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31–527 PDF 2007

OFHEO’S FINAL REPORT

ON FANNIE MAE

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE, AND 

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

JUNE 6, 2006

Printed for the use of the Committee on Financial Services

Serial No. 109–98

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED

ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair 

CHRISTOPHER SHAYS, Connecticut 

PAUL E. GILLMOR, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

SUE W. KELLY, New York 

ROBERT W. NEY, Ohio 

VITO FOSSELLA, New York, 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

MARK R. KENNEDY, Minnesota 

PATRICK J. TIBERI, Ohio 

J. GRESHAM BARRETT, South Carolina 

GINNY BROWN-WAITE, Florida 

TOM FEENEY, Florida 

JIM GERLACH, Pennsylvania 

KATHERINE HARRIS, Florida 

JEB HENSARLING, Texas 

RICK RENZI, Arizona 

GEOFF DAVIS, Kentucky 

MICHAEL G. FITZPATRICK, Pennsylvania 

JOHN CAMPBELL, California 

MICHAEL G. OXLEY, Ohio 

PAUL E. KANJORSKI, Pennsylvania 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

ARTUR DAVIS, Alabama 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

June 6, 2006 ...................................................................................................... 1

Appendix: 

June 6, 2006 ...................................................................................................... 23

WITNESSES 

TUESDAY, JUNE 6, 2006

Lockhart, Hon. James B. III, Acting Director, Office of Federal Housing 

Enterprise Oversight ........................................................................................... 9

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 24

Gillmor, Hon. Paul E. ....................................................................................... 26

Lockhart, Hon. James B. III ............................................................................ 27

(1)

OFHEO’S FINAL REPORT 

ON FANNIE MAE 

Tuesday, June 6, 2006

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 2:00 p.m., in room 

2128, Rayburn House Office Building, Hon. Richard H. Baker 

[chairman of the subcommittee] presiding. 

Present: Representatives Baker, Gillmor, Royce, Kelly, 

Hensarling, Davis, Oxley (Ex Officio), Moore, Frank, and Watt. 

Also present: Representative Garrett. 

Chairman BAKER. Good afternoon. I call this meeting of the Subcommittee on Capital Markets to order. Today, the committee 

meets to discuss OFHEO’s Report of the Special Examination of 

Fannie Mae. 

Upon preliminary review of the findings, there seems to be validation of the work of OFHEO throughout the years, particularly 

that of your predecessor, Mr. Armando Falcon, who labored long in 

the vineyard trying to come to some conclusion. This work was 

highlighted by an appearance before the subcommittee 2 years ago, 

in which rather difficult observations were made public by the 

then-acting director and led ultimately to even more strident conversation about the advisability and need for strengthening the 

tools and the resources that the current regulatory structure may 

benefit from. 

The work has been difficult, and it is certainly necessary, and I 

would, unfortunately, like to point out that the report even gives 

us greater reasons for concern. The collection of facts leads us to 

a very troubling picture, one in which there was, apparent to me, 

an effort at all costs to hit certain earnings and incentives which 

led to the enrichment of the executives in control of preparation of 

that financial data. 

We will delve today in much more detail into those elements and 

try to appreciate, from the work you have done, how we can better 

prepare the accountability of the agencies themselves as well as the 

regulatory body going forward to oversee these increasingly complex financial organizations. 

Although it may not be said necessarily for the committee, it 

should be part of the record that these enterprises are enormously 

important to our housing market. Because of the complexity of 

their counterparty risk and relationships with other financial entiVerDate 0ct 09 2002 12:45 Jan 05, 2007 Jkt 031527 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 F:\DOCS\HBA157.160 HFIN PsN: TERRIE
2

ties, if there were to be adverse economic consequences to either of 

them, it would bring about potentially systemic risk—adverse effects—and for that reason alone, much less the exposure of the 

American taxpayer, the committee should spend considerable time 

and effort in trying to get our legislative proposal for reform adopted during this term of the Congress. 

Mr. Lockhart, I look forward to your testimony and your response to the questions of the subcommittee at the appropriate 

time. 

Mr. Watt, do you have an opening statement? 

Mr. WATT. Thank you, Mr. Chairman, and I thank Mr. Kanjorski, the ranking member of this subcommittee, for asking me to 

sit in for him today. He has an irreconcilable conflict and could not 

be here. I wish it were an indication that I was in training either 

as a ranking member or a chair of one of the subcommittees, but 

my— 

Chairman BAKER. The ranking member seems to be aggressive 

enough, if I might. 

Mr. WATT. —my seniority status is such that both of those probably would appear to be somewhat out of reach at this point, so I 

am just here substituting for him and doing the best I can at today’s hearing which is the fifth in a series of hearings of accountings of irregularities at Fannie Mae. At each of these hearings we 

have learned more details about what went wrong at the government sponsored enterprise and what needs to be done to prevent 

similar situations in the future. 

Mr. Kanjorski, the ranking member, has been very vocal in his 

statements that government sponsored enterprises with their public responsibilities and private capital have a special obligation to 

operate fairly, safely, and soundly, and I certainly agree with his 

assessment. The management at these entities must ensure that 

they produce accounting statements that reflect their real financial 

condition, and I think we, hopefully, are headed back in that direction. 

While the report that we are having the hearing about represents one more important step in the process of examining the 

accounting issues and management issues, we must also keep our 

focus on completing the legislative action that is necessary to improve the oversight of all government sponsored enterprises going 

forward. It is certainly in the public’s interest that we address regulatory issues promptly and properly. 

OFHEO has leveraged its existing general safety and soundness 

authority through the adoption of specific safety and soundness 

standards. The authority to adopt these standards and any other 

safety and soundness standards deemed necessary would be clearly 

established in the House-passed bill, which also would strengthen 

the enforcement authority of the regulator, including enforcement 

of safety and soundness requirements. 

Additionally, the House bill gives the regulator authority to order 

reductions in assets for safety and soundness reasons, similar to 

the action that is taken as one of the resolutions of today’s report. 

Mr. Kanjorski is also a strong supporter, as am I, of the concept 

that a strong, world-class, independent regulator is needed for the 

GSE’s, and we hope that we can move in that direction following 

3

these series of hearings focused primarily on what went wrong and 

tangentially on looking forward to how we can ‘‘right the ship’’ and 

go forward. 

After reviewing OFHEO’s report, I have two specific questions 

that I hope will be answered. First, it would be nice to know 

whether OFHEO believes it now has an appropriate level of cooperation from the management and board of the company. Second, 

it would be nice to learn how long it will take for Fannie Mae to 

get back into financial shape and current with its reporting and be 

able to move forward aggressively with the housing mission that I 

believe most, if not all, of the members of this committee support. 

So we thank you for being here, Mr. Lockhart, and look forward 

to your testimony. 

Mr. FRANK. Mr. Chairman, I wonder if I could proceed out of 

order to note the presence of a former chairman of this committee 

in this room, our former colleague from Rhode Island, Mr. St. Germain—my former colleague, because I don’t know if anybody else 

is still here. You are, I guess, and Mr. Oxley. 

Chairman BAKER. Welcome back, sir. Nice to see you here. 

Mr. ST. GERMAIN. Oh, I am looking for Rick Milano, my former 

staff director. 

Chairman BAKER. Some things never change. We are constantly 

looking for our staff. 

Mr. FRANK. Protocol has been tightened up since you have been 

here, so you have to sit down. 

Chairman BAKER. Chairman Oxley. 

The CHAIRMAN. Mr. Chairman, coming on the heels of Senator 

Redman’s work, OFHEO’s staff is to be commended for giving us 

the comprehensive report from the agency special exam of Fannie 

Mae. I congratulate former OFHEO Director Falcon for initiating 

examination and former Acting Director Blumenthal for completing 

this report. 

Mr. Lockhart, congratulations are in order for you on your nomination by the President to head OFHEO, and I look forward to 

your presentation today. 

OFHEO’s story of Fannie Mae is, unfortunately, fact, not fiction. 

We are told that Fannie Mae’s best-in-class image was a facade. 

According to the report, the company’s board of directors was a 

complacent entity controlled by senior management which systematically withheld vital information. Management routinely violated 

GAAP in order to maximize bonuses and mislead shareholders. Reported details are that Fannie Mae sought to oversee OFHEO, instead of the other way around, even orchestrating a HUD Inspector 

General investigation and reduction in appropriations for the purpose of discrediting the agency, as well as a report that we review 

today. 

According to this report, in October of 2004, Fannie Mae’s former 

chairman and CEO Raines and CFO Howard made, ‘‘inaccurate 

statements’’, in sworn testimony before this subcommittee when 

they denied that expense deferrals had been made. 

Compensation for senior executives tied to earnings per share 

targets dwarfed basic salary and benefits. From 1998 to 2003, more 

than half of $200 million in compensation received by the top five 

executives was EPS related. OFHEO found that the message at 

4

Fannie Mae was clear: EPS results mattered, not how they were 

achieved. 

Last March, in an SEC filing, Fannie Mae reported accounting 

errors in over 20 separate categories. There is no doubt that those 

accounting errors were in part due to a weak and outdated internal 

control system. It was only in 2005, when making certain that the 

company complied with the section 404 internal control requirements of the Sarbanes-Oxley Act, that Fannie Mae’s senior management finally admitted, ‘‘that the company’s internal control over 

financial reporting was ineffective.’’ 

The failure of internal controls and the audit function at Fannie 

Mae reinforces a need for the Sarbanes-Oxley Act. In fact, if not 

for Sarbanes-Oxley, I wonder how much of this would have come 

to light at all. 

OFHEO and the SEC imposed one of the largest penalties ever 

paid by an individual company, making Fannie Mae the Enron of 

the financial services industry. $350 million of the $400 million 

penalty will go to the Fair Fund, which was strengthened and created by the Sarbanes-Oxley Act, and will ultimately be returned to 

investors. The rest goes to the U.S. Treasury. 

This report reminds us how crucial it is for Congress to approve 

legislation to strengthen regulations of the GSE’s. We need to prevent abuses from developing and permit swift enforcement if they 

do. 

In OFHEO’s request, Fannie Mae has agreed to cap the growth 

of its mortgage portfolio. I would point out again to those who characterize it incorrectly that the House bill gives a new GSE regulator clear discretionary authority to require portfolio adjustments. 

OFHEO’s action shows why the regulators should have the flexibility to respond, not be directed by Congress. It is imperative that 

this new regulator have the authority to adjust portfolios as called 

for under the House-passed Baker bill. 

I concur that Treasury possesses the authority to approve GSE 

debt issuances. The 2004 Congressional Research Service legal 

analysis stated, ‘‘If Congress wanted to limit the Treasury Department’s approval authority, then Congress could have done so. Because Congress chose instead to use broad language in describing 

Treasury’s authority, it follows that a broad interpretation of that 

authority would likely be judged to be reasonable.’’ 

I understand that the Department of Justice has given Treasury 

a similar opinion. While I endorse the belief that Treasury possesses this authority, I do not offer an opinion as to whether the 

Department should use it at this time. 

Congress correctly provided Treasury with broad discretion in 

this area, just as we should do in the area of portfolio powers. I 

only note that the Administration’s rhetoric on the matter suggests 

that the matter is urgent. I would like to see that sense of urgency 

find a better outlet than repeatedly asking Congress to tie the new 

regulators’ hands on portfolio authority. 

If OFHEO’s report doesn’t motivate our colleagues in the other 

body to act on this legislation, nothing will. Only after full Senate 

action is complete will we be able to work together on a conference 

committee to send the President the GSE bill in this Congress. 

5

And let me say to the chairman of the subcommittee, who had 

been a lone wolf on this issue and alone in the wilderness for a 

number of years, that his hard work, persistence, vision, and tenacity have paid off with the revelations in the OFHEO report and 

with the successful passage of his legislation by a large bipartisan 

majority in the House of Representatives. We can only hope that 

the other body will respond in kind. 

And I yield back. 

Chairman BAKER. Thank you, Mr. Chairman, for your kind 

words. 

Mr. Frank. 

Mr. FRANK. Thank you, Mr. Chairman. 

I have never been a fan of people in our business who invoke various ancestors for what always seems to me to be very convenient 

reasons, and I strongly suspect that about 90 percent of what is attributed to our dead relatives they never said but can’t defend 

themselves. But, in this case, I am reminded strongly of something 

I do remember hearing my father say. 

He was a man of great charity. And once he got into a major dispute with the people who were running the Jewish Community 

Center in town, which was a very important institution, and shortly thereafter he made a large donation to them, as was his habit. 

Someone expressed surprise that, after having this argument with 

the people on the board of directors about the policy of the institution, he would continue to be so supportive, and he said, ‘‘I am not 

mad at the bricks.’’ 

And that is my attitude here. I think it is very important for us 

to separate out the individuals and the institutions. 

The chairman of the committee is right. The gentleman from 

Louisiana, earlier than anyone else to my knowledge, saw that 

there were abusive practices being engaged in by individuals who 

were running Fannie Mae. There were also abusive practices being 

engaged in by people running Freddie Mac, and that is instructive 

because the Freddie Mac abuses, having been uncovered earlier, we 

now see there is life after manipulation. Because we have today, 

I believe, with Freddie Mac a good, forthright, honorable set of 

leaders who have managed to rescue that institution from a pattern of abuse, excessive compensation, and manipulation. 

Clearly, condemnation is in order for those who ran Fannie Mae 

so abusively. What is important is for us to differentiate between 

their behavior, which should be condemned, and the lack of constraints which allowed that behavior to go forward and the underlying institutions. 

We continue to have in this country a serious crisis in housing 

affordability not just for very low-income people but in many parts 

of the country, including my own, the price of housing for people 

in middle income has gone beyond what it should be. So I want to 

continue to do everything we can not just to preserve, but to improve, the ability of Fannie Mae and Freddie Mac to help us with 

housing, as this committee recently did with regard to the FHA. 

They all worked together. 

That is an important point to keep in mind, that we do not punish the institution. The institution is not the value here. The value 

6

here is the housing that is built for people, and it is very important 

that we not do anything that compromises that. 

I believe that what OFHEO has done shows the way. OFHEO 

has shown us how you can, in fact, correct the abuses without 

interfering with the mission. 

And I am struck, as the chairman is, by the testimony this gives 

to the legislation we passed. I think much of what we did anticipates this, the question of portfolio limits. We clearly, in our legislation, foresaw the importance of giving the regulator, when it became appropriate because of abuses or dangers or problems, to be 

able to deal with the portfolio. So I am very grateful that we have 

that example. 

And I share his frustration that the Senate is refusing to act. 

There can be no justification for that. 

If people think that the powers of the regulator need to be enhanced, I would be willing to listen. I must say I haven’t heard any 

suggestion other than kind of automatic restriction on the portfolio, 

but in terms of the powers it doesn’t seem to me that they have 

been critiqued with any force. 

One last point. In a perverse way, these events and this report 

are a testimony, I believe, to the underlying strengths of Fannie 

Mae and Freddie Mac. That is—and we have had comparisons to 

Enron and MCI, and, in fact, of the abuses there was that kind of 

abuse. But the abuses at Enron and MCI led to collapses of the institutions. 

What is heartening to me here is that the underlying structure 

of Fannie Mae and Freddie Mac, the strength of the housing market, the strength of that model, allowed them to withstand being 

misrun—Freddie Mac earlier, Fannie Mae today. We have not had 

a serious problem—for those who say there is a terrible drain on 

the taxpayers, we have seen these abuses and the taxpayers were 

left whole. So I think the lesson of this is that we need to do a better job going forward in giving the regulator the power to prevent 

these kinds of abuses from happening without in any way endangering or inhibiting the housing mission. I think the legislation 

that we passed that is gathering dust somewhere in the Senate is 

a very good way to deal with that. 

And I know the Senate has very pressing business. I know the 

Senate has got to act immediately to prevent me from wrecking 

marriages all over America. Once they have put that safely behind 

them, I hope they will get down to serious business. 

Thank you, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. 

Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman, and let me add my 

voice to that of the chairman and ranking member and thank you 

for your great leadership. Since I first came to Congress, indeed, 

you have often been a lone voice in the wilderness in trying to 

bring the disinfectant of the sunshine into the activities of the 

GSE’s and ensure that the proper regulatory regime is in place to 

save both the housing markets and the taxpayers. I am happy to 

note, though, that the analogy just goes so far, since your head 

seems to be thoroughly attached to your shoulder blades, and I asVerDate 0ct 09 2002 12:45 Jan 05, 2007 Jkt 031527 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 F:\DOCS\HBA157.160 HFIN PsN: TERRIE
7

sume that before this process is all said and done that there will 

be other heads that indeed roll. 

I also want to thank Mr. Lockhart and OFHEO for the good work 

done, much of it by his predecessor and that team, in wading 

through often complex and arcane issues. 

I suppose what we have today is the end of a 2- to 3-year process 

that for many of us is reinforcing and giving us more concrete evidence on what we already know, and that is, for the period 1998 

through 2004, the company systematically misapplied GAAP relating to the amortization of certain fees on its securities and their 

hedge accounting and that this was done at the direction of senior 

management, which led to materially false, incorrect, and misleading financial statements that were publicly issued and relied 

upon. 

And I suppose what else is new is, if I read the comments of the 

SEC chairman correctly, I believe that this marks the first time 

that there has been an official designation of Fannie Mae’s accounting practices as fraud. So, because of that, I look forward to hearing more about the end result of this report. 

We also know that, Mr. Chairman, we simply cannot turn our 

backs on the systemic risks that are posed by the GSE’s. Right 

now, I think what we have is the second largest borrower in the 

world, second only to Uncle Sam himself, an institution holding a 

Federal charter, an asset portfolio worth over a trillion dollars, and 

they can’t produce a reliable financial statement for the bulk of this 

decade. That is troubling, to say the least. 

So, not unlike our other colleagues, I certainly urge the other 

body to act, and act quickly, on this legislation so that we may go 

to conference and again protect the taxpayer, protect the consumer, 

and protect the housing market. 

With that, I yield back. 

Chairman BAKER. I thank the gentleman. 

Chairman BAKER. Mr. Royce. 

Mr. ROYCE. Thank you, Mr. Chairman. 

I guess the upshot is—and let me begin by thanking Director 

Lockhart for appearing before our committee today. But I think 

that what we notice here is that we now have temporary portfolio 

caps to try to do something about this systemic risk. But that does 

not alleviate the need for portfolio authority to be in GSE legislation, and I think the OFHEO report highlights for us pretty clearly 

the fact that Fannie Mae did not have sufficient controls in place 

to manage its large and risky portfolio. Indeed it is very, very difficult at this—given the size of these portfolios, basically, Fannie 

Mae concocted its own accounting rules to cover up the weakness 

in its ability to manage its portfolio. 

So we notice that OFHEO still does not have the power to adjust 

the portfolio levels of the GSE’s. They can only do that with the 

permission of Fannie Mae. That is basically what was done here. 

This is not a strong regulatory position to be in, and that is the 

position we will be in unless the Senate language passes. 

Even with the agreement between Fannie Mae and OFHEO, we 

should reflect on the fact that the portfolio still stands at close to 

three-quarters of a trillion dollars. 

8

The reason that bankruptcy is not likely is because of the presumption that the U.S. Government will come in and prop up and 

subsidize the GSE’s if there are losses. 

The size of this portfolio continues to be a risk to the domestic 

and the international financial system. You know it is not just our 

regulators that are concerned in the United States. It is a worldwide concern and has been for some time. Without specific guidance to reduce the size of these portfolios, OFHEO will continue to 

be unable to address the risks to taxpayers in the financial system 

these portfolios provide. 

Also, the portfolio cap agreed to by Fannie Mae will only be in 

place on a temporary basis. Once Fannie Mae has submitted a plan 

and met the requirements set by OFHEO, they will be permitted 

to go back to growing the portfolio at risky levels, and this portfolio 

cap only applies to one of the GSE’s, only Fannie Mae. Freddie Mac 

is not a party to it. Thus, the ability to grow the risky portfolio remains, and, thus, the problem which we will get to during questions remain. 

But we thank you very much, Director Lockhart, for the leadership you have taken on this and your willingness to be with us 

today. 

Chairman BAKER. I thank the gentleman. 

Mr. Garrett. 

Mr. GARRETT. Thank you, Mr. Chairman, and I also applaud you 

for being the lone voice in the wilderness for so many years. Hopefully, you are now among a chorus at this point addressing the 

issue. 

I would just like to say that it seems it is quite a coincidence that 

the very same week that OFHEO delivers its report outlining the 

multiple counts of corporate greed committed by the executives of 

Fannie Mae that the one man who so epitomizes for the 21st Century so far, Ken Lay, received his guilty verdict in the wake of the 

Enron scandal. I believe that the comparison between Fannie Mae 

and Enron cannot be ignored. Both companies manipulated their financial statements. They put our financial systems at risk for the 

specific intent of allowing their executives to make their already fat 

pockets even fatter. 

Now, due to the government benefits enjoyed by Fannie Mae—

and I think this would explain to the ranking member why their 

house of cards remains standing when Enron’s do not—and their 

callous and negligent behavior did more than just mislead and defraud the investors. It did this at the expense of the American taxpayer. This has led former OFHEO Director Falcon to suggest that 

Fannie Mae is, ‘‘the Enron of government on government steroids.’’ 

Furthermore, as Fannie Mae was putting in overtime and using 

a vast amount of their internal resources to hit these specific earning targets, they were using less of their resources to help accomplish what their mission is, and that is to provide affordable lowincome and minority housing. This means that Frank Raines, Jim 

Johnson, and the rest were enriching themselves at the expense of 

the Nation’s least fortunate. They were taking advantage of the 

exact people that the company was chartered to help. 

Now I appreciate you coming here to testify today, and I will be 

asking some questions later on. 

9

We know that Freddie Mac said last month that it will not be 

providing quarterly financial statements for 2006 until some time 

later next year. This means, honestly, that is up to OFHEO to protect the financial markets and the taxpayers from risks, because no 

one else can. No one else will have definitive market information 

about what is going on in that company. They will not have the 

regular market discipline to make sure to send signals to it about 

what is going on. 

Freddie Mac said it would curtail new initiatives because of its 

huge problems. But, at the same time, it said it would expand purchases of high-risk, nontraditional mortgages. I will ask you, and 

I will ask you later on, why should OFHEO permit either GSE to 

engage in anything new and potentially risky until all the financial 

information has been made available to the public? 

Finally, Mr. Chairman, in 2002, Fannie Mae’s duration GAAP 

spiked to 14 months. At that time, Director Falcon said, ‘‘that the 

regulatory process is working as it should.’’ In fact, your report 

makes clear that the regulatory process was grievously off course, 

because Fannie Mae took in billions of economic losses to bring its 

interest rates risk back in line. These billions were never even noticed by OFHEO until Fannie Mae’s SEC registration. 

Now I recognize, and other people have already indicated, that 

you have only been on the job for a short period of time. I realize 

that, and it has been a very busy time for you as well. But the 

questions I will be looking for you in the future is what can we 

hear from you today to make sure that nothing of this magnitude 

or scope will ever, ever, ever, happen again with either of the 

GSE’s. 

And I yield back, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. 

It is my pleasure to welcome, I believe for the first time to a Congressional hearing in your capacity as acting Director of the Office 

of Federal Housing Enterprise Oversight, to testify here today on 

the agency’s findings, Mr. James B. Lockhart III. I believe from a 

review of your resume, however, you are, by prior government experience, more than adequately qualified to take on this difficult 

mission, although I suspect that this subject matter may even have 

a few surprises for someone as experienced as yourself. So please 

proceed at your leisure. 

STATEMENT OF THE HONORABLE JAMES B. LOCKHART III, 

ACTING DIRECTOR, OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT 

Mr. LOCKHART. Thank you, and good afternoon. 

Thank you, Chairman Baker, Chairman Oxley, Congressman 

Watt, and members of the subcommittee. Thank you for your support of OFHEO over the years and for this team that is behind me. 

They are the ones who really put in all the work to get this report 

out. I really welcome the opportunity to discuss the findings of our 

Special Examination of Fannie Mae and the settlement agreements. 

As a government sponsored enterprise, Fannie Mae has a very 

special position among American corporations and an extremely 

10

important mission—facilitating the growth of affordable housing in 

the United States. 

The previous management team, led by Chairman Franklin 

Raines, violated that public trust. By encouraging rapid growth, 

unconstrained by proper internal controls, risk management, and 

accounting systems, they did serious harm to Fannie Mae, while 

enriching themselves through manipulating earnings per share. 

The result was an estimated $10.6 billion of overstated profits, well 

over a billion dollars of cost to fix the problems, and ill-gotten bonuses in the hundreds of millions of dollars. 

In September of 2004, OFHEO issued an interim report that detailed serious problems relating to Fannie Mae’s accounting. The 

SEC agreed and ordered Fannie Mae to restate its financial statements. 

The just-released Special Examination Report details what can 

only be characterized as an arrogant and unethical corporate culture. The image of Fannie Mae as one of the lowest-risk and bestin-class institutions was a facade. The examination found an environment where the ends justified the means. 

The executive compensation program at Fannie Mae focused on 

managing earnings rather than risk. Indeed, Fannie Mae took significant amounts of interest rate risk and, when interest rates fell 

in 2002, incurred billions of dollars of economic losses. Fannie Mae 

also had very significant and very large operational exposures that 

were not properly managed. Senior executives were managing 

Fannie Mae in an ‘‘unsafe and unsound’’ manner. They also coopted their internal auditors. They stonewalled OFHEO. 

During the period covered by this report, Fannie Mae hit earnings per share targets with uncanny precision each quarter by deliberately and systematically using inappropriate accounting and 

improper earnings management. Senior management of Fannie 

Mae benefited greatly from these manipulations. From 1998 to 

2003, the total compensation of ex-CEO, Franklin Raines, exceeded 

$90 million, of which $52 million was directly tied to achieving 

earnings per share goals. 

This inappropriate ‘‘tone at the top’’ spread throughout the organization and, in a blatant conflict of interest, the head of the Office 

of Auditing told his staff, in reference to Mr. Raines’ goal of double 

earnings per share by 2003, that they must have, ‘‘$6.46 branded 

in their brains.’’ 

I will now turn to some of their improper accounting and controls. 

First, to prevent large, unpredictable earnings fluctuations, 

Fannie Mae chose to implement investments, derivatives, and 

other accounting standards in a fashion that reduced volatility 

while ignoring GAAP. 

Fannie Mae management also went to extraordinary lengths to 

avoid recording and then hiding GAAP required impairment losses 

on assets whose values had declined. 

By keeping earnings within what could be considered a predictable range, management was in a position every quarter end to 

manipulate and manage earnings to hit specific targets, and they 

did that through the use of cookie-jar reserves, income shifting 

transactions, and inappropriate debt repurchases. 

11

The report details the conscious decisions made by management 

to use outdated accounting systems and to create a weak internal 

control environment. 

Internal Audit failed to properly confirm compliance with GAAP 

or consistently audit critical accounting issues. Similarly, external 

audits performed by KPMG failed to include an adequate review of 

Fannie Mae’s significant accounting policies for GAAP compliance, 

and when they did become aware of the non-GAAP compliant provisions, they still continued to issue totally unqualified opinions on 

Fannie Mae’s financial statements. 

The board of directors is really the last line of defense in a company, and they again failed to be sufficiently informed and independent. Their oversight failings meant that they did not discover, 

let alone correct, the wide variety of unsafe and unsound practices 

at Fannie Mae, even after Freddie Mac’s problems became apparent. The Auditing Committee did not provide proper oversight of 

the internal audit function, critical accounting policies, and the 

whistle-blower claims. 

In the report, OFHEO’s staff makes recommendations to enhance 

safety and soundness. They recommended that we continue to 

strengthen and expand our regulatory infrastructure and regular 

examination programs and, also importantly, that we continue to 

support legislation to provide the powers essential to meeting our 

mission of assuring safe and sound operations at both Fannie Mae 

and Freddie Mac. 

The recommendations directed to Fannie Mae were incorporated 

into the settlement agreement where we had about 60 different 

items we agreed to. Some of the key ones were: Fannie Mae agreed 

to pay a $400 million penalty; Fannie Mae agreed to freeze the 

growth of its portfolio at last year end numbers (December 31, 

2005); and Fannie Mae agreed to undertake a comprehensive reform program aimed at a top to bottom change, from its board of 

directors, internal audit, risk management, compliance, external 

relations, internal controls, accounting systems, and data quality. 

All of those areas need improvement. Fannie Mae also agreed to 

review current and separated employees for remedial actions. 

During the joint settlement announcement, as was mentioned, 

Chairman Christopher Cox of the SEC said that, ‘‘The accounting 

fraud charges that the SEC is filing against Fannie Mae reflect the 

failure by Fannie Mae to maintain the kinds of internal controls 

that could have prevented what in all likelihood would have been 

one of the largest restatements in American corporate history.’’ 

Thank you. I am looking forward to working with members of 

this committee, and I would be pleased to answer questions at this 

point. 

Chairman BAKER. Thank you, Mr. Lockhart. 

[The prepared statement of Mr. Lockhart can be found on page 

27 of the appendix.] 

Chairman BAKER. I wanted to start off by analyzing the 2002 

and 2003 income periods. That is when they experienced their significant negative duration GAAP problem and, to extricate themselves, they spent a big amount of money to cancel pay-fixed swaps 

that were the cause of the interest rate losses. Am I understanding 

the report correctly, that if the actual economic consequences of 

12

that period of time were reported accurately that the enterprise 

would have had about a $12 billion adjustment to its revenue? 

Mr. LOCKHART. Certainly, at that point in time, they discovered 

and they thought before the interest rates fell dramatically that 

they didn’t have as big an issue as they ended up having. We 

saw— 

Chairman BAKER. Let me make it simpler, because my time will 

run quick on me. I have got a lot. 

My point is that, 2002, enterprise suffered an economic loss, 

earnings per share targets were still hit, so maximum bonuses 

were still paid, while shareholder value was depleted. 

Mr. LOCKHART. That is correct. 

Chairman BAKER. Great. Not great, but that is what I was trying 

to get at. 

In a separate direction, reading from the report in several selected areas, Fannie Mae reported extremely smooth profit growth, 

hit earnings per share targets with uncanny precision—I think you 

read that earlier. During the period in question, 1998 through 

2003, CEO Raines earned $90 million, of which 52 was directly tied 

to earnings per share. It is my understanding during the same period, aggregated for the top executives, the total compensation—excuse me, total bonus paid was somewhere in the neighborhood of 

$250 million, is that about correct? 

Mr. LOCKHART. That is about correct. 

And you are right. That chart over there shows that the line is 

the targets and the blue bars are the reported, and it is really uncanny that they could hit those year after year after year. And it 

is because of the quarter to quarter accounting gimmicks, and it resulted in very large bonuses in the range of several hundred million dollars, tied just to EPS. 

Chairman BAKER. In the October 2004 hearing, I asked Mr. 

Raines, prior to the decision being executed to defer the $200 million in expense at the end of 1998 into the quarters of 1999, were 

you consulted or did you have knowledge of the transaction? 

Raines’ response—there was no decision made to defer any expense from 1998 to 1999. Howard can go into greater detail as to 

how the process actually occurs, but we did not make any deferral. 

I was part of a discussion, as I always am as CEO, in the closing 

process in which decisions made in our financial area with regard 

to the calculation of the catch-up provision was discussed—that is 

why he got paid that much; you can’t understand anything—but 

the determination of that was made through our normal process of 

closing our books. 

In a separate question, were there any discussions related to the 

consequences of that expense treatment in relation to the earnings 

per share, Raines responds no. 

I asked, then when did you first realize that earnings per share 

would be $3.23? To which he responded, the first time I would 

know what earnings figures would be is when our comptroller 

would have closed the books and done all of the analyses necessary 

to determine what the final results are, and then that would be reported to me. That would be after any decision that was made in 

regard to the catch-up provision. 

13

Now a summary of the facts that we have just gone through from 

your report, your testimony as well today, and then reading 

through the responses of the CEO to this committee, you can’t 

make a legal judgment, I understand. 

There seems to be clear evidence in my mind that Mr. Raines 

perjured himself to this committee in answering those questions. 

Would there be any reason for a person to dispute that conclusion 

after listening to those facts and hearing his responses? 

Mr. LOCKHART. You are right; I cannot make a legal judgment. 

But I think the report, if you read it—and you have read it, obviously—does contradict the statements that he made. 

Chairman BAKER. We will examine that further. 

Some discussion was made earlier today by some members relative to portfolio constraint. The bill passed by the House does provide authority to the director of the new entity to adjust portfolio 

in any manner. In fact, it is my understanding that if the powers 

conferred in that legislation were given to you, you would have the 

authority, for appropriate reasons, to reduce portfolio to zero. Is 

that a responsive tool that you feel is appropriate in light of the 

current portfolio risk that is presented by the enterprises? 

Mr. LOCKHART. I believe that there is significant risk provided by 

these portfolios, when you add the two of them together, about $1.5 

trillion, half and half now, from the two companies, and it is an 

issue that really does have to be looked at. 

When we froze the portfolio as part of the agreement, that was 

really based on their continuing internal controls, lack of risk management, and lack of accounting systems. It did not address the 

issue of systemic risk and operational risk and, I think if you are 

going to look at these companies, you have to include that in their 

capital calculations and how that might impact their portfolios. 

Chairman BAKER. I am out of time, but one quick follow-up. 

What other tool should be given a regulator to address this problem other than the discretionary authority to reduce, increase, or 

leave alone the size of the portfolio? 

Mr. LOCKHART. The whole legislative package passed by the 

House would be very helpful to give us a whole series of tools to 

make us a better safety and soundness regulator. We don’t have 

the comparable tools that the banking regulators do. We need receivership. We need not to be appropriated. We need a whole series 

of tools that will make us a stronger regulator. 

Chairman BAKER. Thank you. 

Mr. Watt. 

Mr. WATT. Mr. Lockhart, I want to focus on the remedial agreements that you all have reached with Fannie Mae as part of the 

agreement to move forward, not because I am concerned about the 

provisions of them, but because I am concerned about the understanding, and knowing the impact of them. 

If you take the combination of the growth limit, limiting portfolio 

assets to the level as of December 31, 2005, and the capital restrictions previously agreed requirement for a 30 percent capital surplus, can you tell us what the impact of those two in combination 

will have on the housing mission of Fannie Mae? Has OFHEO 

made any assessment of that? 

14

Mr. LOCKHART. We have certainly looked at the issue and, from 

our standpoint, we do not see an impact. There is enough capital 

there certainly to continue the mortgage-backed security packaging 

that it does. 

On the portfolio side, they certainly have assets that can be sold 

as they want to acquire new assets, and that is really what will 

happen over time. They will sell some assets off, place them in the 

marketplace, and use the money to invest in new assets. 

Mr. WATT. So your testimony is that from your perspective, 

OFHEO’s perception, there will be no adverse impact on the housing mission from those things? 

Mr. LOCKHART. For the housing mission, and especially the affordable housing mission, I see no impact. They obviously have a 

lot of work to do in those areas and continue to do work, but these 

two things should not interfere with that. 

Mr. WATT. Focusing further on the part of the agreement related 

to personnel, I am wondering how you—how OFHEO will assess—

how will you define success, so to speak, in there is a part of the 

agreement that says, Fannie Mae’s board must have a third party 

review of Fannie Mae’s government and industry relations programs, and adopt a plan for setting new policies and controls on 

lobbying efforts. 

How would you assess the effectiveness of that? I mean, are 

there criteria that you would use in evaluating the board’s performance in that regard going forward, or will this be solely up to the 

board to make those determinations? 

Mr. LOCKHART. Certainly in that case we will look at the review 

and discuss it with the board and the management team and we 

will do that with many of the other proposals in the agreement. 

The board of directors is responsible for the oversight of this company and we are responsible as a safety and soundness regulator. 

Because the company has so many unsafe and sound practices at 

the moment, let alone in the past, we are very, very actively involved in this company, and I might add also in Freddie Mac from 

that standpoint because they also have continuing unsafe and unsound practices. Both of these companies are probably several 

years away from having adequate accounting internal controls, so 

we are going to be involved in the discussion, and in particular in 

this review of the government relations area. We will look at the 

review and make sure that they don’t re-engage in unsafe and unsound practices. 

Mr. WATT. I am about to run out of time. So I don’t mean to cut 

you off. I wish I had more time to allow you to elaborate, but it 

sounds like there is some subjectivity involved in this on the 

board’s part and on your part and that’s fine. I am not being critical. I’m just trying to figure out what—how you will define success. 

Let me focus on one other area and that’s the $400 million penalty and the use of that for the benefit of—I mean, who gets the 

benefit of that, and I guess the related question is, is there a legal 

mechanism in place now for shareholders who may have been adversely affected to get redress? 

Mr. LOCKHART. Of the $400 million, $50 million went to the U.S. 

Treasury and it’s a monetary penalty provided under our law. The 

15

Sarbanes-Oxley law provided for the shareholder funds and in consultation with the SEC, we agreed that it made a lot of sense to 

put it there. The SEC will be setting up rules related to the fund. 

Mr. WATT. But is there a shareholder right of action here or is 

there— 

Mr. LOCKHART. There are already shareholder suits going on 

and, as I understand it, I believe potentially some of this money 

could be used to settle those suits. 

Mr. WATT. But does this cap— 

Mr. LOCKHART. This does not. 

Mr. WATT. Okay. I appreciate it, Mr. Chairman. I yield. 

Chairman BAKER. The gentleman’s time has expired. Chairman 

Oxley. 

The CHAIRMAN. I would say to my friend from North Carolina 

that the Fair Fund was set up in Sarbanes-Oxley Act to be a receptacle for fines and disgorgement. That money is now accumulating 

in the billions. 

Chairman BAKER. Seven. 

The CHAIRMAN. $7 billion plus, which will then be returned on 

a pro rata basis to shareholders who were injured. A lot of people 

don’t like Sarbanes-Oxley. I think most people like that part of it, 

particularly if you are a shareholder and you lost your shirt. 

Let me ask a couple of questions here, Mr. Lockhart. On the executive compensation issue in the chart that was provided by 

Chairman Baker, the earnings or the executive compensation based 

on earnings per share and the bonuses thereon, Senator Rudman’s 

testimony and his committee investigating could only cite 1 year—

that was 1998—where they could conclusively say that those earnings were manipulated. Your report is very clear that 8 years, why 

this difference? Why is yours so definitive in covering an 8-year period and Senator Rudman’s just 1 year? 

Mr. LOCKHART. First of all, I would say that our team did a great 

job, and as a government regulator we had more incentive to really 

go in and really get the details. If you read the report, it is very 

clear by year to year that there was manipulation of the earnings. 

Some years they were looking in the cookie jar to make earnings 

higher, other years they were doing financial transactions and 

other things to hide earnings for 1 year and push it out in the future. It is hard for me to speculate why the reports are different 

except to say that I believe that our team really did a good job and 

went thoroughly through the accounting issues. 

The CHAIRMAN. You also mentioned that the auditors had been 

co-opted and could you help us with that? How did that happen? 

Mr. LOCKHART. The internal auditors in particular were being 

paid and had bonuses related again just to EPS. 

The CHAIRMAN. So you are referring to internal auditors? 

Mr. LOCKHART. That is what I am referring to and I read the 

statement about the $6.46 target and that was the 5-year bonus 

target and every member of Fannie Mae’s team got a bonus related 

to that. So the internal auditor in that speech where he talks about 

that and thanks Frank Raines for doing it for him, is a total conflict of interest. 

The CHAIRMAN. The Enron case was just concluded with convictions, WorldCom and many of the others had a common thread, 

16

and that was they were described, I think accurately, as accounting 

scandals. At the heart of this, this was really an accounting scandal too, is it not? 

Mr. LOCKHART. Yes, it was. And there is another similarity. 

These two firms were many times thought of as the best in their 

class and, to a certain extent, I think that the management team 

started to believe that, and believed that they could almost walk 

on water and maybe they didn’t have to pay attention to the accounting rules. 

The CHAIRMAN. The legislation that passed the House, and I can 

characterize it a little bit with a—I think, a clear memory. When 

Chairman Baker started this quest, I think it is safe to say that 

he felt, first of all, that he had about 2 votes. But secondly, he had 

a vision to create a world class regulator. And we have had discussions with that. I think at that time, given the political realities, 

Chairman Baker felt that if we could restructure the regulatory 

function that that would be a big win. Since that time and events 

that have moved in that direction, we passed legislation on a bipartisan basis to allow the new world class regulator to determine 

minimum risk base capital standard review and adjust portfolio 

holdings, approve new programs and business activities, mandate 

prudential management and operational standards, take prompt 

corrective and enforcement actions, put a critically undercapitalized GSE into receivership, which was very controversial not too 

many months ago, and require corporate government improvements, higher examination of accounting experts. 

Pretty comprehensive in my estimation dealing with the problem 

at hand and, besides all of that, they have to comply with Sarbanes-Oxley requirements for establishing internal controls and in 

defining risk, and that is a pretty effective package, it seems to me. 

I just wondered if you would just comment again in a global sense 

about how this legislation that passed, the Baker bill that passed 

the House along with the requirements of section 404 and Sarbanes-Oxley worked together to hopefully prevent, because after all 

we can punish all we want but at the end of the day when investors lose money and people’s lives are destroyed, it is great, maybe 

that they can feel good about some executive going to jail but at 

the end of the day they would rather have their money back, and 

if we could prevent this kind of activity from happening in the first 

place with the Baker bill combined with the internal control provisions of Sarbanes-Oxley, seems to me we got a pretty good package. 

Mr. LOCKHART. My belief is if 8 years ago we would have had 

Sarbanes-Oxley and a stronger regulator, which your bill, and 

Chairman Baker’s bill does, it would have been very, very helpful. 

There is the issue, I think, that needs to be stressed as to how the 

regulator sets the capital limits related to portfolio levels and other 

issues, but my view is that it is a very excellent start and we would 

be a lot better off today if we had had it. 

The CHAIRMAN. Thank you, Mr. Chairman. 

Chairman BAKER. Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

Mr. Lockhart, I am curious to know what your decisionmaking 

process is going to be as far as unfreezing Fannie Mae’s ability to 

increase the size of their mortgage portfolio assets. Specifically, I 

17

am sure you are familiar with the fact that the former chairman 

of the Fed, Alan Greenspan, was quite outspoken on the issue of 

the purpose of the GSE’s holding their own securities. In fact, in 

a speech he delivered roughly a year ago, if I can quote, ‘‘the key 

activity of the GSE is the provision of liquidity to the primary 

mortgage market can be accomplished exclusively through the 

securitization of mortgages’’; GSE portfolios of mortgage-related assets cannot serve this function. To sell mortgage-backed securities 

to purchase other mortgage-backed securities clearly adds no net 

support to the mortgage markets. 

So again, the former chairman of the Fed was quite outspoken 

on this issue, and so I am curious, number one, whether you agree 

with that assessment. If you don’t agree with that assessment, 

what is the thinking behind when you would permit Fannie Mae 

to increase its mortgage portfolio? 

Mr. LOCKHART. Certainly I have read the testimony by the chairman and obviously everybody respects what he has to say. I have 

been in the job just a little over a month now, and most of it has 

been, at this point, related to the Fannie Mae report. So I haven’t 

had a lot of time to really get my hands around how you set up 

capital for systemic risk. I know a lot about how you set up capital 

for operational risk, and those are two of the things we must think 

about when we are setting limits on portfolios or at least reserving 

capital against those limits. 

As for the freeze that Fannie Mae agreed to, we said in the 

agreement that there is a way to get some flexibility once they give 

us a report in a couple of months. There are a lot of requirements. 

The risk management, liquidity, housing policy, and internal controls would really be the concerns and frankly, if legislation is 

passed, you know, the limits may be superseded by something else. 

Certainly market concerns would be another issue. We have given 

the company guidelines, but we have also told them that it is really 

at the discretion of the regulator when those will be lifted, and 

frankly it is hard to see a total removal of limits for several years. 

Mr. HENSARLING. In your testimony, you talk about former chairman and CEO Franklin Raines violating a trust. You speak of 

earnings manipulation, you speak of ill gotten bonuses, and you 

speak of an arrogant and unethical corporate culture. If I read your 

testimony properly, though, I didn’t see the term, ‘‘fraud,’’ although 

I have seen that used by SEC Chairman Cox, who claims that 

these activities consist of accounting fraud. Is this a mere manner 

of semantics or should I be reading something into the fact that 

your testimony does not include the word, ‘‘fraud’’? 

Mr. LOCKHART. Maybe a little semantics. It may be that the SEC 

is more the keeper of the word ‘‘fraud’’ than we are as a safety and 

soundness regulator. 

Mr. HENSARLING. In your testimony you also state that the, ‘‘goal 

of senior management was straightforward to force OFHEO to rely 

on the enterprise for information and expertise to such a degree 

that Fannie Mae would essentially regulate itself.’’ So we are—did 

you believe that Fannie Mae was trying to regulate you or were 

you trying—was it the other way around? 

Mr. LOCKHART. That goes back into the history well before I arrived. If you look at some of the indicators, the agency was incredVerDate 0ct 09 2002 12:45 Jan 05, 2007 Jkt 031527 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 F:\DOCS\HBA157.160 HFIN PsN: TERRIE
18

ibly underfunded 6 years ago. It may have been under-skilled as 

well. It was hard to build up the culture and the money to really 

to be a first class regulator. As you all know, Fannie Mae was an 

extremely strong agency. The corporation had very strong lobbying 

activities and other things that I think—and again I wasn’t there 

but I have heard—really made it very hard for OFHEO to do the 

job it should have been doing. The law needs to be strengthened 

too. 

Mr. HENSARLING. Though I had other questions, my time has expired. I am not a subcommittee chairman, so I can’t go on. 

Chairman BAKER. Point well taken. 

Mr. Royce. 

Mr. ROYCE. Thank you, Mr. Chairman. 

Mr. Lockhart, in the President’s Fiscal Year 2007 budget, the Administration calls for the creation of, in its words, a GSE regulator 

with new and explicit authorities currently not possessed by the 

agency. You have been nominated in this case to lead, which is 

OFHEO. And the budget outlines the systemic risks to the financial system posed by, as it explains, the GSEs’ large holdings of 

mortgage-backed securities. In order to mitigate these risks, the 

President has called for Congress to instruct, ‘‘a new GSE regulator 

that asset portfolios are a significant source of systemic risk and 

should be limited by the GSE regulator accordingly.’’ 

In the Administration view, ‘‘mitigating systemic risk requires 

taking action before a crisis occurs.’’ And that a regulator, in their 

words, limited to consideration of safety and soundness and risk 

may not fully consider potential consequences to others in the 

mortgage markets and the larger economy, which is along the lines 

of some of the issues you raised with regard to systemic risk and 

operational risk and not having the power to the receivership authority and so forth. 

But clearly from what the Administration says, it believes that 

Congress should grant the new regulator statutory authority to address both safety and soundness and systemic risk. Now in Congress, the House has passed legislation that deals with part of this. 

We deal with the safety and soundless regulation, in my view, 

whereas, the Senate Banking Committee has passed legislation 

that would allow the new regulator to address systemic risk by giving clear and unambiguous guidance to the new regulator about 

the size and composition of the GSE portfolios along the lines that 

our Fed regulators have talked about. So in essence, the Senate bill 

would anchor the GSE portfolios to their public mission. 

As the acting Director and likely future Director of OFHEO, I 

would like to know if you prefer the House legislation or if you 

agree with the Administration and prefer the Senate Banking Committee legislation. That is what is on my mind. 

Mr. LOCKHART. First of all, I agree with this committee, and the 

Senate committee, and former Chairman Greenspan, that there is 

very significant systemic risk, and it is not just the assets. It is the 

liabilities, it is the borrowing, and it is the derivatives that tie it 

all together, and between those three things, there is a giant exposure to the world economy, and if things went wrong, there could 

be a very large impact. 

19

Systemic risk has to be addressed. I believe that the regulator 

must address it, and I believe that it would be helpful to give some 

guidance on that, that we need to address the systemic risk and, 

as I say, also operational risk in a more broad based way than we 

have in the past. 

Mr. ROYCE. I thank you, and I yield back. 

Chairman BAKER. The gentleman yields back. Mr. Davis. I am 

sorry. Mrs. Kelly. 

Mrs. KELLY. Thank you, Mr. Chairman. 

Mr. Lockhart, the Subcommittee on Oversight held a hearing last 

year in which it was revealed that Fannie Mae had deliberately 

withheld information from the United States Government about 

fraudulent mortgages. 

I quoted the Inspector General of HUD here. He said Fannie Mae 

did not pass information on First Beneficial’s transgressions to others, allowing First Beneficial to issue more than $7.5 million in 

fraudulent loans ensured by taxpayers. 

In response to that hearing, I have worked with a number of my 

colleagues to include in H.R. 1461 legislative language requiring 

Fannie Mae to report fraudulent transactions to a third party—by 

a third party rather—to OFHEO’s successor agency, which is the 

Federal Housing Finance Agency. I understand that your agency 

has now taken regulatory steps to accomplish that goal and is 

working with FinCEN so Federal housing enterprises will no longer 

occupy a unique position, not being accessible to the Federal agencies that are fighting money laundering or terrorist finance, and I 

wonder if you will please explain to the committee your thoughts 

on what happened in the First Beneficial case, how it ties in to the 

corruption that was shown in the Rudman report and what your 

agency is doing to ensure that every one of the people involved in 

this case who failed to act as good corporate citizens, in the words 

of the HUD Inspector General, are not allowed to work at a regulated enterprise. 

Mr. LOCKHART. The First Beneficial case was extremely unfortunate and I think it does show some of the arrogance of Fannie Mae 

and as this was done, I think, out of the Atlanta office, it was further down the organization. We obviously got involved. We worked 

with the company and the company, I believe, paid us a $7 million 

fine. The person who was the lead on this was reprimanded. But 

as you pointed out, and I think more importantly going forward, we 

will now be reporting mortgage fraud to FinCEN and we are continuing to work with other government agencies to try to prevent 

things like this from happening in the future. 

Mrs. KELLY. I appreciate that, but I want to go back to the idea 

that someone who has essentially committed fraud in a government 

agency is then allowed to go on and work at another government 

agency that is a regulated agency. Is there any kind of step being 

put in place to prevent people from moving from job to job? 

Mr. LOCKHART. At this point, I am not really sure of the details 

of that. I thought this individual was actually working at Fannie 

Mae. But I can tell you that, in some cases, we can, and have, exercised debarment, which is effectively what you are talking about in 

the Fannie Mae case, and Frank Raines and CFO Howard had 

20

been debarred as part of our agreement and, yes, we can do that 

if these situations reach that proportion. 

Mrs. KELLY. Thank you very much. I have one other question. I 

want to know if you think that OFHEO’s risk-based capital rule 

needs revision. 

Mr. LOCKHART. OFHEO’s risk-based capital rule is useful but it 

is really just a stress test in my mind, and coming out of the insurance and banking industries, and having worked actually at a leading firm that was a risk management firm for 4 years, my view is 

that it needs a lot of work. We need to—and hopefully part of the 

legislation will give the agency the power to do that—start looking 

at how to set up a best in class, if I can use that phrase, enterprise 

risk management risk-based capital standard. 

Mrs. KELLY. I would hope that you would work diligently to do 

that. I think that is an oversight piece that needs to be done, and 

I am glad you are willing to jump in and help. Thank you very 

much. 

I yield back, Mr. Chairman. 

Chairman BAKER. I thank the gentlelady. I have a few follow-up 

questions. 

First on the gentlelady’s comment, legislation pending provides 

explicit authority for the Director to engage in a whole set of binocular observations and microscopic analysis, so I think we have 

got you well-tooled. 

Going back to the portfolio discussion because that really is 

where we are today, is the linchpin on being able to get a legislative remedy moving forward. I would not suspect, but I have to ask, 

that you would have today a methodology nor a dollar figure in 

mind to which portfolios would be reduced if you are confirmed and 

if legislation grants you by whatever mechanism the authority to 

reduce. Or would that rather be something arrived at by some 

counsel study with staff over some period of time? 

Mr. LOCKHART. Certainly not a dollar figure because I am not 

sure a dollar figure is the right way to go. I think there is a methodology and we have to look at the methodology. 

Chairman BAKER. You don’t have that in your pocket? 

Mr. LOCKHART. I do not have a methodology especially for systemic risk. I may have a methodology from operational risk given 

my background. I basically believe that we need to do further study 

and we are starting to do that kind of study. 

Chairman BAKER. That is the reason for my question, to get to 

that study conclusion because whether it was Secretary Snow or 

other financial regulators, no individual has yet recommended a 

particular target or a particular formula by which you get to a target, but rather some sort of studied approach. The bill now pending 

does provide and I want to address—Mr. Royce has stepped out—

but for the record, the study requires the new Director over a period of 12 months to assess a general description of portfolio, a description of the risk implications, an analysis of the portfolio for 

safety and soundness purposes, which everybody points to, analysis 

of whether the holdings fulfill the mission purposes, which is not 

often mentioned, an analysis of the potential systemic risk, which 

has been missed on occasion, for the enterprises, for the housing 

and capital markets and for the entire U.S. financial system. So it 

21

is a very broad-based risk assessment strategy and coupled with 

that is the clear mandate to reach a conclusion and report as to 

whether those portfolios should be reduced, limited in growth. 

Whatever conclusion that is appropriately to be reached we specifically—specifically and intended to leave out the word, ‘‘grow’’ or 

‘‘enlarge’’, so the bias in the bill as it stands is to give the new Director the tool to say within 12 months you got to, and here are 

the guidelines which you must utilize, and come back with a reason 

why, and a method to get to a specific target. 

We also, on the subject of capital, had very intentional language 

on page 56 of the bill pending, notwithstanding the capital classifications of the enterprise, that the Director by order may require, 

and goes on with a bunch of things. Today they have to be significantly capital-impaired in order for you to take certain actions. As 

I understand it, the basis on which the consent agreement was 

reached with Fannie Mae was principally leveraged by the uncertainty of their financial conditions because of the inability to certify 

financials. Therefore, you could then, as Director, enter into negotiations and reach an agreement, which ultimately was signed, leveraged by the underlying financial uncertainty. If Freddie Mac’s 

financials were not certified, you could impose the portfolio limit on 

them at this time, utilizing that same ability, that legal leverage. 

But as I understand it, the agency has found Freddie Mac’s financial condition at this time is sufficiently well to certify therefore 

that you are not in a regulatory position to engage in a portfolio 

limit as you did with Fannie Mae, is that correct? 

Mr. LOCKHART. Not necessarily. 

Chairman BAKER. Okay. 

Mr. LOCKHART. Freddie Mac is still years away, at least 2 years 

away, from really having acceptable accounting and internal controls and a risk management system. 

Chairman BAKER. That being the case and that was the leverage 

point which you entered into the discussion with Fannie Mae and 

reached a consent agreement which limited the growth of portfolio, 

what is the regulatory impairment to doing a similar strategy with 

Freddie Mac because I am an equal treatment GSE guy? I believe 

whatever you do to one you should do to both. Is there any impairment in your ability to enter into a consent agreement for that purpose? 

Mr. LOCKHART. Again, we can enter into a consent agreement if 

they consent and, because the law is not as strong as we would 

like, it may be difficult if they didn’t consent. The chairman of 

Freddie Mac mentioned that, I believe last week, in a press conference he did mention that we have discussed the idea that there 

should be some sort of freeze there as well. And, frankly, it is not 

that well known but over the last 3 or 4 years, Freddie Mac has 

grown its portfolio by 20 percent, while Fannie Mae has shrunk its 

portfolio by 20 percent. So there is an issue there that we are considering, but I can’t say at this point whether we are going to do 

anything about it or not. 

Chairman BAKER. If you fail to act on that point, it will not be 

due to a regulatory impairment to act, it will be a question of 

whether or not it is appropriate to act? 

Mr. LOCKHART. I believe that is correct, yes. 

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Chairman BAKER. Mr. Watt. 

Mr. WATT. I chose not to focus on the shortcomings of OFHEO 

because I think everybody is aware that there was a period of time, 

for whatever reason, that OFHEO was being duped just like the internal auditors and the external auditors were being duped. 

I want to get your assessment generally of how much better 

equipped OFHEO is now. I mean, are you confident that OFHEO 

has the capacity currently, and the resources currently, to do what 

the current regulatory scheme allows you to do, as well as what 

both the House and Senate bills might allow OFHEO to do in the 

future? 

Mr. LOCKHART. Certainly we would like a bill, and that will give 

us some of the strength that we need to be the safety and soundness regulator we should be. We want to work with everybody and 

make that happen. On the resource side, we were significantly 

under-resourced. Over the last 6 or 7 years, we probably tripled the 

number of people in our budget. We have added some really good 

people, some very professional people. We are going to need to continue to hire people. We are going to continue to need to do training and we are going to need to have to have occasionally a team 

that we can put in the field very quickly if there is a crisis, which 

then speaks to getting outside the appropriations process which 

this bill does. 

Mr. WATT. I am not sure you answered my question. 

Mr. LOCKHART. I guess the answer is yes, we have a very good 

team. I think we can build on this team and continue to get better 

and better, but we do need legislation to really get us to where we 

want to be. 

Mr. WATT. Thank you, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. 

Mr. Lockhart, some of us have said they are paving the way to 

home ownership. Nobody had ever in mind it would be an interstate system to go from coast to coast to get us to final resolution 

on this manner. I appreciate very much, and all members of the 

committee do, your participation here today, but it is a very long 

road. We have a long way to go. We look forward to working with 

you as Director in the coming months. 

Mr. LOCKHART. I thank you and I look forward to working with 

you. 

Chairman BAKER. Our meeting stands adjourned. 

[Whereupon, at 3:20 p.m., the subcommittee was adjourned.] 

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A P P E N D I X

June 6, 2006

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