Testimony 

Before the Committee on Banking, 

Housing, and Urban Affairs, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Thursday, April 21, 2005 HOUSING GOVERNMENTSPONSORED 

ENTERPRISES 

A New Oversight Structure 

Is Needed 

Statement of David M. Walker, 

Comptroller General of the United States 

GAO-05-576T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-576T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Thomas J. 

McCool at (202) 512-8678 or 

mccoolt@gao.gov. 

Highlights of GAO-05-576T, a testimony 

before the Committee on Banking, 

Housing, and Urban Affairs, U.S. Senate 

April 21, 2005

HOUSING GOVERNMENT-SPONSORED 

ENTERPRISES 

A New Oversight Structure Is Needed 

While the GSEs provide certain public benefits, they also pose potential 

risks. Fannie Mae and Freddie Mac’s primary activity involves purchasing 

mortgages from lenders and issuing mortgage-backed securities that are 

either sold to investors or held in the GSEs’ retained portfolio. The 12 

FHLBanks traditionally made loans to their members and more recently 

instituted programs to purchase mortgages from their members and hold 

such mortgages in their portfolios. While not obligated to do so, the federal 

government could provide financial assistance to the GSEs if one or more 

experienced financial difficulties that could result in significant costs to 

taxpayers. Due to the GSEs’ large size, the potential also exists that financial 

problems at one or more of the GSEs could have destabilizing effects on 

financial markets. 

The current housing GSE regulatory structure is fragmented and not wellequipped to oversee their financial soundness or mission achievement. 

For example, although all the GSEs face increasingly similar risks 

(particularly potential losses in their mortgage portfolios resulting from 

fluctuations in interest rates), OFHEO is responsible for Fannie Mae and 

Freddie Mac’s safety and soundness oversight while FHFB is responsible for 

the safety and soundness and mission oversight of the FHLBanks. OFHEO 

also lacks key regulatory authorities necessary to fulfill its oversight 

responsibilities. Moreover, the Department of Housing and Urban 

Development (HUD), which has housing mission oversight responsibility for 

Fannie Mae and Freddie Mac, faces a number of challenges in carrying out 

its responsibilities. In particular, HUD may not have sufficient resources and 

technical expertise to review sophisticated financial products and issues. 

Creating a single housing GSE regulator could better ensure consistency of 

regulation among the GSEs. With safety and soundness and mission 

oversight combined, a single regulator would be better positioned to 

consider potential trade-offs between these sometimes competing 

objectives. To ensure the independence and prominence of the regulator and 

allow it to act independently of the influence of the housing GSEs, this new 

GSE regulator should have a structure that consists of a board or a hybrid 

board and director model. To be effective, the single regulator must also 

have all the regulatory oversight and enforcement powers necessary to 

address unsafe and unsound practices, respond to financial emergencies, 

monitor corporate governance and compensation practices, assess the 

extent to which the GSEs’ activities benefit home buyers and mortgage 

markets, and otherwise ensure that the GSEs comply with their public 

missions. 

Serious concerns exist regarding 

the risk management practices and 

the federal oversight of the housing 

government-sponsored enterprises 

(GSE)—Fannie Mae, Freddie Mac, 

and the Federal Home Loan Bank 

System (FHLBank System), which 

had combined obligations of $4.6 

trillion as of year-end 2003. In 

2003, Freddie Mac disclosed 

significant accounting 

irregularities. In 2004, the Office of 

Federal Housing Enterprise 

Oversight (OFHEO) cited Fannie 

Mae for accounting irregularities 

and earnings manipulation. Fannie 

Mae has to restate its financial 

statements for 2001-2004 and 

OFHEO has required the GSE to 

develop a capital restoration plan. 

Also in 2004, the FHLBanks of 

Chicago and Seattle entered into 

written agreements with their 

regulator, the Federal Housing 

Finance Board (FHFB), to 

implement changes to enhance 

their risk management. 

To assist Congress in its housing 

GSE oversight, this testimony 

provides information on GSEs’ 

missions and risks, the current 

regulatory structure, and proposed 

regulatory reforms. 

What GAO Recommends

GAO recommends that Congress 

establish a single regulator with a 

board or hybrid board and director 

governance model. This single 

regulator should be equipped with 

adequate authorities to oversee all 

housing GSE activities. 
Page 1 GAO-05-576T 

Mr. Chairman, Mr. Ranking Minority Member, and Members of the 

Committee: 

I appreciate the opportunity to participate in today’s hearing to discuss 

federal oversight of the housing government-sponsored enterprises (GSE), 

namely Fannie Mae, Freddie Mac, and the Federal Home Loan Bank 

System (FHLBank System). When I testified before this committee in 

February 2004 on this same topic, it was shortly after Freddie Mac had 

disclosed significant financial problems associated with its accounting 

practices.1

 Freddie Mac’s regulator—the Office of Federal Housing 

Enterprise Oversight (OFHEO)—did not detect the GSE’s accounting 

irregularities at an early stage. At that hearing, I discussed the need for the 

establishment of a capable, credible, strong, and independent regulatory 

structure to help ensure that the housing GSEs operate safely and soundly. 

To accomplish this goal, GAO—and others—-proposed that Congress 

replace the current fragmented regulatory structure for housing GSE 

oversight with a single regulator that would be responsible for safety and 

soundness and mission activities. Subsequently, this committee took the 

lead in approving a strong bill to create a single GSE regulator. 

Over the past year, the need for fundamental regulatory reform of the 

housing GSEs has become even more clear and compelling. As you well 

know, Fannie Mae has been found to have engaged in the misapplication 

of accounting standards and earnings manipulation, and company staff 

even allegedly falsified signatures on documents. Fannie Mae will have to 

restate its financial statements for the past several years and OFHEO has 

required the GSE to develop a capital restoration plan. I am encouraged 

that OFHEO identified these deficiencies at Fannie Mae and has moved 

aggressively to correct them. I also note that the FHLBank System’s 

regulator—the Federal Housing Finance Board (FHFB)—has identified 

risk management deficiencies at the Chicago and Seattle FHLBanks and 

entered into written agreements with these institutions to correct 

identified deficiencies. Nevertheless, I believe the evidence clearly shows 

that the current regulatory structure is not well-equipped to oversee the 

operations and effectively monitor the risks of the large and complex 

 1

See GAO, Government Sponsored Enterprises: A Framework for Strengthening GSE 

Governance and Oversight, GAO-04-269T (Washington, D.C.: Feb. 10, 2004). 
Page 2 GAO-05-576T 

housing GSEs, which had combined financial obligations of about $4.6 

trillion at year-end 2003.2

To assist the committee in its oversight of the housing GSEs and their 

regulation, my testimony today is divided into two sections. First, I will 

provide an overview of the GSEs and their missions, identify the risks they 

pose to taxpayers and the financial system, and describe the current 

regulatory structure, which is divided among OFHEO, the Department of 

Housing and Urban Development (HUD), and FHFB. Second, I will identify 

deficiencies in the current regulatory structure and discuss how a single 

regulator that is governed by a board and endowed with adequate legal 

authorities is, in our view, the best potential means to help ensure that the 

GSEs meet their housing-related missions while doing so in a safe and 

sound manner. 

To prepare for this testimony, we relied heavily on a substantial amount of 

work that we had done on the housing GSEs and their regulatory oversight 

in the past (see Related GAO Products), but we also reviewed our 

historical positions in light of recent events. We conducted our work in 

Washington, D.C., in April 2005 in accordance with generally accepted 

government auditing standards. 

I would like to begin my testimony by briefly describing the missions and 

activities of each of the GSEs, and the risks they pose to taxpayers. Then I 

will describe the current GSE regulatory structure. 

Fannie Mae and Freddie Mac’s mission is to enhance the availability of 

mortgage credit across the nation during both good and bad economic 

times by purchasing mortgages from lenders (banks, thrifts, and mortgage 

lenders), which then use the proceeds to make additional mortgages 

available to home buyers. Most mortgages purchased by Fannie Mae and 

Freddie Mac are conventional mortgages, which have no federal insurance 

 2

The reported housing GSEs’ financial data for financial obligations and retained mortgage 

portfolios identified in this testimony are subject to change. Both Fannie Mae and the 

FHLBank System are currently revising previous financial statements. 

Overview of the 

Housing GSEs, Their 

Risks, and Regulatory 

Structure 

The Housing GSEs Share 

Similar Missions 
Page 3 GAO-05-576T 

or guarantee. The companies’ mortgage purchases are subject to a 

conforming loan limit that currently stands at $359,650 for a single-family 

home in most states. Although Fannie Mae and Freddie Mac hold some 

mortgages in their portfolios that they purchased, most mortgages are 

placed in mortgage pools to support mortgage-backed securities (MBS). 

MBS issued by Fannie Mae or Freddie Mac are either sold to investors (offbalance sheet obligations) or held in their retained portfolios (on-balance 

sheet obligations). Fannie Mae and Freddie Mac guarantee the timely 

payment of principal and interest on MBS that they issue. 

The 12 FHLBanks that constitute the FHLBank System traditionally made 

loans—also known as advances—to their members (typically banks or 

thrifts) to facilitate housing finance and community and economic 

development. FHLBank members are required to collateralize advances 

with high-quality assets such as single-family mortgages. More recently, 

the FHLBanks initiated programs to purchase mortgages directly from 

their members and hold them in their retained portfolios. This process is 

similar to Fannie Mae and Freddie Mac’s traditional business activities, 

although the FHLBanks do not currently have the authority to securitize 

mortgages.3

The housing GSEs’ activities have generally been credited with enhancing 

the development of the U.S. housing finance market. For example, when 

Fannie Mae and the FHLBank System were created during the 1930s, the 

housing finance market was fragmented and characterized by regional 

shortages of mortgage credit.4

 It is widely accepted that the housing GSEs’ 

activities helped develop a unified and liquid mortgage finance market in 

this country. 

While the housing GSEs have generated public benefits, their large size 

and activities pose potentially significant risks to taxpayers. As a result of 

their activities, the GSEs’ outstanding debt and off-balance sheet financial 

obligations were about $4.6 trillion as of year-end 2003. The GSEs face the 

risk of losses primarily from credit risk, interest rate risk, and operational 

 3

Securitization is the process of aggregating similar financial instruments, such as loans or 

mortgages, into pools and selling investors securities that are backed by cash flows from 

these pools. 

4

Freddie Mac was established in 1970. 

Housing GSE Activities 

Involve Significant Risks 
Page 4 GAO-05-576T 

risks.5 Although the federal government explicitly does not guarantee the 

obligations of GSEs, it is generally assumed on Wall Street that assistance 

would be provided in a financial emergency. In fact, during the 1980s, the 

federal government provided financial assistance to both Fannie Mae and 

the Farm Credit System (another GSE) when they experienced difficulties 

due to sharply rising interest rates and declining agricultural land values, 

respectively. The potential exists that Congress and the executive branch 

would determine that such assistance was again necessary in the event 

that one or more of the GSEs experienced severe financial difficulties. 

Because the markets perceive that there is an implied federal guarantee on 

the GSEs’ obligations, the GSEs are able to borrow at interest rates below 

that of private corporations. 

The GSEs also pose potential risks to the stability of the U.S. financial 

system. In particular, if Fannie Mae, Freddie Mac, or the FHLBank System 

were unable to meet their financial obligations, other financial market 

participants depending on payments from these GSEs may in turn become 

unable to meet their financial obligations. To the extent that this risk, 

called systemic risk, is associated with the housing GSEs, it is primarily 

based on the sheer size of their financial obligations. For example, as 

discussed in OFHEO’s 2003 report on systemic risk, if either Fannie Mae 

or Freddie Mac were to become insolvent, financial institutions holding 

the enterprise’s MBS could be put into a situation where they could no 

longer rely on those securities as a ready source of liquidity.6

 Depending 

on the response of the federal government, the financial health of the 

banking segment of the financial services industry could decline rapidly, 

possibly leading to a decline in economic activity. As another example, 

derivatives counterparties holding contracts with a financially troubled 

GSE could realize large losses if the GSE were no longer able to meet its 

obligations. If such an event were to occur, widespread defaults could 

occur in derivatives markets. 

 5

Credit risk is the possibility of financial loss resulting from default by homeowners on 

housing assets that have lost value; interest rate risk is the risk of loss due to fluctuations 

in interest rates; and operational risk includes the possibility of financial loss resulting 

from inadequate or failed internal processes, people, and systems or from external events. 

6

Office of Federal Housing Enterprises Oversight, Systemic Risk: Fannie Mae, Freddie 

Mac, and the Role of OFHEO (Washington, D.C.; Feb. 4, 2003). 
Page 5 GAO-05-576T 

The current regulatory structure for the housing GSEs is divided among 

OFHEO, HUD, and FHFB, as described below: 

• OFHEO is an independent office within HUD and is responsible for 

regulating Fannie Mae and Freddie Mac’s safety and soundness. OFHEO 

oversees the two GSEs through its authority to examine their operations, 

determine capital adequacy, adopt rules, and take enforcement actions. 

Although OFHEO’s financial plans and forecasts are included in the 

President’s budget and are subject to the appropriations process, the 

agency is not funded with tax dollars. Rather, Fannie Mae and Freddie 

Mac pay annual assessments to cover OFHEO’s costs. 

• HUD is responsible for ensuring that Fannie Mae and Freddie Mac are 

accomplishing their housing missions. HUD is to accomplish this 

responsibility through its authority to set housing goals, and to review and 

approve new programs, and through its general regulatory authority. HUD 

is funded through appropriations. 

• FHFB is responsible for regulating the FHLBank System’s safety and 

soundness as well as its mission activities. The agency has a five-member 

board, with the President of the United States appointing four members—

each of whom serves a 7-year term—subject to Senate approval. The fifth 

member is the Secretary of HUD. The President also appoints FHFB’s 

chair subject to Senate approval. Like OFHEO, FHFB carries out its 

oversight authorities through examinations, establishing capital standards, 

rule making, and taking enforcement actions. FHFB is funded through 

assessments of the 12 Federal Home Loan Banks and is not subject to the 

appropriations process. 

As I stated previously, OFHEO has moved aggressively over the past year 

to identify and address risk management and accounting deficiencies at 

Fannie Mae and Freddie Mac, and FHFB has entered into written 

agreements with two FHLBanks to correct interest rate risk management 

deficiencies. Nevertheless, we continue to believe that the current 

fragmented regulatory structure for the housing GSEs is inadequate to 

monitor these large and complex financial institutions and their mission 

activities. Establishing a single housing GSE regulator with a board 

structure and equipping the agency with adequate authorities would better 

ensure that the GSEs operate in a safe and sound manner and fulfill their 

housing missions. 

Housing GSE Regulatory 

Structure Is Divided 

among OFHEO, HUD, and 

FHFB 

Housing GSE 

Regulatory Reform Is 

Necessary to Better 

Ensure Safety and 

Soundness and 

Mission Achievement 
Page 6 GAO-05-576T 

The current fragmented structure of federal housing GSE regulation does 

not provide for a comprehensive and effective approach to safety and 

soundness regulation. Although the housing GSEs operate differently, 

their business activities and risks are becoming increasingly similar. As I 

described previously, the FHLBank System has established mortgage 

purchase programs over the past several years and FHLBank System 

mortgage holdings were $113 billion at year-end 2003. While still small 

compared with Fannie Mae and Freddie Mac’s combined retained 

mortgage portfolios of $1.3 trillion for the same time period, the FHLBank 

System now operates more like Fannie Mae and Freddie Mac and is 

increasingly incurring interest rate risks. Management of interest rate risk 

for mortgage holdings involves the application of sophisticated riskmanagement techniques, including the use of financial derivatives. 

Although such strategies are appropriate for risk management, they 

require specialized expertise, sophisticated information systems, and an 

understanding and application of sometimes complex accounting rules. In 

my view, it simply does not make sense for the federal government to 

entrust regulation of large and complex GSEs that are incurring similar 

risks to two different regulators, which have different approaches to 

examinations and setting capital standards. 

Moreover, OFHEO, and FHFB to a lesser degree, lack key authorities to 

fulfill their safety and soundness responsibilities, as described below: 

• Unlike with bank regulators and FHFB, (1) OFHEO’s authority to issue 

cease and desist orders does not specifically list an unsafe and unsound 

practice as grounds for issuance and (2) OFHEO’s powers do not include 

the same direct removal and prohibition authorities applicable to officers 

and directors. 

• Bank regulators have prompt corrective action authorities that are 

arguably more robust and proactive than those of OFHEO and FHFB. 

These authorities require that bank regulators take specific supervisory 

actions when bank capital levels fall to specific levels or provide the 

regulators with the option of taking other actions when other specified 

unsafe and unsound actions occur.7

 Although OFHEO has statutory 

authority to take certain actions when Fannie Mae or Freddie Mac capital 

falls to predetermined levels, the authorities are not as proactive or broad 

 7

Capital can be a lagging indicator of unsafe and unsound conditions at financial 

institutions. Declining asset quality is an unsafe and unsound condition that may be 

identified months or years before capital declines. 

Current GSE Regulatory 

Structure Is Fragmented, 

OFHEO Lacks Key 

Authorities, and HUD’s 

Mission Oversight 

Capacity Is Questionable 
Page 7 GAO-05-576T 

as those of the bank regulators.8 OFHEO has also established regulations 

requiring specified supervisory actions when unsafe conditions are 

identified that do not include capital, but OFHEO’s statute does not 

specifically mention these authorities. FHFB’s statute does not establish a 

prompt corrective action scheme that requires specified actions when 

unsafe conditions are identified. Although FHFB officials believe they 

have all the authority necessary to carry out their safety and soundness 

responsibilities, the agency has significant discretion in resolving troubled 

FHLBanks. Consequently, there is limited assurance that FHFB would act 

decisively to correct identified problems. 

• Unlike bank regulators—-which can place insolvent banks into 

receivership—and FHFB, which can take actions to liquidate an FHLBank, 

OFHEO is limited to placing Fannie Mae or Freddie Mac into a 

conservatorship.9

 Thus, it is not clear that OFHEO has sufficient authority 

to fully resolve a situation in which Fannie Mae or Freddie Mac is unable 

to meet its financial obligations. 

Finally, we have significant concerns about HUD’s capacity as the mission 

regulator for Fannie Mae and Freddie Mac. As I stated in my testimony last 

year, HUD officials we contacted said the department lacked sufficient 

staff and resources necessary to carry out its GSE mission oversight 

responsibilities. HUD officials said that although the GSEs’ assets had 

increased nearly sixfold since 1992, HUD’s staffing had declined by 4,200 

positions and GSE oversight—which consisted of about 13 full-time 

positions—must compete with other department priorities for the limited 

resources available. While HUD’s ability to ensure adequate resources for 

its GSE oversight responsibilities is limited, its mission oversight 

responsibilities are increasingly complex. For example, as we have noted 

in the past, it is not clear that HUD has the expertise necessary to review 

sophisticated financial products and issues, which may be associated with 

the department’s program review and approval and general regulatory 

 8

For example, bank regulators are generally required to take specified regulatory actions at 

earlier stages of capital depletion than is OFHEO. Bank regulators are also required to 

initiate four supervisory actions against an undercapitalized institution—including 

restricting asset growth—while OFHEO is mandated to take only two actions (not 

including restricting asset growth). 

9

According to OFHEO officials, a receivership is empowered to take over the assets and 

operate an entity, assuming all of its powers and conducting all of its business as well as 

removing officers and directors. A receiver may place the failed institution into liquidation 

and sell its assets. While a conservator may also remove officers and directors of an entity, 

a conservator is typically appointed to conserve rather than dispose of assets. 
Page 8 GAO-05-576T 

authorities.10 In addition, without the authority to impose assessments on 

Fannie Mae and Freddie Mac to cover the costs associated with their 

mission oversight, it would appear that HUD will always be challenged to 

fulfill its GSE mission oversight responsibilities. 

To address the deficiencies in the current GSE regulatory structure that I 

have just described, we have consistently supported and continue to 

believe in the need for the creation of a single regulator to oversee both 

safety and soundness and mission of the housing GSEs.11 A single housing 

GSE regulator could be more independent, objective, efficient, and 

effective than separate regulatory bodies and could be more prominent 

than either one alone. We believe that valuable synergies could be 

achieved, and expertise in evaluating GSE risk management could be 

shared more easily, within one agency. In addition, we believe that a single 

regulator would be better positioned to oversee the GSEs’ compliance 

with mission activities, such as special housing goals and any new 

programs or initiatives any of the GSEs might undertake. This single 

regulator should be better able to assess these activities’ competitive 

effects on all three housing GSEs and better able to ensure consistency of 

regulation for GSEs that operate in similar markets. 

Further, a single regulator would be better positioned to consider potential 

trade-offs between mission requirements and safety and soundness 

considerations, because such a regulator would develop a fuller 

understanding of the operations of these large and complex financial 

institutions. Some critics of combining safety and soundness and mission 

have voiced concerns that doing so could create regulatory conflict for the 

regulator. However, we believe that a healthy tension would be created 

that could lead to improved oversight. The trade-offs between safety and 

soundness and compliance with mission requirements could be best 

understood and accounted for by having a single regulator that has 

complete knowledge of the GSEs’ financial condition, regulates the 

mission goals Congress sets, and assesses efforts to fulfill them. 

 10See GAO, Government Sponsored Enterprises: Federal Oversight Needed for 

Nonmortgage Investments, GAO/GGD-98-48 (Washington, D.C.: Mar. 11, 1998). HUD’s 

general regulatory authority can be used to limit or disallow activities that are determined 

not to support the mission of Fannie Mae or Freddie Mac. 

11See GAO, Government-Sponsored Enterprises: Advantages and Disadvantages of 

Creating a Single Housing GSE Regulator, GAO/GGD-97-139 (Washington, D.C.: July 9, 

1997). 

A Single Housing GSE 

Regulator with a Board or 

Hybrid Board/Director 

Governance Model and 

Equipped with Sufficient 

Authorities Is Critical 
Page 9 GAO-05-576T 

In determining the appropriate structure for a new GSE regulator, I note 

that Congress has authorized two different structures for governing 

financial regulatory agencies: a single director and board. Among financial 

regulators, single directors head the Office of the Comptroller of the 

Currency, the Office of Thrift Supervision and OFHEO, while boards or 

commissions run FHFB, the Securities and Exchange Commission, and the 

Board of Governors of the Federal Reserve, among others. The single 

director model has advantages over a board or commission; for example, 

the director can make decisions without the potential hindrance of having 

to consult with or obtain the approval of other board members. 

In our previous work, however, we have stated that a “stand-alone” agency 

with a board of directors would better ensure the independence and 

prominence of the regulator and allow it to act independently of the 

influence of the housing GSEs, which are large and politically influential. A 

governing board may offer the advantage of allowing different 

perspectives, providing stability, and bringing prestige to the regulator. 

Moreover, including the secretaries of Treasury and HUD or their 

designees on the board would help ensure that GSE safety and soundness 

and housing mission compliance issues are considered. 

I would note that in other regulatory sectors—-besides financial 

regulation—-Congress has established alternative board structures that 

could be considered as potential models for the new GSE regulator. One 

such alternative structure would be the hybrid board/director governance 

model. Under such an approach, there would be a presidentially appointed 

and Senate-confirmed agency head who would report to a board of 

directors composed of secretaries from key executive branch agencies, 

such as Treasury and HUD. Having board members from the same political 

party could lessen some of the tensions and conflicts observed at boards 

purposefully structured to have a split in membership along party lines. A 

board composed of members from the same political party, however, may 

not benefit from different perspectives to the same extent as a board with 

members from different political parties. Therefore, an advisory 

committee to the regulator could be formed to include representatives of 

financial markets, housing, and the general public. This advisory 

committee could be required to have some reasonable representation from 

different political parties. 

It is also essential that the new GSE regulator have adequate powers and 

authorities to address unsafe and unsound practices, respond to financial 

emergencies, and ensure that the GSEs comply with their public missions. 

These authorities include (1) cease and desist authority related to unsound 

New GSE Regulator Should 

Have a Board or Hybrid 

Board/Director Governance 

Structure 

Adequate Regulatory 

Authorities Are Essential 
Page 10 GAO-05-576T 

practices, (2) removal and prohibition authority related to officers and 

directors, (3) prompt corrective action authority, and (4) authority to 

resolve a critically undercapitalized GSE, which may include placing it into 

receivership. Additionally, the new housing GSE regulator should have the 

authority to adjust as necessary the housing enterprises’ minimum and 

risk-based capital requirements to help ensure their continued safety and 

soundness. 

I would also like to comment on an area of recent debate concerning 

discussions of GSE regulatory reform, i.e., restrictions on Fannie Mae’s 

and Freddie Mac’s retained mortgage portfolios, which were 

approximately $1.3 trillion as of year-end 2003. In testimony before this 

committee on April 6, 2005, Federal Reserve Chairman Greenspan stated 

that the GSEs’ large retained mortgage portfolios do not necessarily 

benefit housing finance, are primarily intended to increase the GSEs’ 

profitability, and increase the potential for systemic financial risks. To 

address these concerns, Chairman Greenspan called for limits on the 

GSEs’ mortgage portfolios to be phased in over time. Moreover, Treasury 

Secretary Snow also expressed concern about the GSEs’ mortgage 

portfolios and called for limits on their size. We also have commented that 

the GSEs’ housing portfolios raise potential risks, and their benefits to 

housing finance markets are not clear. In my view, providing the new 

regulator with strong criteria to evaluate the costs and benefits of the 

GSEs’ mortgage portfolios and the authority to limit them, if necessary, is 

essential. The criteria could include the extent to which the mortgage 

portfolios enhance the GSEs’ housing mission, increase financial risks, and 

raise financial stability concerns. 

Further, the new housing GSE regulatory agency should be provided with 

explicit authority to oversee the GSEs’ corporate governance and 

management compensation practices. As I stated in my previous 

testimony, while the GSEs should have been leaders with respect to 

corporate governance, in many respects they were not. For example, 

unlike leading organizations, the chairman of Fannie Mae’s board also 

served as the GSE’s chief executive officer (CEO). I note that both Fannie 

Mae and Freddie Mac have formally agreed with OFHEO to separate the 

positions of chairperson of the board and CEO, thereby helping to ensure 

that the GSE boards independently establish company policies that their 

CEOs are responsible for carrying out. OFHEO also found that Fannie 

Mae’s compensation system provided managers with financial incentives 

to take actions—such as accounting irregularities—that increased the 

GSE’s reported short-term profitability. Without the authority to police 
Page 11 GAO-05-576T 

such practices, the new regulator would not be able to fully carry out its 

oversight responsibilities. 

I also believe that the new GSE regulator should be tasked with the 

responsibility to conduct research on the extent to which the housing 

GSEs are fulfilling their housing and community development missions. As 

I described earlier, there are already questions about the extent to which 

the housing GSEs’ mortgage holdings benefit housing finance markets. 

Moreover, federal agencies, academics, and the GSEs have initiated 

studies that have estimated the extent to which Fannie Mae’s and Freddie 

Mac’s activities generate savings to home buyers, which have reached 

differing conclusions. Additional studies may be needed to more precisely 

estimate the extent to which the GSEs’ activities benefit home buyers. 

Further, there is virtually no empirical information on the extent to which 

FHLBank advances lower mortgage costs for home buyers or encourage 

lenders to expand their commitment to housing finance. Without better 

information, Congress and the public cannot judge the effectiveness of the 

GSEs in meeting their missions or whether the benefits provided by the 

GSEs’ various activities are in the public interest and outweigh their 

financial and systemic risks. 

Finally, I would now like to comment on issues surrounding the potential 

funding arrangements for a new housing GSE regulator. Exempting the 

new GSE regulator from the appropriations process would provide the 

agency with the financial independence necessary to carry out its 

responsibilities. More importantly, without the timing constraints of the 

appropriations process, the regulator could more quickly respond to 

budgetary needs created by any crisis at the GSEs. However, being outside 

the appropriations process can create trade-offs. First, while the regulator 

will have more control over its own budget and funding level, it will lose 

the checks and balances provided by the federal budget and 

appropriations processes or the potential reliance on increased 

appropriations during revenue shortfalls. As a result, the regulator would 

need to establish a system of budgetary controls to ensure fiscal restraint. 

Second, removing the regulator from the appropriations process could 

diminish congressional oversight of the agency’s operations. This trade-off 

could be mitigated through increased oversight by the regulator’s 

congressional authorizing committees, such as a process of regular 

congressional hearings on the new GSE regulator’s operations and 

activities. 

Regulatory Funding Structure 
Page 12 GAO-05-576T 

Mr. Chairman, this completes my prepared statement. I would be happy to 

respond to any questions that you or other Members of the Committee 

may have. 

For further information regarding this testimony, please contact Thomas J. 

McCool, Managing Director, at (202) 512-8678 or mccoolt@gao.gov; or 

William B. Shear, Director, at (202) 512-4325 or shearw@gao.gov. 

Individuals making contributions to this testimony include Allison M. 

Abrams, Marianne E. Anderson, Wesley M. Phillips, and Karen C. Tremba. 

GAO Contacts and 

Staff 

Acknowledgments 
Page 13 GAO-05-576T 

Federal Home Loan Bank System: An Overview of Changes and Current 

Issues Affecting the System. GAO-05-489T. Washington, D.C.: April 13, 

2005. 

Government-Sponsored Enterprises: A Framework for Strengthening 

GSE Governance and Oversight. GAO-04-269T. Washington, D.C.: 

February 10, 2004. 

Federal Home Loan Bank System: Key Loan Pricing Terms Can Differ 

Significantly. GAO-03-973. Washington, D.C.: September 8, 2003. 

Financial Regulation: Review of Selected Operations of the Federal 

Housing Finance Board. GAO-03-364. Washington, D.C.: February 28, 

2003. 

OFHEO’s Risk Based Capital Stress Test: Incorporating New Business Is 

Not Advisable. GAO-02-521. Washington, D.C.: June 28, 2002. 

Federal Home Loan Bank System: Establishment of a New Capital 

Structure. GAO-01-873. Washington, D.C.: July 20, 2001. 

Comparison of Financial Institution Regulators’ Enforcement and 

Prompt Corrective Action Authorities. GAO-01-322R. Washington, D.C.: 

January 31, 2001. 

Capital Structure of the Federal Home Loan Bank System. GAO/GGD-99-

177R. Washington, D.C.: August 31, 1999. 

Federal Housing Finance Board: Actions Needed to Improve Regulatory 

Oversight. GAO/GGD-98-203. Washington, D.C.: September 18, 1998. 

Federal Housing Enterprises: HUD’s Mission Oversight Needs to Be 

Strengthened. GAO/GGD-98-173. Washington, D.C.: July 28, 1998. 

Risk-Based Capital: Regulatory and Industry Approaches to Capital and 

Risk. GAO/GGD-98-153. Washington, D.C.: July 20, 1998. 

Government-Sponsored Enterprises: Federal Oversight Needed for 

Nonmortgage Investments. GAO/GGD-98-48. Washington, D.C.: March 11, 

1998. 

Related GAO Products 
Page 14 GAO-05-576T 

Federal Housing Enterprises: OFHEO Faces Challenges in Implementing 

a Comprehensive Oversight Program. GAO/GGD-98-6. Washington, D.C.: 

October 22, 1997. 

Government-Sponsored Enterprises: Advantages and Disadvantages of 

Creating a Single Housing GSE Regulator. GAO/GGD-97-139. 

Washington, D.C.: July 9, 1997. 

Housing Enterprises: Investment, Authority, Policies, and Practices. 

GAO/GGD-91-137R. Washington, D.C.: June 27, 1997. 

Comments on “The Enterprise Resource Bank Act of 1996.” GAO/GGD-96-

140R. Washington, D.C.: June 27, 1996. 

Housing Enterprises: Potential Impacts of Severing Government 

Sponsorship. GAO/GGD-96-120. Washington, D.C.: May 13, 1996. 

Letter from James L. Bothwell, Director, Financial Institutions and 

Markets Issues, GAO, to the Honorable James A. Leach, Chairman, 

Committee on Banking and Financial Services, U.S. House of 

Representatives, Re: GAO’s views on the “Federal Home Loan Bank 

System Modernization Act of 1995.” B-260498. Washington, D.C.: October 

11, 1995. 

FHLBank System: Reforms Needed to Promote Its Safety, Soundness, 

and Effectiveness. GAO/T-GGD-95-244. Washington, D.C.: September 27, 

1995. 

Housing Finance: Improving the Federal Home Loan Bank System’s 

Affordable Housing Program. GAO/RCED-95-82. Washington, D.C.: June 9, 

1995. 

Government-Sponsored Enterprises: Development of the Federal Housing 

Enterprise Financial Regulator. GAO/GGD-95-123. Washington, D.C.: May 

30, 1995. 

Federal Home Loan Bank System: Reforms Needed to Promote Its Safety, 

Soundness, and Effectiveness. GAO/GGD-94-38. Washington, D.C.: 

December 8, 1993. 

Improved Regulatory Structure and Minimum Capital Standards Are 

Needed for Government-Sponsored Enterprises. GAO/T-GGD-91-41. 

Washington, D.C.: June 11, 1991. 
Page 15 GAO-05-576T 

Government-Sponsored Enterprises: A Framework for Limiting the 

Government’s Exposure to Risks. GAO/GGD-91-90. Washington, D.C.: May 

22, 1991. 

Government-Sponsored Enterprises: The Government’s Exposure to 

Risks. GAO/GGD-90-97. Washington, D.C.: August 15, 1990. 

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