their presence in these marketplaces.

    We note that both companies have initiated new programs to achieve that and most recently of course Fannie Mae has committed itself to a substantial increase in its lending across the board. So we think it is doable and we welcome working with them to expand opportunities in underserved communities.
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    Ms. VELAZQUEZ. If Congress enacted H.R. 3703 into law this year, could that delay HUD's efforts to finalize the affordable housing goal for Fannie Mae and Freddie Mac?

    Mr. APGAR. We are very concerned about the timing and the transition. As Mr. Falcon said, there is a major safety and soundness rule underway. There is GSE affordable housing rule in place and we would be careful about the transition period. It is our intention though to have our affordable housing rule finished and in place before the end of the year so it would affect it that way.

    But we do believe that HUD has demonstrated its record as being an effective regulator. We believe that—we share the view that Secretary Gensler mentioned that we need to have coordination in the housing policy arena and to the extent to which we have mission regulation it ought to be coordinated with those who are knowledgeable about housing policy and we think that is HUD and Secretary Cuomo I think has demonstrated that capacity to use his authority in the GSE regulations as part of development of an overall housing policy for the Nation.

    Ms. VELAZQUEZ. Thank you, Mr. Apgar.

    Mr. Falcon, as you know, this legislation will create a new five-person board combining all the representatives from the current regulatory agencies, but the bill does not integrate the different rules and functions of the current agencies. Doesn't this proposal seem to encourage a confusing bureaucratic situation that has the potential to detract from the safety and soundness activities of the board?
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    Mr. FALCON. I think it is critical to make this happen properly if it is Congress' will to make this happen that there be an adequate transition period to make sure that you don't run into these types of problems. I believe one of the things that the bill would do would be to require that OFHEO's risk-based capital standard be applied or some variation of it to Federal Home Loan Banks. To try to do that at the same time that you are merging the agencies and trying to put in place a new management structure for the agency would be very difficult and would make it, I think, difficult to properly integrate the different administrative functions, everything from payroll systems to staff and operation of the agencies.

    Ms. VELAZQUEZ. Thank you. I just have one more question, please. Mr. Morrison, the bill under consideration is called the Regulatory Improvement Act. There is no question that the bill will change the regulatory structure for the housing GSEs. The question is whether this change will be an improvement. In your opinion, would this legislation improve on the current regulatory structure, and if so, in which ways? If not, where does this bill fall short?

    Mr. MORRISON. Well, I think my sense is that it is the intention of the authors of the bill to improve regulation. I think there are a number of ways in which what is proposed here could do so. And the aspects of it that I think would be specific improvement are the coordination of policy for housing GSEs in one place. These entities are in the same business. One operates primarily at the primary level and the other two at the secondary level, but they are in the same business and different regulatory policies affecting them lead to unequal results.

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    And to the extent that they can be coordinated, that will be better. That doesn't mean that the current structure lacks any coordination, because Mr. Apgar serves on the Finance Board and that provides a level of coordination. There is informal communication and coordination all the time among the agencies. So we are not in any crisis. This is really a future-oriented question.

    I think that there are risks whenever you make changes in Government organization and you can get a mess. I think Mr. Falcon has been quite eloquent on that point, about what the risks are. So I think the Congress ought to think about this question not in a ''What do we need to do tomorrow?'' way, but rather ''What would we like this structure to look like five years from now? What are we likely to see on those charts in five years?'' and ''What would we like to be in place?''

    And if more consolidation and coordination is your choice, and that would be my choice if I were sitting in your seat, then plot a way to get there so you don't have the down sides. Resolve all of the competing concerns and move in that direction. There is no need to act precipitously. There is no crisis out there. This is about refining something, but no one should underestimate what we are talking about here.

    We are talking about trillions of dollars of assets under management in twelve Federal Home Loan Banks and two secondary market enterprises. It is a huge part of our economy and it doesn't look that way when you see three regulators here, each with his hand on one part of the system.

    Ms. VELAZQUEZ. Thank you. Thank you, Mr. Chairman.
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    Chairman BAKER. Just a little bit of equal time on the question of performance, Mr. Apgar. Ira Peppercorn, your predecessor, appeared before the subcommittee on July 30, 1996 and made a statement with regard to his observations about performance where in that time period of review low income borrowers accounted for 8.3 percent of GSE's purchasers of home mortgages compared to 13.5 percent of mortgages originated by commercial banks.

    Underserved neighborhoods accounted for 20.3 percent of GSE mortgage purchases compared to 26 percent of commercial banks. I remember reading something in recent weeks of your comments with regard to the practices of Fannie and Freddie in meeting minority needs. I don't know given the press reports of it how accurate those comments were. Do you stand by what I believe to be your observation about the performance of GSEs and minority lending and is it not in fact a more historic problem rather than just a recent revelation with regard to how they compare with the commercial banking industry?

    Can you speak to that, because I know Ms. Velazquez has a real interest in seeing these institutions perform and my point is they might can be doing a little better.

    Mr. APGAR. Yes. A lot of the discussion was about their performance relative to the overall banking and mortgage lending in general. The reason we are raising the goal is, because we perceive they can do more, that in fact we see that among minority lending in general they tend to lag the market, but there are particular areas where they lag even more so.

    We pointed out in the rule, although I have to admit it is in an obscure table deep in the bowels of the rule that in fact when you look at the overall record of Fannie Mae and Freddie Mac for African American lending and for Hispanic lending both of their share of business in those arenas are less than the performance of banks, thrifts and other mortgage lenders, and so we stand by those facts.
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    I think our focus on the rule is they can do better. The rule is to encourage them to do better and by all admissions they have committed to doing better so that is looking forward we think where we will be heading.

    Chairman BAKER. Just to put a fine point on this, commercial banks over the duration of analysis of regulators looking at percent of portfolio to African Americans have out-performed the GSEs every year for which I have been given data.

    Mr. APGAR. That is correct, even up to the most recent period for which we have the data.

    Chairman BAKER. Thank you.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman, and let me first of all welcome my fellow Texan, Mr. Falcon, to the panel. I apologize for not being here when you started. And I have to tell you, Armando, it is interesting to sit up here and see a list of questions that we might ask you. I am sure that you never had any opportunity to prepare these when you were staff some time ago, but I am going to stay away from those.

    I do want to follow up on the Chairman's line of questioning and also some comments that Mr. Morrison just made. And I don't know if the Chairman is implying perhaps we ought to apply the Community Reinvestment Act to the GSEs to see if they do a better job.
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    Chairman BAKER. No. I was just merely pointing out that making a $4 billion profit last year hasn't translated into loans to minorities.

    Mr. BENTSEN. But I guess you could say that the CRA has had some impact on banks and their lending into minority neighborhoods. Mr. Apgar, obviously we all know that HUD and the Secretary have been engaged in a war of words with the GSEs, particularly with Fannie and Freddie over their minority lending primarily to African Americans and Hispanic Americans. And you have a rule that you are proposing now to increase their targets for that lending.

    In your opinion, were Congress to enact the legislation that the Chairman is holding the hearing on today, particularly repealing the line of credit and potential credit market impact that could have on the GSEs, would you view that as being counterproductive to the rule that HUD is proposing at this point in time or do you think the GSEs could swallow both the changes that are provided for in the bill being discussed today and what HUD is proposing?

    Mr. APGAR. I would echo Secretary Gensler's comments with respect to the line of credit along with the Chairman. We think it is largely symbolic. We think that its elimination would reinforce what everyone believes to be the case that there is no explicit Government guarantee, but I think that that change particularly will affect their cost of funds and therefore will have no effect, in my opinion, on their capacity to meet the GSE affordable goals.

    Mr. BENTSEN. Now it is my understanding, and I thought I had it with me today and I don't though, that one of the rating agencies, I believe it was Moody's Investor Service, had said without this implicit guarantee that is assumed through that line of credit that Fannie or Freddie would go from a AAA to a AA-minus. As I told Mr. Gensler still a pretty good rating, nonetheless that would clearly affect their pricing and affect the pricing of their products, pricing of their debt and the pricing of their products. But you don't think that would have any impact on the targets that——
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    Mr. APGAR. Well, again I just echo Mr. Gensler's comments that there are other facts in terms of assuring the overall stability of the system that have positive effects and that those would tend to work in opposite directions so again we do not perceive that there is a major issue relative to this bill as relates to achieving affordable housing goals.

    Mr. BENTSEN. So from HUD's perspective you would agree with Treasury, Congress ought to go ahead and just repeal that and move away from the implicit guarantee for Fannie and Freddie?

    Mr. APGAR. Right. We try to be one Administration and so we share the Treasury's view on the line of credit. They have expertise in that area that far exceeds mine. And again the specific question concerning mission regulation, we don't see a conflict there.

    Mr. BENTSEN. Mr. Morrison said we should not act precipitously in this. There is not a crisis at hand, but we ought to be thinking long term, because of the size of the GSEs combined including the bank, the Home Loan Banks. Mr. Falcon's agency has spent the last several years, seven years, I guess, developing a risk-based capital model for Fannie and Freddie, that is in the final stages now at least of the rulemaking procedure and we will by the end of the year I guess get a feel for where OFHEO believes the GSEs are from a creditworthiness standpoint.

    Would it be in your opinion, Mr. Morrison, appropriate that we should wait for OFHEO and review that Mr. Falcon is doing with his agency before passing any legislation that would change the overall regulatory structure?
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    Mr. MORRISON. Well, I don't think you have to necessarily wait, nor do I think you have to necessarily act before that time. Whatever you do, you ought not to interfere with OFHEO concluding its process of finalizing that rule and putting it into effect. Nor should any change similarly affect what we are doing at the Finance Board to write a new risk-based capital scheme for the Federal Home Loan Banks, which is due out by November 12. No change should be managed in such a way to interfere with those goals, which are more important than how the boxes go together in the Government, more important to the safety and soundness of the GSEs.

    So does that mean you can't consider the question of what would be the best way in the long run to oversee those capital rules, to bring those capital rules into conformity? They theoretically should be the same, but they can't be, because OFHEO was given a very tight set of statutory rules that they must follow in writing—rules that are different from ours. So five years from now all three housing GSEs should probably have comparable capital rules, but they won't in the short run, and they probably never will if they are not under the same regulatory scheme.

    Mr. BENTSEN. Mr. Chairman, with your indulgence, can I just go back real quick to Mr. Apgar? And, Armando, I am sorry to leave you out of all this what my questions are. Are you saying HUD doesn't—Mr. Gensler, if I recall, said that there would be—there is a pricing differential that occurs, because of the rating and presumably without this implicit guarantee. I think this is right that Fannie and Freddie would lose their current AAA rating. Now I don't know whether HUD agrees with that or not. That would be my first question.

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    But second of all, are you saying that if there was a 30 or 40 basis point pricing differential that that would not have—you all don't believe that would have any material effect on Fannie and Freddie's ability to service the lower income market?

    Mr. APGAR. First of all, you presume that there will be a substantial change. He outlines scenarios in which there would be offsetting factors which would mitigate any interest rate change. But again it is a matter of what share of their business is oriented toward low- and moderate-income borrowers. We do not perceive that in many instances affordable lending is any more less the profit-making than mainline business is a question of developing extra business systems, the outreach and the context.

    We have done extensive studies on the margins, if you will, that can be earned by doing affordable lending and they hold up quite nicely. So while it may affect their overall business activity their proportion of activity that is devoted to low- and moderate-income folks we don't think it would necessarily be affected.

    Mr. BENTSEN. If we cut off their line of credit, why not just cut them off completely and spin them off completely. Let them break up whatever and let them go on and do their business as they will. I mean what connection do we have to them after that?

    Mr. APGAR. We perceive that our capacity to encourage them to engage in outreach to low- and moderate-income borrowers is enhanced by their current quasi-Government status. As a purely private entity, we think that they would move even further away from affordable lending than they are today.

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    Mr. BENTSEN. What quasi-Government status do they have once they have no implicit guarantee?

    Mr. APGAR. They have the oversight. They have the safety and soundness reviews. They have an association with the Government from its historical——

    Mr. BENTSEN. But in reality, and I don't mean to be argumentative, but in reality banks have the oversight and they have the safety and soundness review, but the only difference would be the long-term association, but the Government would——

    Mr. APGAR. And we best be clear, we are talking about securities which on their face say this has no Government guarantee, yet the market perceives that, because of the association of the entity historically with the Government, its Government roots, its Federal oversight through its board structure and other things that they have some guarantee. How that psychology change, because of the symbolic change, I remain to see.

    Mr. BENTSEN. Well, I don't completely agree with that, but my time has expired.

    Chairman BAKER. Thank you. Let us take the flip side of that just for an observation, a little equal treatment time on the other side here. Why don't we just take the implicit guarantee and make it explicit. If all the benefits that are flowing to the market are good for consumers by having the implicit guarantee and the line of credit to the Treasury, why not just put this sucker in the Treasury Department and say it is a nationalization of home mortgage debt in this country? Why don't we really make mortgages cheap? What do you think about that?
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    Mr. MORRISON. Would you like an answer?

    Chairman BAKER. Yeah, I really would. I mean the logic here is that by having the implicit guarantee, the line of credit, we are doing good things here, we are making home mortgages available to everybody, it is cheap, it is the way to go. Let us just put it on the record.

    Mr. MORRISON. As the Chairman knows, we do that with the FHA program and with the VA program.

    Chairman BAKER. Yeah, but I am saying let us bring everybody to the party.

    Mr. BENTSEN. If the Chairman will yield. The only point that—and the Chairman makes a very good point, and I guess my point is I think we are looking at this bill and not having a discussion about the broader issue before us, which I don't know if this is the intent or not, as to whether or not we are decided that the GSEs have gotten too big and it is time for us to move away from them. And here it seems to me we are maybe taking a back door approach to that. If we are going to have that discussion, let us have that discussion.

    Chairman BAKER. I am with you. Let us open all the doors. Let them all come down. Mr. Morrison, would you care to——

    Mr. MORRISON. Well, let me make clear that what I am about to say doesn't speak for anybody but yours truly. There is an attempt to somehow shuffle around this implied guarantee question. There is no question that the markets infer a guarantee. That is a fact. Mr. Bentsen is absolutely correct that Moody's has said that they wouldn't give a AAA to Fannie or Freddie if they didn't feel that the Government support was there because of their capital levels and other such things.
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    So it is there. And it doesn't serve a purpose to pretend that that isn't what is going on in the market. So when you make a decision, whether it be the Treasury line of credit or something else, you are faced with the question of what is the market going to think when you do that. And I think Congress is stuck with the reality. However it came to pass, if various kinds of Government assistance are removed, that is going to have cost impacts. And you are just going to have to decide which risks you want to take in that regard.

    The fact is that when there was a problem in deposit insurance, as there was in 1989, what Congress decided to do was just what you just said, go from that implied backing to full faith and credit. So I suggest if there ever is a problem with GSEs, you could figure out how it is likely to come out. But the real issue is that the concern ought to be the ''too big to fail'' issue. In other words, what are the taxpayers signing up to and are there ways to run the GSE businesses to stop maximizing the amount of debt and the size of the assets in the portfolio?

    And then whether they are ''too big to fail'' or not, they won't be so big and the taxpayer risk won't be so great. And I think that discussion—which has not been reached yet, but which I know that you and your colleagues are up for—is worth having. When I go elsewhere in the world and talk about housing policy, I find that everyone wants what we have been able to achieve by the sleight of hand of implied guarantees. Everybody asks ''How do we get an implied guarantee for our debt so that we can support housing in our country?'' The answer that those countries are all given is that ''the full faith and credit of your government is the best you can do if you want to replicate this.'' So the American people have gotten a bargain here. I don't know that anybody ought to want to mess with it, given its success.

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    Chairman BAKER. Let me characterize it this way. I am a co-signer as long as every other member on Fannie's debt and if that helps get better prices to our constituents, I will co-sign. I just don't want my phone to ring making good on that partial obligation of mine to pay off their debt in case things don't work out right.

    Mr. MORRISON. Which is the question of the quality of the regulation that you get.

    Chairman BAKER. That is it.

    Mr. KANJORSKI. Mr. Chairman, if we are going to get into that issue—and it is not a bad issue to get into, I would like to know the distinction between the implicit full faith and credit support and too-large-to-fail. I do not see a distinction. And, quite frankly, if we are going to open that up, are these multi-trillion dollar banks too large and are they getting an implicit underwriting of the taxpayers? In fact, would we not bail them out as the Federal Reserve did in the Long-Term Capital Management situation?

    Chairman BAKER. Let me reclaim regular order here. I started this mess and I apologize, but I just kind of got overcome by some of the arguments.

    Ms. Waters.

    Ms. WATERS. Let just ask a few quick questions so I can make sure I understand. Mr. Apgar, now Fannie Mae does not originate loans, right? They are originated by lenders, is that right?
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    Mr. APGAR. That is correct.

    Ms. WATERS. Now these lenders can sell the loans or keep them, is that right?

    Mr. APGAR. That is also correct.

    Ms. WATERS. Some of these loans don't carry any mortgage insurance, is that right?

    Mr. APGAR. That is true.

    Ms. WATERS. Which prohibits Fannie from being able to take them if they are not insured, is that right?

    Mr. APGAR. That is also true.

    Ms. WATERS. Now all of this data in this discussion that was in the papers about African Americans, have you seen that data?

    Mr. APGAR. Have I seen it?

    Ms. WATERS. Do you review the information that Fannie Mae submits and are you privy to what was in the voluminous information for review that is submitted by Fannie Mae?
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    Mr. APGAR. OK. Now we have to be careful here. With respect to their performance of GSE affordable housing

    Ms. JONES. Excuse me. Would you put the microphone in front of your mouth so I can be sure I understand everything you say, please? Thank you.

    Mr. APGAR. OK. I am not sure what voluminous data you are talking to. They submit to us very——

    Ms. WATERS. OK. What is your role in fair lending enforcement?

    Mr. APGAR. I have no role in the fair lending——

    Ms. WATERS. You have no role in fair lending enforcement, but you——

    Mr. APGAR. I do have a role in reviewing the performance under GSE goals, which includes performance in meeting the needs of underserved communities. The data that was presented in here was not a part of the fair lending review. It is part of our overall oversight of Fannie and Freddie relative to——

    Ms. WATERS. So you establish goals?

    Mr. APGAR. We establish goals.
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    Ms. WATERS. You establish goals for African Americans?

    Mr. APGAR. No, we do not. We establish goals for low income folks——

    Ms. WATERS. Why don't you establish goals for African Americans? You spoke about what Fannie Mae is not doing in relationship to African Americans, did you not?

    Mr. APGAR. We did.

    Ms. WATERS. Well, if you don't have any goals, what is your role in insuring that African Americans are outreached to or have advantage of getting the Fannie Mae product? I mean what——

    Mr. APGAR. Well, the underserved area goal, which is defined by a combination of low income status——

    Ms. WATERS. No, I am not talking about underserved. The article was about African Americans.

    Mr. APGAR. Well, if I can explain how increasing the underserved area goal will directly benefit minorities. It is proportioned——

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    Ms. WATERS. No. I said the discussion was specifically about African Americans, and I am really interested in African Americans.

    Mr. APGAR. Fair enough. A proportioned large share——

    Ms. WATERS. So I want to know why you don't have goals, and if you don't have goals, how do you determine whether or not Fannie Mae is meeting goals?

    Mr. APGAR. OK. The goals were identified by legislation as part of the 1992 Act. They prescribed what goals we can impose on them. We track——

    Ms. WATERS. On what?

    Mr. APGAR. On Fannie Mae and Freddie Mac.

    Ms. WATERS. For African Americans?

    Mr. APGAR. No. There is no specific African American goal. The Congress in its wisdom concluded it was not——

    Ms. WATERS. How do we determine whether or not Fannie Mae is meeting African American goals?

    Mr. APGAR. They report to us their information on their lending and we compare their lending to other lenders in the area and we note that their performance among African Americans lag other lenders in the market area.
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    Ms. WATERS. OK. All right. And that is good. I don't mean to be mean, you know. I am just like this. Let me ask you this. Did you do these kinds of comparisons. Remember when I first started talking the other day, I talked about subprime lenders at mortgage companies with extraordinary fees lending to people in ways that only cause them to be foreclosed on?

    Mr. APGAR. Yes.

    Ms. WATERS. Now are you putting those in the category of people that you compare Fannie Mae with——

    Mr. APGAR. No.

    Ms. WATERS. ——who are making these loans in these underserved communities that you think are kind of majority African American?

    Mr. APGAR. No.

    Ms. WATERS. Who, tell me who these others are that are doing so much better?

    Mr. APGAR. Who are these others? The thrifts, depository institutions, others who have presence in African American communities.

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    Ms. WATERS. Such as? I live there. Tell me. I know something about this. Tell me who they are.

    Mr. APGAR. Banks.

    Ms. WATERS. Which banks?

    Mr. APGAR. I can get you a list.

    Ms. WATERS. Bank of America? Nation's Bank? Wells Fargo? Tell me which ones.

    Mr. APGAR. Depository institutions in general often in response to their CRA obligations. We can get you a list of——

    Ms. WATERS. Did you see the latest information on the seven largest banks that serve Southcentral Los Angles and the number of loans they made in 1999?

    Mr. APGAR. I haven't seen the evils of Southcentral. I have seen national data.

    Ms. WATERS. If you are comparing, sir, if you are comparing, you ought to know what is being done. CRA activists, Greenlining and the others, Greenlining in particular, came out with a study that showed what the seven largest banks did, in 1999, in Southcentral Los Angeles. Do you know how many loans they made? 49.
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    Mr. APGAR. OK.

    Ms. WATERS. In Southcentral Los Angeles.

    Mr. APGAR. I would suggest that they ought to do more lending. Other depository institutions are.

    Ms. WATERS. Well, let me suggest something to you. The reason I engage you is this. You know, in some instances—well, we are constantly burdened with the fact that we must struggle to get the best that we can get from all of these institutions. If you were privy to what happened in the Bank Conference Committee where we were doing banking modernization and the fight that we put up on CRA, then you understand that the African American community, the underserved community, they are not doing well.

    They are not being serviced in ways that we think make good sense, but what I don't want you to do, because there is this competition fight between the FM Watch and Fannie Mae people who want to reduce the competition, want to kill off Fannie Mae's ability to do what it is doing, afraid of Fannie Mae expanding, all of that. I don't want you to come in here and point the finger at the only GSE that we have real access to, GSEs who meet with my minority banks and who purchase paper in ways that I don't think others would do.

    I again mention to you we have access. I can't get the CEOs of the major banks that own the subprime lending operations. I can't do very much about the mortgage entities that charge exorbitant fees and are foreclosing on my constituents day-in and day-out. So I don't want Fannie Mae to be diminished in any way, because it is responsive. I want them to expand their lending. They are going to try to meet these 50 percent goals.
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    And so I don't know what this is all about. And I think that Mr. Morrison, I think it is, said it best, no matter what you do, you've got to keep your eye on what is good for the consumer. I don't care about this fight and some may be here, and I am not suggesting you are, because I don't know who is, but I will find out, some may be here trying to protect the so-called participants in the FM Watch.

    But, my business is to look out for the consumers. And again, let me just say to you, this information that was unveiled did not take in a lot of the factors such as the ones that I have raised with you about who the banks are selling the paper to, whether or not the bankers are—some of them are keeping it in their portfolios and how the mortgage entities are getting more than I would like to see them with sometimes.

    And so this data really doesn't mean an awful lot. What is important to me is that the Government takes an interest in making sure that we keep at this thing of trying to get the underserved communities served. And let me just close by saying these advantages that we keep talking about, we don't talk about the restrictions and when I look at the banks and the thrifts, I see that they have to have—they are under the national charter. The deposits are guaranteed by the full faith and credit of the U.S. Government.

    They have access to the Fed window. They have access to the Federal Home Loan Bank advances. Look, they are all covered in some way. They are all covered in some way. They are all connected to the Government in some way. We are guaranteeing. And so let us not try and pretend.

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    Chairman BAKER. Can you begin to conclude?

    Ms. WATERS. Well, I guess I must, but——

    Mr. APGAR. Mr. Chairman, if I could make just a reaction to——

    Chairman BAKER. If Ms. Waters has wrapped up. Ms. Waters.

    Ms. WATERS. Well, let me just conclude by saying I am particularly addressing myself to you, because of your role in the discussion about loans to African Americans by Fannie Mae, and I particularly took a look at what your role was and what your involvement is and tried to make a determination about whether or not you had the facts and you had the data, you had the information. And I have come to the conclusion that there was a lot that was not discussed in coming to this conclusion. Thank you.

    Chairman BAKER. Thank you, Ms. Waters.

    Mr. Apgar, I know you wish to respond. Let me bring up one set of facts, which I believe you did make available in your defense. If I am correct, your observation is that approximately 5 percent of the conventional mortgage market, not the subprime lenders——

    Mr. APGAR. Subprime, correct.

    Chairman BAKER. We are talking about traditional banks and financial institutions. About 5 percent of the conventional mortgage business went to fund loans for African Americans. In the same timeframe approximately 3.2 percent of Fannie Mae's loans went for African Americans' purposes, while 3 percent of Freddie Mac. Now can you speak to Ms. Waters' concerns and address the points I have just raised?
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    Mr. APGAR. Yes. You just read the numbers off of my chart, which I was about to state and then the issue is what is this performance. I believe it is not for lack of trying. I know there is great leadership in both companies in trying to work on this, particularly Fannie Mae. But again, the idea that they are captives of the primary market I think is not correct to say.

    I would be happy to come work with you and show you the names of many people who would sell loans to them and enhance their service to African American communities if they were allowed the flexibility of the underwriting that they think would help them make these business connections. So there are many mortgage insurers and others who would be able to expand their outreach in the African American communities if Fannie Mae and Freddie Mac were more flexible in their underwriting circumstances.

    With respect to banks and thrifts, there are many banks who have portfolio loans which they would like to recycle if they could get favorable terms for Fannie Mae and Freddie Mac in order to buy those loans. That would free up capital to expand their lending in minority communities so it is not a question of them doing nothing, it is a question of can they do more and by all agreement we think they can do more. And Chairman Raines and Leland Retzel have agreed that they could reach out and do more. That is why they have embraced the goals and that is why we think we are moving forward in a solid direction.

     Chairman BAKER. If I can, let me suggest this proceeding for us. We just had bells. Mrs. Maloney and Ms. Jones have been very patient and waiting. Can I call on Mrs. Maloney now for a full five minutes. That will give us down to the five-minute bell and then just a quick wrap up and we will be happy to let you go.
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    Mrs. Maloney.

    Mrs. MALONEY. Fannie Mae and Freddie Mac have been tremendously successful in the district that I represent and really in New York City in providing loans for all kinds of people. They have really helped to grow home ownership, which I feel is an important social goal. But one of the things about the bill that I have a question about is the approval of new GSEs program.

    And to give one example, I approached Fannie back in 1998, because I don't have homes in my district. Everybody lives vertically. They are either in an apartment or a co-op or condominium. I said, ''You are doing great things to help Harlem and Historia and other areas of the city.'' Actually, Historia is in my district, but East Harlem used to be in my district and they were providing all kinds of loans there. I said, ''But you are not doing anything for the low-income people in Central Manhattan.''

    Within six weeks, they came back and devised a program to provide loans for co-ops and condominiums and have proceeded to grow home ownership dramatically. And to tell you the truth, I was very impressed that they had that type of flexibility to come back with a program that was really tailored to the economic problems or challenges of the district that I represented.

    And my question is, when you change the new products and put them not under HUD, but under this new regulatory agency or whatever it is going to be, this new regulator, and then you add 120 days to make such determinations, I am concerned that you wouldn't have the same type of flexibility and quick market response. What if this new regulator said, ''Oh, no, we don't think you should be giving loans to co-ops and condominiums.''
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    So, I just want to ask about that. And the oversight now—or rather the approval of new programs, seems to be working fine now in HUD, is that not true?

    Mr. APGAR. Yes. I think——

    Mrs. MALONEY. So why have this change, why have this change to this other regulator?

    Mr. APGAR. The example you give is in the arena that you suggest, the mortgage lending condominiums or cooperatives, that is clearly within the four quarters of this charter and would not require new program review. The new program authority is when they begin to venture outside of traditional boundaries of their activities, engage, for example, the sale of distressed properties, engage in home equity lending or other types of activities that are different from the mortgage lending.

    And I do share with you the concern that we don't want to make this process cumbersome and so I think all the commentators suggested that maybe the notice and comment feature of the rule as the legislation has specified may limit the flexibility to respond quickly and that would not be the desired effect. But clearly there has to be some mechanism to establish whether or not, given their advantages in the marketplace, they are sticking to this focused arena of expanding home ownership opportunity.

    Mrs. MALONEY. But, doesn't HUD have a review now? How long does it currently take HUD to complete reviews of new programs, and are there any problems that necessitate such a change now?
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    Mr. APGAR. We do have the current authority to review new programs. What we don't have is any requirements that they alert us ahead of time before they initiate a new program and so, quite frankly, we read about new activities in the paper and then we begin to inquire. We think there should be some clarification of the obligation of the GSEs to notify us when they are considering a new activity and give us at least a preliminary chance to review that before going ahead with a yea or nay.

    But in the case that you suggest that the condominium lending, triple-decker lending are all kinds of things within the clear mandate of providing mortgage capital that would challenge either ours or any perspective new program review authority.

    Mrs. MALONEY. Who is here from OFHEO, Mr. Falcon? What steps is OFHEO taking to ensure that taxpayers will not be asked to salvage insolvent GSEs?

    Mr. FALCON. We have a very, I think, state of the art capital in the works, as well as our examination program. I think our examination program look at every possible aspect of the enterprises, market risk, interest rate risk, corporate governance of the enterprises——

    Chairman BAKER. I hate to intercede, but begin to wrap up, because I want to make sure Ms. Jones gets her opportunity if you can.

    Mrs. MALONEY. OK. Well, I tell you, Mr. Chairman, you said let everything hang out there. Why not expand the mission to include Kiddie Mac? They have been successful in home ownership. Maybe they can do the same for day-care and help the building of day-care which is so desperately needed throughout our country. Seriously. I mean I know that is a goal that you support. Maybe that is something we could look at.
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    Chairman BAKER. I would bet if this legislation moves forward, you would have people mighty willing to talk about it.

    Ms. Jones.

    Ms. JONES. Unfortunately, I missed my first opportunity because we had a vote and when I got back you were on to the next panel so I would ask unanimous consent to include my opening statement in the record, Mr. Chairman.

    Chairman BAKER. Absolutely.

    Ms. JONES. We wouldn't be here, Mr. Apgar, Mr. Falcon and Mr. Morrison, if Fannie Mae wasn't doing a heck of a job, Freddie Mac, and they are out in the market doing wonderful things. Talking about too-big-to-fail, correct?

    Mr. APGAR. They are doing remarkable things in the marketplace.

    Ms. JONES. And the question I asked you was, we would not be here discussing too-big-to-fail if they weren't doing such a great job. That is a yes or no?

    Mr. APGAR. They are big. Yes, that is part of the hearing purpose. I believe we would be here anyway——

    Ms. JONES. Mr. Falcon.
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    Mr. APGAR. I am sorry.

    Ms. JONES. I don't have much time, so I am taking short answers. Mr. Falcon, is that correct?

    Mr. FALCON. Yes, they are well-run, healthy companies.

    Ms. JONES. Mr. Morrison.

    Mr. MORRISON. And the same is true of the Federal Home Loan Banks.

    Ms. JONES. The GSEs, excuse me. I didn't mean to leave everybody else out, but it made my question much shorter. So here we are, we've got three GSEs doing a great job and we are deciding now that regulation is the important thing to do, because we are afraid we may end up like we were in the thrift situation. Yes?

    Mr. APGAR. Yes.

    Mr. FALCON. Yes.

    Mr. MORRISON. And they are growing much faster than the thrifts.

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    Ms. JONES. OK. And they are growing much faster, but as of yet their performance has been wonderful, yes?

    Mr. FALCON. Yes.

    Ms. JONES. Yes?

    Mr. APGAR. Not in affordable housing——

    Ms. JONES. But my question really is—I am laying a record, because——

    Mr. APGAR. That was a no for me.

    Ms. JONES. ——because all these questions——

    Mr. MORRISON. I think you are going to have to let us answer and the answer is they could do better.

    Ms. JONES. I don't have—the answer is that they are doing a good job. My next is they could perhaps do better, but right now they are doing a good job, yes, Mr. Morrison?

    Mr. MORRISON. They could do better.

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    Ms. JONES. OK. Well, unfortunately I don't have enough time to do my great cross examination of you, so I am going to leave you alone and move on to something else. I am concerned, because as we talk about how Fannie Mae gets in the position to buy the flexibility of underwriting and you raised the issue that they ought to be more flexible when they are underwriting and have more favorable terms to purchase other people's mortgages, is that correct?

    Mr. APGAR. That is correct.

    Ms. JONES. I sat in my office, for the record, I am the Chair of Housing for the Congressional Black Caucus. I am from the City of Cleveland and the 11th Congressional District of Ohio, and I sat in my office with Fannie Mae representatives and a representative's metropolitan strategy group and discussed the very issue you are discussing. And one of the things that was raised by the Fannie Mae representative is, if it is a home loan that does not have mortgage insurance, Fannie Mae can't buy that, fair?

    Mr. APGAR. That is correct.

    Ms. JONES. Do you think that could be a factor in the amount of purchasing that Fannie Mae does from certain companies?

    Mr. APGAR. If it is a low down payment mortgage they need to have some form of credit enhancement. My sense is that they can enhance their flexibility and enable them to have more——

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    Ms. JONES. Answer the question. The question was, do you believe that could be a factor in determining whether or not Fannie Mae would have a better record in purchasing some of those loans since they do not have the mortgage insurance?

    Mr. APGAR. It could be.

    Ms. JONES. Thank you. What did you want to say?

    Mr. FALCON. I simply want to make the point, Congresswoman, that mortgage insurance is one of only three credit enhancements that is required for mortgages to be purchased which have a loan valuation of greater than 80 percent. If it is below 80 percent mortgage insurance is not required.

    Ms. JONES. Let me also say that I would encourage Federal agencies to not be in the newspaper pointing fingers at one another about issues that impact affordable housing in our communities, because when it happens like that it puts a bad face on all Federal agencies, and as we sit here pointing fingers at Fannie Mae. As much as I love Fannie Mae and Freddie Mac, the people in my community are more distressed as a result of HUD having properties in our community where they have been administered by poor landlords and then the landlords drop a property back on HUD and HUD can't find another buyer.

    And you know the property I am talking about in the City of Cleveland, Mr. Apgar, and I am still waiting to hear about that. So let us not get in the public pointing fingers at who is doing a good job or who is doing a bad job. Let us talk about how we can do a better job and increasing affordable housing in communities across the country. I yield the balance of my time, Mr. Chairman.
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    Chairman BAKER. Thank you very much, Ms. Jones.

    I am going to sum up very quickly. I appreciate all of your courtesies and participating. I would point out that H.R. 3703 contains eight legislative proposals, of which three have been the subject of discussion in the course of today's hearing with representatives of OFHEO, the Federal Housing Finance Board, HUD, and the Under Secretary of the Treasury.

    I take great comfort in the fact that there is some meritorious content in this legislation and would point out that the GSEs can do better, not only from a mission compliance perspective, but from a safety and soundness perspective although all three are well funded, well capitalized and we believe are being operated very safely. This legislation is about the future. And for those who do not wish to even look, I am frankly shocked. For those who do not wish to know the facts, I am rather perplexed.

    I think that the discussions that I propose to have over the coming months will shed more light on what should be the appropriate course of action for this Congress and this subcommittee to take. I am committed to make sure that taxpayers are not at the end of a long dark tunnel that leads to their requirement to pay off debts of investments they had no hand in.

    Likewise, I want to make sure that we do not inadvertently make sure that the cost of housing goes up. I think the two are not mutually exclusive. I think we can have sound regulation, affordable housing and we can allow the GSEs to engage in new products as they deem appropriate. But to fail to take on this obligation and to stick our head in the proverbial sand and wait for the inevitable to occur will not happen on my watch. Thank you.
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    Ms. JONES. Mr. Chairman, I can't allow you to end the hearing with saying that that is what Members on the other side of this subcommittee are doing.

    Chairman BAKER. No, I am not saying the other side. I am saying——

    Ms. JONES. Members on the other side of the subcommittee don't have their heads in the sand.

    Chairman BAKER. If the gentlelady will——

    Ms. JONES. I didn't interrupt you, Mr. Chairman. I am saying to you that——

    Chairman BAKER. I know, but the reason why——

    Ms. JONES. Members on this subcommittee do not have their heads in the sand and they are not saying that regulation isn't important, but they are saying that why do you need regulation when you don't have a dilemma? And I just want the record to be clear that our heads are not in the sand, Mr. Chairman.

    Chairman BAKER. I don't know where they are, but I will tell you this, Members on both sides——

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    Ms. JONES. Mine is on top of my head.

    Chairman BAKER. Members on both sides have their observations about this legislation and I am entitled to mine, Ms. Jones.

    I am sorry she had to leave. I would like to continue this on, but for the sake of winding this up, I appreciate your courtesies, your input. It has been most helpful and I am convinced we will come to a favorable legislative conclusion. Thank you very much.

    [Whereupon, at 2:30 p.m., the hearing was adjourned.]

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