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22–763 PDF 2005

ADDITIONAL ACCOUNTING

AND MANAGEMENT FAILURES

AT FANNIE MAE

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE AND 

GOVERNMENT SPONSORED ENTEREPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

APRIL 6, 2005

Printed for the use of the Committee on Financial Services

Serial No. 109–12

(

(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 

PETER T. KING, New York 

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 

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 

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: 

April 6, 2005 ..................................................................................................... 1

Appendix: 

April 6, 2005 ..................................................................................................... 21

WITNESS 

WEDNESDAY, APRIL 6, 2005

Falcon, Hon. Armando Jr., Director, Office of Federal Housing Enterprise 

Oversight .............................................................................................................. 3

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 22

Gillmor, Hon. Paul E. ....................................................................................... 24

Hinojosa, Hon. Rube ́n ....................................................................................... 25

Kanjorski, Hon. Paul E. ................................................................................... 26

Ney, Hon. Robert W. ........................................................................................ 28

Falcon, Hon. Armando Jr. ................................................................................ 30

(1)

ADDITIONAL ACCOUNTING 

AND MANAGEMENT FAILURES 

AT FANNIE MAE 

Wednesday, April 6, 2005

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 call, at 10:03 a.m., in Room 

2128, Rayburn House Office Building, Hon. Richard Baker [chairman of the subcommittee] presiding. 

Present: Representatives Baker, Shays, Gillmor, Royce, Oxley, 

Kelly, Ney, Miller of California, Kennedy, Tiberi, Feeney, 

Hensarling, Davis of Kentucky, Kanjorski, Moore, Hinojosa, Baca, 

Lynch, Scott, Watt, Davis of Alabama, and Wasserman Schultz. 

Mr. BAKER. I would like to call this meeting in the Subcommittee 

on Capital Markets to order. 

Today, the committee meets for the purposes of receipt of additional testimony from the Honorable Armando Falcon, director, Office of Federal Housing Enterprise Oversight, on his interim report 

relative to accounting and management failures at Fannie Mae and 

the enterprise’s observations as to the ongoing difficulties with 

these disclosures and potential recommendations for our future actions. 

It, indeed, is disappointing to read press reports indicating that, 

in some cases, signatures that were even falsified to documents 

were not an incidental or irregular act of a single individual, but 

apparently, an ongoing business practice. This is deeply troubling 

in light of the underlying financial uncertainties that are already 

facing the Congress with regard to the capital adequacy of Fannie 

Mae and, to a lesser extent, Freddie Mac, and so I look forward 

with some anticipation to the director’s information concerning 

these matters. 

Time permitting, I would also bring to the director’s attention 

legislation which was introduced yesterday on reform of the regulatory oversight process and to seek his insights on that legislation, 

if he so chooses. 

Perhaps more importantly today is, after reading other press stories as of yesterday, it is my understanding the director has made 

clear to the White House his intention to depart his responsibility 

as director in the near term, and I feel I owe it to him, given our 

2

longstanding professional working relationship, to make some comment. 

As he would well acknowledge, we have had our moments. However, I would say, in the last 18 months of professional conduct, he 

has been more than exonerated and held in high esteem by all who 

have studied this matter. It has been a very difficult professional 

responsibility to be publicly critical of either of these enterprises, 

and you were held up to some significant criticism even by members of this committee on occasion. I just want to say to you that 

I think you have done an outstanding job and a valuable public 

service, to you and all members of your staff. 

Should legislation be adopted, there is contained in the bill, at 

least as I proposed, significant rules of accommodation for transition for those in OFHEO to the new regulatory body, and this is, 

to a great extent, in recognition of the difficult work and, I think, 

the good reports that the agency has developed on the activities of 

the enterprises, and it is work that should not be overlooked or 

soon forgotten. 

So, for those reasons, I commend you and wish you well in whatever future endeavors may bring you. 

Mr. Kanjorski? 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

We meet today to review the most recent developments concerning the special examination of Fannie Mae by the Office of 

Federal Housing Enterprise Oversight. As I have regularly noted 

in our past hearings on these matters, it is important and appropriate for our panel to conduct comprehensive and regular oversight over our housing government-sponsored enterprises to ensure 

that they fulfill their mission and operate safely and soundly. 

At our first hearing this year, we heard from the chief accountant of the Securities and Exchange Commission about his decisions 

related to Fannie Mae’s accounting practices. Today, we will follow 

up on that hearing by receiving testimony from a frequent witness 

before our panel, Armando Falcon, the Director of the Office of Federal Housing Enterprise Oversight. As always, I appreciate learning of his insights on these issues and, again, welcome him here. 

I should also note that, because he will be leaving the agency 

next month, this appearance will likely be the last time that Director Falcon testifies before our panel in his current capacity. During 

his tenure, he has steadfastly worked to increase the agency’s resources and its effectiveness. 

The main focus of today’s hearing is the March supplemental supervisory agreement between Fannie Mae’s board and the Office of 

Federal Housing Enterprise Oversight. This agreement addresses 

additional deficiencies identified by the regulator during its ongoing special examination. These failings relate to insufficient internal controls, the improper application of accounting standards and 

inadequate corporate governance. 

Like many of my colleagues, I am troubled by these latest revelations. As a government-sponsored enterprise with public responsibilities and private capital, Fannie Mae has a special obligation 

to operate fairly, safely and soundly. These newest disclosures indicate that the company fell short in meeting these responsibilities. 

3

Nevertheless, I am also heartened that Fannie Mae, according to 

its regulator, is cooperating and working to address these issues in 

a responsible manner. I am also pleased that, although serious, 

these problems do not appear to pose a systemic risk, according to 

those most knowledgeable of the facts in these matters. 

As we proceed today, I also suspect that some of my colleagues 

will return to the question of how best to modify the regulation of 

government-sponsored enterprise, including you, Mr. Chairman. It 

is in the public’s interest that we ensure that Fannie Mae and 

Freddie Mac continue to operate safely and soundly. We must further ensure that these public-private entities achieve their public 

responsibilities for advancing home ownership opportunities. 

As I said at our very first hearing on the oversight of government-sponsored enterprises in March of 2000, we need to have 

strong, independent regulators that have the resources that they 

need to get the job done. I can assure everyone that I continue to 

support the strong, world-class and independent regulation of 

Fannie Mae and Freddie Mac. 

A strong and world-class independent regulator will protect the 

continued viability of our capital markets and promote confidence 

in Fannie Mae and Freddie Mac. It will also insure taxpayers 

against systemic risk and expand housing opportunities for all 

Americans. 

In closing, Mr. Chairman, I commend you for your continued perseverance in these matters, and I look forward to hearing from our 

distinguished witness. 

[The prepared statement of Hon. Paul E. Kanjorski can be found 

on page 26 in the appendix.] 

Mr. BAKER. I thank the gentleman. 

By a prior agreement of the chairman and ranking member, because of an expected recess of the committee at 11 o’clock for the 

address on the House floor, we have agreed to limit opening statements to the chair, ranking member. 

And since neither Mr. Frank or Mr. Oxley are now present, I 

would make all members’ statements part of the official record and 

move at this time to recognize Mr. Falcon for whatever statement 

you may choose to make, sir. 

Proceed as you like. Your formal statement, as is the usual practice, will be made part of the record. 

STATEMENT OF HON. ARMANDO FALCON JR., DIRECTOR, 

OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT 

Mr. FALCON. Thank you, Mr. Chairman. 

I will give a summary of my written testimony. 

First of all, may I say thank you for your comments about the 

agency and my tenure there. 

You, Mr. Chairman, and Mr. Kanjorski have been steadfast supporters of strong safety and soundness regulation and the agency. 

I appreciate that very much on behalf of the agency. 

I am pleased to appear before you today to discuss OFHEO’s supplemental agreement with Fannie Mae and the issues that gave 

rise to the agreement. 

We have two objectives in our ongoing special examination of 

Fannie Mae. First, we must identify all the problems and fix them. 

4

As my testimony today indicates, that task is not yet complete. Second, we must institute a comprehensive reform program to prevent 

problems from recurring. This program will include far stronger internal controls and corporate governance measures; an adequate 

investment in systems, processes and personnel; and the establishment of a corporate culture fully dedicated to compliance with the 

law, with GAAP and all relevant rules and regulations. 

With the continued cooperation of the board and management, 

we expect that Fannie Mae will ultimately emerge from its troubles 

as a healthy, well-managed enterprise properly focused on fulfilling 

its public mission. That is the ultimate goal of the supervisory actions we have taken. I believe it is a goal now shared by Fannie 

Mae’s board and its interim leadership as well. 

As you are aware, last September, we entered into an agreement 

with the board of directors that set forth a series of matters requiring immediate attention, particularly in the area of accounting. The 

agreement also outlined longer-term remedial steps, such as 

changes in the company’s compensation program and corporate 

structure. In addition, we required that the company maintain a 

30-percent minimum capital surplus in order to address safety and 

soundness concerns. 

More recently, we entered into a supplemental agreement with 

Fannie’s board to address problems found by OFHEO. The agreement requires additional remedial steps in accounting policy and 

accounting management and expands on reforms in controls and 

corporate governance. 

Significant among the corporate governance reforms was the requirement that Fannie Mae separate the chief executive officer and 

chairman of the board positions. We also required that the company report weekly to OFHEO on its efforts to meet capital requirements, including any corporate decisions on dividend payments or other matters that would affect the company’s capital position. 

In general, Fannie Mae has moved forward in addressing the 

matters set forth in our agreements. Experts have been engaged, 

studies undertaken, certain personnel changes have been made, 

and the company has formulated preliminary plans for new organizational structures and reporting lines. 

OFHEO’s special examination of Fannie Mae has revealed a significant number of new accounting problems at the enterprise. As 

with previous accounting problems, they reflect Fannie Mae’s tendency towards overly aggressive interpretation of GAAP or, in certain instances, a willful disregard of accounting rules. They also reflect situations where Fannie Mae’s accounting policies actually do 

comply with GAAP, but enterprise personnel have failed to follow 

those policies. 

I have covered these issues in detail in my written statement, so 

I will not go into them further in my oral remarks. 

During our special examination, we have also identified several 

problems involving procedures for preparing, reviewing, validating, 

authorizing and recording journal entries related to amortization 

adjustments. These issues include falsified signatures on journal 

entries; the failure to require that journal entry preparers determine the entries were valid and appropriate; a failure to require 

5

that journal entries include supporting documentation, a lack of 

independent review of journal entries, and an absence of written 

policy guidance concerning journal entry procedures. 

My written testimony describes the intent of our review in this 

area and because it is a matter under investigation, I cannot go 

into further detail beyond what is contained in my written statement. 

As the scope of the Fannie Mae special examination has proceeded well beyond our expectations, we will need additional funds 

this year. Accordingly, we have used our special assessment authority to assess Fannie Mae an additional $5 million. However, 

while we have collected the funds, OMB has opined that due to a 

technical deficiency in the statute we may not spend the funds. 

While we do not agree with OMB’s interpretation, we are bound by 

it. 

I think this provides yet another example of why Congress must 

enact legislation to give the regulator the full authority it needs to 

do its job. Until then, I would ask the committee’s assistance in resolving this funding matter. 

Finally, Mr. Chairman, I would like to also end on a personal 

note, if I may. As you mentioned, my 5-year term as Director of 

OFHEO expired last October, but I have remained in the office to 

guide the agency through a very challenging period. With the most 

critical and pressing issues at the enterprises now addressed, I 

have decided to step down from my position next month. 

I am proud of OFHEO’s achievements during my tenure. The 

agency has successfully dealt with very serious problems at two of 

the largest financial institutions in the world, and we have done so 

without disrupting our financial markets, while allowing both enterprises to continue fulfilling their vital mission of making home 

ownership more affordable. 

I am particularly proud of the efforts of OFHEO’s employees and 

our conduct during the special examinations. Seldom does a safety 

and soundness regulator identify improper actions, with potentially 

billions of dollars of adverse impact, before they manifest themselves in a way that does permanent harm to the company. 

It has been a privilege to serve the public as the Director of 

OFHEO, and I want to thank this committee for its support over 

the years. 

Thank you, Mr. Baker. I would be happy to answer any questions 

the committee may have. 

[The prepared statement of Hon. Armando Falcon Jr. can be 

found on page 30 in the appendix.] 

Mr. BAKER. Thank you very much. 

I do not know that your position would require you to make an 

assessment as to systemic risk potential, but, given the knowledge 

you have now gained pursuant to these inquiries, given the time 

it appears that the management lapse allowed practices inconsistent with GAAP to be engaged in, if unchecked, would you have 

had some concern about some potential future day when the numbers would not add up, the capital would have been inadequate and 

a systemic risk potential having been created? 

Mr. FALCON. I would be concerned that, at some point in time, 

the problems we found in the company would manifest themselves 

6

some way. Fortunately, we did find them before that occurred, but 

the practices of the company in terms of its approach towards compliance with regulations, be they accounting or internal controls or 

best practices in risk management, were not healthy. 

Mr. BAKER. And had been engaged in on more than just, say, a 

single reporting quarter. This was year-over-year activity, not 

merely an aberrant activity. 

Mr. FALCON. Yes. 

Mr. BAKER. Do you have any window yet as to when Fannie 

would be in a position to give us certified or accurate financials? 

Mr. FALCON. We cannot say with any degree of certainty right 

now, but I think a useful model might be to look at the Freddie 

Mac situation. There, it did take a couple of years for the company 

to produce financial statements, and it will take a couple of years 

beyond that to get timely. I think that might be a useful example 

of what might be involved here. 

Mr. BAKER. There has been no resolution or determination yet 

made, however, with regard to the accounting treatment of the special purpose entities. 

Mr. FALCON. Right. 

Mr. BAKER. And I am speaking through you to Mr. Pollard because he was at a hearing not long ago relative to the First Beneficial matter in which he indicated to me at that hearing that that 

examination was still continuing. We do not yet have closure on 

any liabilities that may accrue from the transactions with First 

Beneficial, for example. 

Mr. FALCON. Right. That is still the subject of an examination by 

OFHEO. 

Mr. BAKER. My point in asking these series of questions is to 

make clear that, with your departure from the enterprise and there 

having been significant gains made, significant disclosures 

achieved, that there are matters of some consequence still pending 

which will require 18 months to a couple of years to get final resolution or closure. Would that be a fair statement? 

Mr. FALCON. There is still a great deal of work before the agency 

and Fannie Mae. That is absolutely the case. 

Mr. BAKER. I do not know that you would have had time, given 

your preparation for your appearance here today, to be familiar at 

all with the provisions of the bill now introduced relative to the 

creation of an enhanced regulator. Do you have any comment to 

make about the provisions that are included in the bill generally, 

or is there a specific area of concern you would like to bring to the 

committee’s attention you do not feel is addressed by the bill? 

Mr. FALCON. As you said, I have not had a chance to go through 

much of the details of the bill, but I think the intent of the legislation to provide the regulator with authorities on par with every 

other safety and soundness regulator is progress. Anything which 

fills the gaps in the regulator’s authority to do its job would be a 

positive step forward. Beyond that, the details of any particular 

provision, I have not had a chance to review them. 

Mr. BAKER. There has been some discussion primarily led by 

Chairman Greenspan as to the advisability of limiting the growth 

or even further reducing the size of the existing investment portfolio, as it is his view, according to press reports, that it does not 

7

have a correlation to housing function. He had suggested even a 

hard-dollar limit of some $200 billion down from the $1.6 trillion 

currently engaged. Do you have any opinion as to whether it is advisable or not to have further restrictions on growth at the least 

or to pursue the reductions over time, in your view? 

Mr. FALCON. The company does need to retain a portfolio of some 

amount towards liquidity needs. I think that is very evident. What 

that amount is I could not tell you where any cap should stand. 

Mr. BAKER. But $1.6 trillion is more than adequate. 

Mr. FALCON. Yes. It is clear, I think, that the current levels are 

more than adequate to provide for their legitimate safety and 

soundness needs for their risk management purposes. How much 

below the current levels would be necessary and then how much 

beyond that simply for other purposes would require some study. 

Mr. BAKER. And it would be your concern, I presume, that if they 

were precipitously lowered over too short a period of time, that 

could have adverse consequences for the enterprises? 

Mr. FALCON. Yes. 

Mr. BAKER. Mr. Kanjorski? 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

On the insufficient internal controls and improper application of 

accounting standards to meet adequate corporate governance, what 

did your final examination show, how long a period that existed—

just in the last year, the last 2 years, the last 5 years, the last 10 

years—or has it been endemic to the organization? 

Mr. FALCON. It varies by issue, Congressman. There was one 

lapse in their systems that dated back 21 years, other matters may 

have taken place in the last 1 or 2 years, but, generally, I would 

say that they fall within the last 4 years or so. 

Mr. KANJORSKI. I am concerned about, first of all, are these 

lapses. Are they of huge significance where they could put at risk 

the safety and soundness of the organization, or are they not that 

significant? 

Mr. FALCON. I view the weaknesses in internal controls as very 

significant. As you know, there are many examples in history 

where lapses in internal controls have brought down large old financial institutions almost overnight. Barings Bank is one example 

of how internal controls can bring down a company, even a wellcapitalized company. So lapses in internal controls, even though we 

often speak of them after the accounting issues, I think, are just 

as, if not more, serious than the accounting problems. 

Mr. KANJORSKI. Were these lack of internal controls you found 

really substantial, though, in this particular instance? 

Mr. FALCON. I think they were substantial. I do think they were 

because there were almost no controls in some instances. There 

was one example where one employee was allowed, through the 

lack of internal controls, to make a change in an accounting formula on the spreadsheet that resulted in an improper reporting of 

a billion dollars. It is that type of lack of internal controls that concern me. With proper internal controls, one employee could not go 

and make those changes without a couple of layers of verification 

before changes like that are made. 

Mr. KANJORSKI. Well, I guess I do not sufficiently understand the 

nature and focus of the regulator’s involvement, but what sort of 

8

bothers me here is that your testimony says, in one instance, this 

problem existed over 21 years, and then substantial internal control failure. 

Why wasn’t this picked up by the regulator over the last several 

years or the last 10 years? That is what I do not quite understand. 

Is it because you did not get depthfully involved in the books before? 

Under prior testimony before the committee, I understood that 

you were sort of like a meat inspector at a meat plant. You are 

there on a day-to-day basis and you watch the whole process as it 

evolves and you sit at their internal audit exit meetings and that 

you are made aware of everything that the corporate governance 

entity is made aware of. 

Why didn’t you pick this up? What is the why? 

Mr. FALCON. I think you are accurate in your reasoning. It is the 

need to do things with adequate depth. When I took over the agency, we had 30 examiners, and I had our examination staff do a review, a benchmarking study, comparing our program to other regulators and how many examiners they would have on staff to supervise two companies of this size. 

This benchmarking study showed that on average another regulator might have 60 or so examiners per institution. We were working with 15 examiners per institution, which is why we have moved 

over the last 5 years to try to increase our resources. I wish I had 

the number of examiners that I have today back then. Perhaps we 

would have had the ability to catch many of these problems. 

Mr. KANJORSKI. But why didn’t we catch some of them? I have 

been under the impression that over the years both Freddie Mac 

and Fannie Mae were fairly well-run organizations, and, every time 

we have had hearings over the last 5 years on this subject, that 

is what we were led to believe by both the regulators and by the 

company. 

Now maybe some of the people that were testifying on behalf of 

the company did not even know these problems—is that your testimony—or their absence of knowledge is in itself a governance problem? 

Mr. FALCON. I think many of these internal control problems 

revolve around accounting procedures and the recordkeeping activities of the company, and this is an area we have not looked at traditionally. Safety and soundness regulators rely on the outside 

audit function to do its job properly. 

We have never second-guessed the external auditors to make 

sure that the company’s statements are compliant with GAAP. 

That is the role of the external auditor, and only after the accounting problems were uncovered did it become very apparent that controls around the accounting activities of the company and its financial systems were inadequate. 

Mr. KANJORSKI. So what you are telling us now is not only the 

internal accounting, it is also their external auditor that participated in this misrepresentation, either by omission or commission, 

and I would like you to sort of specify. Do you think it was by omission, or were they participants in it? 

Mr. FALCON. Well, it is clear that the external auditor—in this 

case, KPMG—certified financial statements as compliant with 

9

GAAP that we now know, obviously, were not compliant with 

GAAP. We are examining the question of whether that was just the 

result of inadequate work done by the auditor or was it the result 

of some complicity on the part of the auditor. 

Mr. KANJORSKI. You have not determined that? 

Mr. FALCON. No, Congressman. 

Mr. KANJORSKI. Under present law, does the regulator have authority to not only punish the corporation or extract some fine or 

fee from the corporation but also from the other contracted parties, 

like the auditor, if errors like this are made? In other words, can 

you assess that auditor some penalty? 

Mr. FALCON. We do not have that explicit authority. What we 

could possibly do is limit the company’s ability to do business with 

certain counterparties. 

Mr. KANJORSKI. What risk does the accounting firm run if they 

do not come forth with accounting principles that are according to 

GAAP? If they miss those either by omission or commission, are 

they at any risk or is that part of the game, do it so that you have 

a client and satisfy the client’s needs? 

Mr. FALCON. I think that spreads more to the responsibility of 

the PCAOB to examine whether or not the auditor in this instance 

properly did its job, and they are involved in that type of review. 

Mr. KANJORSKI. Okay. 

Thank you, Mr. Chairman. 

Mr. BAKER. As much as is practicable, given our potential 11 

o’clock recess, I am going to try to stick to the 5-minute rule pretty 

strictly to give as many members as possible a chance to be heard. 

Mr. Shays? 

Mr. SHAYS. Thank you. 

Mr. Falcon, I wish you well in whatever you do in the future, and 

I thank you for your service to your country and in this capacity. 

Having said that, I wish you were as good earlier as you have 

been in the last few years. 

I want to understand why OFHEO became more aggressive. I 

felt like—and I will just say this—you basically were almost created by Fannie Mae and Freddie Mac in that you were doing what 

they wanted rather than what Congress needed until the last year 

or two. What explains, though, the difference in approach that you 

have had? 

Mr. FALCON. With the resources available to us in more recent 

years, it allowed us more flexibility to cover more areas and, certainly, when the problems of Freddie Mac became apparent, it did 

illustrate a particular area where we needed to focus more of our 

attention, as traditionally we had not. So really, with the additional resources, it provided us with the means to become more 

thorough in how we went about examining the two institutions. 

Mr. SHAYS. Well, I believe if you had done what you have done 

in the last year, we would not even be talking about a new regulator, and that is the sad part of this because we had Mr. Raines 

come before us, challenge your last findings, almost arrogantly dismissed it, and I thought you were very forceful and, frankly, somewhat courageous, and the SEC backed what you all had determined. 

10

So I think you are going out in a way that is important, but it 

is sad that we never got a handle on Fannie Mae and Freddie Mac 

sooner. That is what is sad. 

I would like to just ask you in regard to the illegal entries, the 

forged entries, what is the significance of it? I mean, I know they 

were illegal. Whose signatures were forged? And what is the significance of that? What does it mean? I want to understand what 

it means. I know it was illegal, but what does it mean in terms of 

its impact on the accounting? 

Mr. FALCON. There was a breakdown in the integrity of the process by which financial statements are produced. The financial 

statements are produced from the ledgers of the company, and the 

ledgers’ data is entered through preparers who will——

Mr. SHAYS. Well, was it false information besides forged signatures? 

Mr. FALCON. This was related to the amortization entries. In our 

September report, we referred to some FAS 91 accounting. 

Mr. SHAYS. Can you answer the question, though? I mean, were 

the amounts inaccurate? 

Mr. FALCON. Yes, the amounts were improper under accounting 

rules. These were the so-called catch-up amounts that were adjustments. 

Mr. SHAYS. Do we know how high it goes up in the organization? 

Mr. FALCON. We do not at this time, but we are looking into that. 

Mr. SHAYS. Yes. Is your statement as comprehensive as your 

knowledge of this, or are you saying less in your statement than 

you know? 

Mr. FALCON. We are doing much more work in this area and, because of the sensitivity of it, we have only said what we thought 

might be appropriate to provide the committee with information, 

not do anything which might undermine our efforts. 

Mr. SHAYS. So there is more to this story that you know that you 

are not really feeling comfortable to disclose. 

Thank you, Mr. Chairman. 

Mr. BAKER. I thank the gentleman. 

Mr. Davis? 

Mr. DAVIS OF KENTUCKY. Thank you, Mr. Chairman. 

Mr. Falcon, I certainly wish you well as you move into another 

phase of your career. 

Let me bring up a subject that, frankly, we have not talked about 

a lot this morning. As you know, there was an inspector general’s 

report that I think came out back in December, if I am not mistaken. I think it happened while we were in recess. It may be that 

Congress was here for a day on the homeland security bill, but it 

was basically during a recess period, if I am not mistaken. I am 

sure the chair will correct me if I am wrong. If I am not mistaken, 

I do not think that we have had a hearing on the inspector general’s report. 

Have you reviewed the other contents of the report, Mr. Falcon? 

Mr. FALCON. I have. 

Mr. DAVIS OF KENTUCKY. And respecting my 5-minute timeframe, we do not have an opportunity to get into all of it, but my 

recollection of it is that there were some fairly stinging criticisms 

11

of OFHEO that were contained in that report. Do you agree with 

that? 

Mr. FALCON. Yes. 

Mr. DAVIS OF KENTUCKY. I recall one observation in the report 

that OFHEO acted not as a disinterested party, but that OFHEO 

may have acted in a fairly aggressive way toward Fannie Mae, that 

it may have overstepped the bounds of being disinterested. Was 

that one of the observations in the report, as you recall it? I am 

not asking if you agree with it. Was that one of the observations? 

Mr. FALCON. It has been a while since I have read it. I could not 

tell you all the details of it. 

Mr. DAVIS OF KENTUCKY. So is that a pretty fair characterization, that the report critiqued OFHEO for not being a disinterested 

regulator? 

Mr. FALCON. I think it was, yes. 

Mr. DAVIS OF KENTUCKY. Well, obviously, OFHEO was still in existence, and so we do our task of creating a new regulator, which 

I think there is wide consensus that we will. Obviously, I presume 

that that report has some relevance to you in the last weeks of 

your tenure. I am a little bit concerned about the fact that you 

have not reviewed it in a while. 

More importantly, can you tell me what steps, if any, OFHEO 

has taken to respond to any of the criticisms identified in the inspector general’s report? 

Mr. FALCON. I am not sure that any response was warranted. 

Mr. DAVIS OF KENTUCKY. Was there any corrective action? 

Mr. FALCON. The Justice Department, the Department of HUD 

determined that we had done nothing improper, and so that was 

the end of it. 

Mr. DAVIS OF KENTUCKY. Did you make your own independent 

assessment of the report and its accuracy? 

Mr. FALCON. I did. 

Mr. DAVIS OF KENTUCKY. And what were your conclusions? 

Mr. FALCON. I disagreed with the criticisms. 

Mr. DAVIS OF KENTUCKY. I do not mean this pejoratively towards 

you, but I am having a mental picture in my mind that when you 

all came up with your report on Fannie Mae, Mr. Raines and Mr. 

Howard, I think, sat there, and they said fairly forcefully that they 

disagreed with your conclusions. 

What suggestion would you offer us, Mr. Falcon, as to what you 

think this committee or this Congress should be doing to look at 

that report and to learn from it, because, obviously, as we create 

a new regulator, we are going to try to make sure they do a better 

job, frankly, than you all did. I would think that it is relevant what 

is contained in that report. What would you suggest Congress do, 

or do you think it would be appropriate, for example, if Congress 

had a hearing on that report? 

Mr. FALCON. I think you should use the report as you would like, 

Congressman, but, as I said, the matters were reviewed by agencies outside my own and they determined there were no rules or 

laws broken, and that was the end of it. 

Mr. DAVIS OF KENTUCKY. What about the portion of the report 

that said that there was contact between OFHEO and between 

some news organizations? Do you recall that part of the report? 

12

Mr. FALCON. Vaguely. 

Mr. DAVIS OF KENTUCKY. Well, now you say you recall it vaguely. 

That strikes me as being a fairly serious allegation, isn’t it? 

Mr. FALCON. I think agencies have contacts with the press all the 

time. 

Mr. DAVIS OF KENTUCKY. Well, contacts with the press regarding 

a confidential document that was only meant for the board of directors of Fannie Mae. Presumably, that does not happen all the time, 

does it? 

Mr. FALCON. I am not sure what you are referring to. 

Mr. DAVIS OF KENTUCKY. Well, again, speeding along, as my time 

is about to run out, my recollection is there was a portion of the 

IG’s report that said that there had been some leaking or some dissemination of the confidential report in a manner that would have 

violated OFHEO’s internal standards. Tell me what steps you took 

to investigate that allegation that there were improper contacts regarding confidential documents. 

Mr. FALCON. The matter was entirely investigated by the inspector general’s office. 

Mr. DAVIS OF KENTUCKY. What did you do as the person who 

runs OFHEO? Did you take any steps of your own? 

Mr. FALCON. I do not know. I cannot tell you what the source of 

any leaks on any matter on any given day were. 

Mr. DAVIS OF KENTUCKY. Did you investigate them? 

Mr. FALCON. I cannot consume my time with trying to pursue it. 

Mr. DAVIS OF KENTUCKY. Did you investigate it? 

Mr. FALCON. I do not recall what it was, specifically what the 

document was. I do not. 

Mr. DAVIS OF KENTUCKY. Well, I would assume this observation, 

Mr. Falcon, because my time is running out, I hope that, as we do 

construct a new regulator, that, frankly, that regulator is a little 

bit more attentive to the possibility that there could be problems 

in its own house because I am not sure that you have been sufficiently so in the last few months, but I do wish you well in the private sector. 

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

Mr. Hensarling? 

Mr. HENSARLING. Thank you, Mr. Chairman. 

Well, Mr. Falcon, I want to congratulate you for your service to 

your country, and I believe you are a gentleman who was tasked 

with a very important mission and one for which many of us believe you had insufficient resources in which to accomplish the mission that you were given. 

Let me ask a few questions about your examination in regard to 

Fannie Mae not applying its own policies with regard to SSAS 65 

as it relates to the booking of loans for sale or investment. I think 

that you have indicated that the problems with accounting for 

these loans were recently discovered, but the practice had been ongoing for over 20 years. 

So how can Fannie be unaware that they were in breach for over 

20 years and, indeed, how was it that, over a 20-year period, 

OFHEO did not discover this breach? 

Mr. FALCON. It was just an error in their systems, which was not 

uncovered until the systems were upgraded in 2004. It was such 

13

a precise error in, I believe a drill-down type issue that was not the 

type of thing that we caught. 

Mr. HENSARLING. It is my understanding that when OFHEO discovered accounting problems at Freddie Mac that the executives of 

Fannie stated that they had reviewed all of their internal accounting practices and policies and that they had found no violations. 

We have since, obviously, learned, according to you, according to 

the SEC, that there have been a number of GAAP violations. So 

do you believe that OFHEO and this committee were purposely 

misled by executives at Fannie? 

Mr. FALCON. I think that is certainly something that we are reviewing in the course of our special examination. While we do believe in certain instances there were willful violations of accounting 

principles, whether or not that was hidden from us or from the 

Congress is something we are still determining. 

Mr. HENSARLING. Could it be said if de facto Fannie had the ability to designate their securities for accounting purposes as either 

held for investment or held for sale that that would give them an 

advantage over their competitors in the marketplace? 

Mr. FALCON. It would provide certain accounting benefits if they 

were to classify some assets as held to maturity versus available 

for trading. Then they would not have to recognize any loss in market value in those assets. That is certainly the case. 

Mr. HENSARLING. I think also in your testimony you indicated 

that, although a number of Fannie’s policies were not GAAP compliant, obviously, a number of them were, but that Fannie personnel failed to follow through on these policies. So are there particular individuals who are being investigated for knowingly violating these GAAP principles? 

Mr. FALCON. We are looking at the role that various employees 

of the company had in both the promulgation of the accounting 

policies as well as the role in the implementation of the policies. 

So you cover both ends. One, how is the improper policy formulated 

and adopted? And, secondly, if it was crafted properly; why wasn’t 

it followed? That is the subject of further review by us. 

Mr. HENSARLING. To speak somewhat prospectively in the limited 

amount time I have left, as you know, our Chairman Baker has introduced a comprehensive piece of legislation dealing with a new 

regulator for the GSEs, and I know that you have not had an opportunity to examine the particulars of that piece of legislation, 

but, conceptually, do you think that the GSE safety and soundness 

regulator should also have the authority of new programs and new 

activity review from your experience? If so, why? 

Mr. FALCON. I think it should. The safety and soundness regulator is going to learn about these new activities anyway. We have 

to assign capital to them. We have to make sure that the risk of 

any new activities are properly managed so we will be intimately 

familiar with how those activities will impact the company. 

Every other safety and soundness regulator also has a responsibility, when it conducts that review, to make sure that the activity 

is consistent with the terms of the charter of the entity. Compliance with laws, rules and regulations does also rise to a safety and 

soundness issue, so it is just a natural fit that both happen at the 

same place. 

14

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

Mr. Watt? 

Mr. WATT. Thank you, Mr. Chairman. 

Mr. Falcon, thank you for being here. 

I want to change the focus from what we have been talking about 

to something else. I really have no interest in focusing on Fannie 

or Freddie’s shortcomings in the past or your or OFHEO’s shortcomings or successes in the past or on this committee’s oversight 

shortcomings or successes in the past. 

Throughout this process, my interest has been in the housing 

function, the housing mission of Fannie and Freddie, and on that, 

on page 11 of your prepared testimony, you come closest to addressing that issue. 

You say during your tenure, ‘‘The agency has successfully dealt 

with very serious problems at two of the largest financial institutions in the world. We have done so without disrupting our financial system,’’ which, of course, is true, but it has had some financial 

impact, and then you go on to say, ‘‘while allowing both enterprises 

to continue fulfilling their vital mission of making home ownership 

more affordable,’’ which also, of course, is true because the mission 

is going on. 

My concern is that there has, obviously, been some disruption of 

the ability to do the housing mission. Has your agency made any 

assessment of what impact this investigation and these financial 

disclosures have had on the ability of Fannie and Freddie to aggressively pursue the housing mission? I am not trying to assess 

whether that investigation went right or wrong. Obviously, it 

turned out to be right. 

But what impact, if any, can you tell us this has had on aggressive pursuit of the housing mission and, more importantly, how can 

we more aggressively pursue that housing mission either through 

Fannie and Freddie or otherwise as we go forward in the structure 

of the regulatory institutions we put in place? 

Give us whatever suggestions, as you have experienced this, both 

on the staff, in your regulatory position. What suggestions do you 

have for us about how we can more aggressively pursue the housing mission? 

Mr. FALCON. I think the guaranteed side of their business where 

they purchase qualifying affordable housing goal type mortgages, 

that does continue, and it is proceeding at a healthy pace. Despite 

the problems the company has with their accounting issues and internal control problems, that side of the business remains sound. 

So I can give you some comfort there, that while we are having 

to take some supervisory actions with the company to make sure 

that they continue to be as aggressive in fulfilling their mission as 

possible, when we get these other issues addressed properly over 

time, it will not deter them from continuing their guarantee side 

of their business. 

I have always looked at our responsibility at OFHEO as part 

housing mission. A company that is experiencing severe financial 

difficulties is going to constrain the amount of work it can do in 

fulfilling its mission, and so the greater extent to which we can 

make sure that the company does not get into any kind of trouble 

15

makes sure that there is no interruption in their ability to continue 

to fulfill the mission and innovate. 

With a fully authorized, well-resourced regulator, I think there 

would be a good safeguard to make sure that there are not unnecessary interruptions in the company’s business as a result of safety 

and soundness problems. The sooner we can get in there and identify and fix problems before they manifest themselves in the form 

of larger problems, I think, is only a benefit to the company’s mission. A strong safety and soundness regulator is part of that. 

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

Just by way of notice to members who have——

I am sorry, Mr. Watt. 

Mr. WATT. Mr. Chairman, could I have him address the prospective suggestions? 

Mr. BAKER. Sir, please. That is all right. Okay. 

Mr. FALCON. Prospectively, I think you could look at other examples of what has been done at other agencies. The AHP program 

of the federal home loan bank system is one possibility where you 

have some dedicated amount of funds that are used towards affordable and low-income housing. 

But I would like to also think about it and possibly get back to 

you, Congressman, if I may. 

Mr. WATT. That would be great. That way, it will not disrupt the 

chairman’s schedule. I thank you. I would welcome any suggestions 

you have because I think you have a picture of this that probably 

is unique now, given your years of service in a number of different 

capacities. So I would welcome those suggestions. 

Thank you, Mr. Baker. 

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

By way of prior announcement, we will likely adjourn shortly 

after 11 o’clock. I am told that the full committee will have a meeting commencing at 1 o’clock. They need to have access to the room 

by at least 12:30. The matter is on the floor. We will probably keep 

members beyond 12 o’clock. So, as members can expedite their comments, otherwise, we will have to take every member’s comment 

and put it into the record for response. I will forward to the witness, if you so choose. 

The next person here is Mr. Ney. You are up. 

Mr. NEY. Thank you, Mr. Chairman. 

On Monday, April the 4th, OFHEO—I think it was about a year 

in the making—added to their corporate governance rule. It takes 

effect in 60 days. What does that mean for Fannie? 

Mr. FALCON. I think it is an important addition to our corporate 

governance measure that we have taken at the agency. It does include more guidance to the company in regards to the board of directors, the activity of the board, and it works to ensure that there 

is strong oversight exercised by the board. We think it is a good 

addition to a corporate governance rule that we already had out 

there. 

Mr. NEY. Also, Fannie was given until September of this year, 

and that was to meet the 30 percent capital, and I think that was 

an extension. It was a 90 more days’ extension. 

Mr. FALCON. Originally, it was the end of June. 

Mr. NEY. Do you believe they will be able to reach that goal? 

16

Mr. FALCON. We monitor it very closely, and the plan that they 

have submitted to us does indicate that if everything happens as 

planned that they will meet the goal. If at any point between now 

and the end of September it looks like there are problems, then we 

will work with the company to make adjustments in the plan so 

that they can meet it by the end of September. 

Mr. NEY. If they do not meet it, what happens? 

Mr. FALCON. If they do not meet it, we will have to determine 

what additional remedial steps might be necessary in order to 

make sure that they can come into compliance with it as soon as 

possible. 

Mr. NEY. People have raised today the issue with whether it was 

20 years gone undetected or 5, you know, and that has been raised 

several times, and Fannie had brought this out to the attention of 

OFHEO actually about this problem that had been over a 20-year 

period. 

I guess the question I have is: How did they not know and how 

did OFHEO, though, not know or, you know, over a certain period 

of time, you know, that they were operating in a faulty and inaccurate way?: 

Mr. FALCON. This was a very technical problem in their accounting systems. Assets that were being classified as either available 

for sale or held to maturity were properly designated by the company at the time of purchase. However, the system itself categorized everything as held to maturity, and that was just not uncovered until 21 years later. 

Mr. NEY. So it was more of a technical problem than something 

that was conspired to do this and not be found for 20 years. 

Mr. FALCON. Yes. That is what we expect by that. 

Mr. NEY. Can we expect another capital assessment of Fannie by 

OFHEO? 

Mr. FALCON. Capital assessment? Yes, Congressman. 

Mr. NEY. Or capital adequacy to report under. 

Mr. FALCON. Yes. 

Mr. NEY. The GSEs, I should say, not just Fannie Mae. 

Mr. FALCON. Yes. We typically classify the enterprises at the end 

of every quarter for the previous quarter and, at the end of March, 

we would typically classify both. We only classified Freddie Mac. 

We are continuing to have discussions with Fannie Mae about their 

capital classification. 

Under the terms of our regulation governing this, they have 30 

days to comment on our proposed classification, and that is where 

this currently stands. When they give us their comments, we will 

take them into consideration and then determine what the proper 

classification will be. 

Mr. NEY. Okay. Good luck with your ventures down the road. 

I want to thank Chairman Baker for having this hearing. Thank 

you. 

Mr. BAKER. I thank the gentleman. 

Mr. Baca? 

Mr. BACA. Thank you very much, Mr. Chairman. 

Mr. Falcon, thank you very much for being here today. 

As you know, I support a strong well-funded regulator, and I also 

support the work of Fannie Mae in providing—I say in providing—

17

housing to the underserved. Do you believe you have the necessary 

expertise within your agency to regulate GSE in a productive manner in an ever-growing complex market? 

Mr. FALCON. I do, Congressman. I am very proud of the talented 

people we have at the agency. 

Mr. BACA. When do you believe this process will be over because, 

in your report, you indicate that you have two objectives in an ongoing special examination of Fannie Mae. The first was to identify 

all the problems and fix it. In your testimony, you indicate that you 

have not completed that. There is also the second portion: Does the 

comprehensive reform program provide problems with recurring? 

Mr. FALCON. Well, we would like to get it done as soon as possible. It is in our interest, the company’s interest, and I know you 

would like to see it done as soon as possible. 

I hesitate to give you a specific timeframe because just the new 

re-audit of the company by the new external auditor may possibly 

continue to uncover issues, even if we feel like our review is close 

to being brought to a conclusion. So we really need to work closely 

with them as they do their accounting review as well as ours. 

I know that is not a good answer, but it is hard for me to pinpoint it. Our goal is to try to get it done as soon as possible. 

Mr. BACA. Given the importance of the entity to home ownership, 

how will you know when you have fulfilled your obligation as a regulator thoroughly and fairly—and I say thoroughly and fairly—so 

that Fannie Mae can continue to further its home ownership in the 

country in a manner that is safe and sound? 

Mr. FALCON. I think when the company has addressed the issues 

related to proper accounting policies, adequate internal controls 

and any additional remedial actions that have taken place, when 

the company is able to submit timely financial statements to the 

SEC, I think when all that comes together, we will feel comfortable 

that the company has put itself back on a solid footing, and that 

is the time that we would begin to consider lifting some of these 

supervisory steps that we have taken, like the 30 percent capital 

surcharge. 

Mr. BACA. Are you providing guidance or assistance or training 

at this point to make sure that there is adequate accounting that 

is done, because that is part of the process and part of your auditing report, and that was the problem, I believe, that Davis asked 

originally when it was leaked out to the media without allowing 

them to correct their own particular problems before it went out. 

So are you now then providing the guidance, the training to assure 

that the proper accounting is done, the procedures and policies are 

followed? 

Mr. FALCON. We are, and the board is also very actively engaged 

in this also. The company is working to retain many qualified individuals in the accounting field so that the company can begin to 

develop proper accounting policies, but we are working with them 

very closely. 

Mr. BACA. Can you clarify the views of the amount of capital that 

Fannie Mae should have and how you arrive at that number? That 

is question number one. 

18

And two is: Can you give a sense of under what condition you 

would be satisfied with remediation procedures not required to excess capital? 

Mr. FALCON. Well, current capital levels are contained in the 

statute, 2-1/2 percent for on-balance sheet assets and 45 basis 

points for off-balance sheet. When we see safety and soundness 

concerns at either company, we exercise our discretion to require 

additional capital, but just for the time period where we see problems at each company. 

Whether or not a permanent minimum capital level should be 

higher than 2-1/2 percent, we would have to study that issue a little more closely. 

Mr. BACA. Okay. We know that Fannie Mae has taken a number 

of steps to address the problems that are very positive, even the 

change in its leadership right now because of its services. My question and final question would be: You indicated in your statement 

that OFHEO became more aggressive as resources became available. Who went after the resources, and why did they go after the 

resources to make sure that they were more aggressive? 

Mr. FALCON. We have been pursuing additional resources since 

I first got to the agency. As I said earlier, it became very evident 

to me when I assumed my position that we just did not have adequate resources to properly fulfill our mission at OFHEO and, from 

the very beginning, I have been seeking to increase the agency’s 

budget, and we have had much success in that. With the committee’s support, our resources have increased. 

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

Mr. BACA. Hopefully, you will apply the same standard to other 

entities to as well have the same standards, same policies, same 

procedures and same aggressiveness in holding everybody else accountable as well. 

Thank you. 

Mr. BAKER. I thank the gentleman. 

Chairman Oxley? 

Mr. OXLEY. Thank you, Mr. Chairman. 

Mr. Falcon, it is good to have you back, and, based on your announcement yesterday, I want to wish you Godspeed and success 

in whatever you do. You have led the OFHEO folks at a very difficult time and have done remarkable work, and our sincere congratulations and best wishes to you. 

Let me ask you. The last time that OFHEO discovered accounting problems at Fannie, the SEC was engaged to determine whether Fannie needed to restate earnings. Based on your testimony and 

the recent discovery, will that process be followed as well, or has 

the SEC already made a determination in terms of whether Fannie 

Mae was GAAP compliant? 

Mr. FALCON. The process that was followed previously, Mr. 

Chairman—by the way, thank you for your comments—was an extraordinary set of circumstances. Typically, the process involves the 

regulator working with the company and the company’s external 

auditor on resolving any accounting issues that arise and, with the 

issues related to FAS 133 and 91, Fannie Mae decided to seek the 

input of the SEC on those accounting issues. So the SEC did provide guidance on them. 

19

In this case, that has not happened. We are working with the 

company. We have met with the SEC to review these additional 

issues with them and have kept them fully apprised of what we are 

finding and answering any questions they may have, but the SEC 

is working with us under the standard process for these types of 

matters, and they have not been asked to intervene with a formal 

interpretation or answer like they were previously. 

Mr. OXLEY. That could happen at some point, but it just depends 

on how the negotiations go with the private entity? 

Mr. FALCON. It could, Mr. Chairman. 

Mr. OXLEY. Okay. 

Your testimony raised some concerns about internal controls at 

Fannie Mae, and that has been, obviously, an ongoing issue in corporate America for the last 3 or 4 years. I guess my question is: 

What role does OFHEO play in the whole issue of internal controls 

vis-a-vis the SEC and perhaps the Public Company Accounting 

Oversight Board? How does OFHEO’s role fit into the overall issue 

of internal controls? 

Mr. FALCON. We do work closely with PCAOB on this, and we 

have. They participate in many of the sessions and meetings that 

we have had, and, obviously, we have worked very closely with the 

SEC. 

As a safety and soundness regulator, we do examine very closely 

for internal control deficiencies. In addition, obviously, under Section 404 of Sarbanes-Oxley, companies are required to certify the 

adequacy of their internal controls. So we work very closely to 

make sure that certain minimum, if not best practice, standards 

with regards to internal controls are met by the company, and we 

apply these standards through our examination program. 

In addition, because of Sarbanes-Oxley, there are certifications 

that are required on the part of management so they have their 

own strong incentives now to make sure that internal controls are 

adequate. Where we see issues related to accounting disclosure 

matters that require some review by the SEC, we will have discussions with the SEC. We have a very good working relationship with 

them. 

Mr. OXLEY. Is it fair to say then that the internal controls issue 

as it relates not just to a financial company in a general sense, but 

more particularly to a GSE is treated somewhat differently than 

say a steel company or an oil company? 

Mr. FALCON. I would say not just because they are a GSE, but 

because they have a safety and soundness regulator. I think that 

the same levels of internal control review that we apply to Fannie 

Mae and Freddie Mac would also be applied with respect to any 

bank or thrift that is regulated by a safety and soundness regulator 

and that might very well be different from the type of internal control review that is applied with respect to a steel company. 

Mr. OXLEY. Thank you. 

Mr. Chairman, I just want to again compliment Mr. Falcon for 

his leadership and also to recognize Mr. Blumenthal. I know Mr. 

Falcon as an alumnus of this committee in his former iteration as 

the Banking Committee, and Mr. Blumenthal, who will be named 

as interim in your position, was a very able staffer over in the comVerDate 0ct 09 2002 11:13 Aug 17, 2005 Jkt 000000 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 G:\DOCS\22763.TXT FIN1 PsN: MICAH
20

mittee across the hall that I served on for a few years, and we look 

forward to working with him as well. 

Thank you, Mr. Chairman. 

Mr. FALCON. Thank you for your comments, Mr. Chairman. 

Mr. BAKER. Thank you, Mr. Chairman. 

I am advised that floor proceedings have now been initiated, and, 

at this time, I would ask members who have additional questions 

to please submit them for the record. We will get responses from 

Mr. Falcon. 

I wish to again extend our appreciation to you for your appearance here today and for your good work. 

Our meeting now stands adjourned. 

Mr. HINOJOSA. Mr. Chairman, may I ask unanimous consent——

Mr. BAKER. Yes, Mr. Hinojosa. 

Mr. HINOJOSA.——that the opening statement be part of the 

record? 

Mr. BAKER. Yes, sir. All member statements have been made 

part of the record, and the record will remain open for 5 days for 

any additional correspondence members may choose to forward. 

Mr. HINOJOSA. Thank you. 

Mr. BAKER. The meeting stands adjourned. 

[Whereupon, at 11:07 a.m., the subcommittee was adjourned.] 

(21)

A P P E N D I X

April 6, 2005

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