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82–684 PDF 2002

OFHEO RISK-BASED CAPITAL STRESS TEST

FOR FANNIE MAE AND FREDDIE MAC

HEARING

BEFORE THE

SUBCOMMITTEE ON

CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON

FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

JULY 23, 2002

Printed for the use of the Committee on Financial Services

Serial No. 107–79

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa

MARGE ROUKEMA, New Jersey, Vice Chair

DOUG BEREUTER, Nebraska

RICHARD H. BAKER, Louisiana

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

PETER T. KING, New York

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

ROBERT W. NEY, Ohio

BOB BARR, Georgia

SUE W. KELLY, New York

RON PAUL, Texas

PAUL E. GILLMOR, Ohio

CHRISTOPHER COX, California

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

STEVEN C. LATOURETTE, Ohio

DONALD A. MANZULLO, Illinois

WALTER B. JONES, North Carolina

DOUG OSE, California

JUDY BIGGERT, Illinois

MARK GREEN, Wisconsin

PATRICK J. TOOMEY, Pennsylvania

CHRISTOPHER SHAYS, Connecticut

JOHN B. SHADEGG, Arizona

VITO FOSELLA, New York

GARY G. MILLER, California

ERIC CANTOR, Virginia

FELIX J. GRUCCI, JR., New York

MELISSA A. HART, Pennsylvania

SHELLEY MOORE CAPITO, West Virginia

MIKE FERGUSON, New Jersey

MIKE ROGERS, Michigan

PATRICK J. TIBERI, Ohio

JOHN J. LAFALCE, New York

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

KEN BENTSEN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

JULIA CARSON, Indiana

BRAD SHERMAN, California

MAX SANDLIN, Texas

GREGORY W. MEEKS, New York

BARBARA LEE, California

FRANK MASCARA, Pennsylvania

JAY INSLEE, Washington

JANICE D. SCHAKOWSKY, Illinois

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

WILLIAM LACY CLAY, Missiouri

STEVE ISRAEL, New York

MIKE ROSS, Arizona

BERNARD SANDERS, Vermont

Terry Haines, Chief Counsel and Staff Director

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

ROBERT W. NEY, Ohio, Vice Chairman

CHRISTOPHER SHAYS, Connecticut

CHRISTOPHER COX, California

PAUL E. GILLMOR, Ohio

RON PAUL, Texas

SPENCER BACHUS, Alabama

MICHAEL N. CASTLE, Delaware

EDWARD R. ROYCE, California

FRANK D. LUCAS, Oklahoma

BOB BARR, Georgia

WALTER B. JONES, North Carolina

STEVEN C. LATOURETTE, Ohio

JOHN B. SHADEGG, Arizona

DAVE WELDON, Florida

JIM RYUN, Kansas

BOB RILEY, Alabama

VITO FOSSELLA, New York

JUDY BIGGERT, Illinois

GARY G. MILLER, California

DOUG OSE, California

PATRICK J. TOOMEY, Pennsylvania

MIKE FERGUSON, New Jersey

MELISSA A. HART, Pennsylvania

MIKE ROGERS, Michigan

PAUL E. KANJORSKI, Pennsylvania

GARY L. ACKERMAN, New York

NYDIA M. VELA ́ ZQUEZ, New York

KEN BENTSEN, Texas

MAX SANDLIN, Texas

JAMES H. MALONEY, Connecticut

DARLENE HOOLEY, Oregon

FRANK MASCARA, Pennsylvania

STEPHANIE TUBBS JONES, Ohio

MICHAEL E. CAPUANO, Massachusetts

BRAD SHERMAN, California

GREGORY W. MEEKS, New York

JAY INSLEE, Washington

DENNIS MOORE, Kansas

CHARLES A. GONZALEZ, Texas

HAROLD E. FORD, JR., Tennessee

RUBE ́ N HINOJOSA, Texas

KEN LUCAS, Kentucky

RONNIE SHOWS, Mississippi

JOSEPH CROWLEY, New York

STEVE ISRAEL, New York

MIKE ROSS, Arizona

(V)

C O N T E N T S

Page

Hearing held on:

July 23, 2002 ..................................................................................................... 1

Appendix:

July 23, 2002 ..................................................................................................... 35

WITNESS

JULY 23, 2002

Falcon, Armando Jr., Director, Office of Federal Housing Enterprise Oversight (with attachment) ....................................................................................... 7

APPENDIX

Prepared statements:

Barr, Hon. Bob .................................................................................................. 36

Gillmor, Hon. Paul E. ....................................................................................... 39

Hinojosa, Hon. Rube ́n ....................................................................................... 40

Israel, Hon. Steve ............................................................................................. 41

Ney, Hon. Bob ................................................................................................... 42

Falcon, Armando Jr., ........................................................................................ 43

(1)

OFHEO RISK-BASED CAPITAL STRESS TEST

FOR FANNIE MAE AND FREDDIE MAC

Tuesday, July 23, 2002

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 2:15 p.m., in Room

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

Present: Representatives Baker, Ney, Shays, Gillmor, Lucas of

Oklahoma, Oxley, Rogers, Bentsen, Maloney, Ford, Lucas of Kentucky, and Israel.

Mr. BAKER. [Presiding.] I would like to call this meeting of the

Capital Market Subcommittee to order.

Today the Subcommittee meets to discuss the long-awaited results of OFHEO’s risk-based capital rules for the housing government-sponsored enterprises Fannie Mae and Freddie Mac.

The importance of this long-awaited test cannot be over emphasized because essentially what is at stake—giving both investors

and taxpayers—is the clearest possible financial picture of the two

government-backed companies with, today, having a combined debt

of over $1 trillion, implicitly linked to taxpayer pockets.

Because of this importance, and in the context of the current

market environment, demanding unprecedented fullness, accuracy

and integrity in financial disclosure, I feel it important to recount

the history behind the risk-based capital test and how we have, at

long last, arrived here today.

In 1992, a legislative act directed OFHEO to issue a risk-based

capital rule within 18 months after the appointment of the director,

in effect, by the end of 1994. OFHEO proposed rules for public comment, accordingly, in 1995, 1996 and 1999. In 1999, the proposed

rule issued for comment actually included a table showing the required risk-based capital calculations for Fannie and Freddie as of

September 30, 1996 and June 30, 1997.

Interestingly enough, on both occasions, Fannie Mae had a deficit, while Freddie had a surplus on both accounts. Saying it another way, one GSE failed the proposed test as early as 1996 and

1997.

On August 1st of 2001, Director Falcon testified that OFHEO

would publish in early 2002 how the enterprises would fair under

the rule then promulgated using fourth quarter, 2001 data.

2

Subsequently, on September 13, 2001, OFHEO finalized the riskbased capital rule. However, due to apparent complications, by December 11th of 2001, OFHEO announced in light of the proposed

changes in the rule, the agency would, instead, use first quarter

2002 numbers to calculate how the enterprises were gauged.

Finally, after a ten-year process, OFHEO announced the results

of its amended rule for the first quarter 2002, using the amended

test, showing that both Fannie and Freddie had easily passed.

We can be pleased with that report, but it was as we all should

have expected in light of this important statement made by Director Falcon prior to announcing the results. with the proposed rule

in referencing June of 1999, the enterprises then began a program

of managing their activities to ensure they would meet the requirements of the rule. I take that to mean in the middle of 1999 the

enterprises were advised and prepared to initiate business strategies to comply with any rule subsequently issued by OFHEO.

What is of importance to me today is to understand at least what

changes were made in the rule initially promulgated that resulted

in an additional delay in its implementation. Were the changes the

result of the failure of either the GSEs to pass the test? Or was

it an underlying failure in the adequacy of the test?

Was the eight-and-three-quarter year period that developed the

first test, subsequently modified in the 60 days following, was the

result of running the test and determining that either GSE did not

meet the minimal capital standards?

Did either GSE request specific modifications?

In my request of Director Falcon and OFHEO earlier this year,

I specifically requested that the test be conducted in four different

methodologies—prior to its modification in December; as promulgated after eight-and-a-half years of work on the last quarter of

2001; the first quarter of 2002; and, additionally, after the modification, as proposed by OFHEO on the same data set.

It is my understanding in response to that request, the agency

indicated that the data for the 2002 first quarter could be released

publicly, but specific request was made of me in the committee not

to release the information promulgated on the fourth quarter of

2001, specifically using the pre-amendment test.

I am curious as to why that request was deemed to be confidential in the first place. I am understanding that the explanation was

that the agencies were not managing to the standards of that test.

I simply refer to the quote of the Director in 2002, which indicates,

‘‘With the proposal of the rule in June 1999, the enterprises began

a program of managing their activities to ensure they would meet

the requirements of the rule.’’

Why is it so hard to get professional assessment of the enterprises that are so important to our economy without political manipulation? Taxpayers may or may not be at risk. We honestly just

do not know. But in this environment of corporate questioning,

where every accounting rule is studied and re-studied, where every

CEO is questioned and re-questioned, are there those who suggest

that these two corporations, so vital to our economic success, are

above questioning?

I hope not.

I would recognize Mr. Bentsen, now, for an opening statement.

3

Mr. BENTSEN. I thank the chairman for recognizing me. And I

thank him for calling this hearing today.

The subcommittee will hear from Director Armando Falcon, the

director of the Office of Federal Housing Enterprise Oversight on

the final risk-based capital rule for Fannie Mae and Freddie Mac.

And we are pleased to welcome Mr. Falcon back to the committee,

of which he is a graduate as a former counsel to this committee.

As the chairman mentioned, OFHEO was created in 1990 to act.

And I would note that Mr. Falcon and his predecessor have undertaken, in many respects, not without criticism, a Herculean task of

creating this risk-based capital rule and the analysis to go along

with it. And doing it with a number of congressionally-mandated

strictures that would not, otherwise, be in place for other types of

analysis that are done within the market.

I think it is also important that we hear from Mr. Falcon today

because over the last several years, as we have had debates over

the issue of the GSEs, often OFHEO has been overlooked as they

have been toiling away and trying to come up with this rule.

And I would also just remind the chairman that while there may

be concern among some that the GSEs are managing their activities in order to meet the requirements of the rule, in fact, that is

the whole idea of having rules, whether they are risk-based capital

rules for GSEs or for banks for thrifts or for any other institution

is, in fact, you want them to manage their operations in order to

meet the confines of the rule.

So, Mr. Chairman, I am glad to hear from Mr. Falcon today, look

forward to his testimony and the opportunity to question him on

the issues that you have raised and others.

And I yield back.

Mr. BAKER. Thank you, Mr. Bentsen.

Mr. Ney?

Mr. NEY. Thank you, Mr. Chairman.

Thank you for holding this—

Mr. BAKER. Oh, I am sorry.

Chairman Oxley, did you wish to be recognized at this time?

Yield to Mr. Ney?

Yes, sir?

Mr. NEY. I am pleased that the committee has had a chance to

review the final risk-based capital rule for Fannie Mae and Freddie

Mac. This capital standard has been a long time coming and we are

grateful that the process has now been concluded.

We look forward to this rule being enforceable, hopefully, in the

months ahead.

The risk-based capital rule is designed to ensure that GSEs can

survive the worst of housing downturns, with high credit losses and

huge moves in interest rates over, basically, a ten-year period.

This risk-based capital is unique because it requires the GSEs to

operate their businesses in a way that creates an incentive for risk

reduction activities. And I think it should be, really, a model for

all companies these days.

It is important for this subcommittee to realize, and I know they

do, that the risk-based capital standard is just one piece of an overall safety and soundness regime for these congressionally chartered

companies. To be clear, after the 1992 legislation, both of these

4

companies were bound by minimum capital standards and continuous on-site examinations.

Long before Enron and WorldCom, in October 2000, Fannie Mae

and Freddie Mac announced six initiatives that the financial markets now rely upon to maximize financial transparency and market

discipline. Unlike many other companies, these two companies

have signed up for the annual credit rating; additional interest rate

and credit risk disclosures; additional liquidity management; interim implementation of the risk-based capital standard; and the

issuance of subordinated debt.

Less than two weeks ago, I did join SEC Chairman Harvey Pitt

and Fannie and Freddie for an announcement where the two companies agreed to register their common stock under the 1934 SEC

Act, which now binds these two companies to comply with SEC requirements for periodic corporate financial disclosures. In the press

interviews after the announcement, Frank Raines committed on

CNBC that Fannie Mae will—and I stress will—certify 2001 financial statements by mid-August, just as SEC Chairman Harvey Pitt

has asked of the top 1,000 publicly traded companies in this country to do.

In addition, I was pleased to hear this morning new light about

the fact that both companies have announced they are recommending to their boards of directors that they begin expensing all

stock-based compensation. In the current economic environment,

few other companies are stepping up to the plate to lead on financial disclosure and transparency in the way I think these two are,

although I predict many companies will with what is going on now

in the United States.

And, Mr. Chairman, I just want to, again, congratulate you,

Chairman Baker, for all your work and I look forward to hearing

Director Falcon.

Thank you.

Mr. BAKER. Thank you, Mr. Ney

[The prepared statement of Hon. Bob W. Ney can be found on

page XX in the appendix.]

Mr. Ford, did you have an opening statement?

Mr. FORD. Chairman, I will defer to the witness and have statements once he finishes.

Mr. BAKER. Thank you, Mr. Ford.

Mr. Shays?

Oh, excuse me, sir, Chairman Oxley?

Mr. OXLEY. Thank you, Mr. Chairman.

And thank you for your leadership on this important issue.

The Capital Market Subcommittee meets this afternoon to consider the new risk-based capital rule for Fannie Mae and Freddie

Mac, which has been finalized by the regulator, the Office of Federal Housing Enterprise Oversight.

OFHEO is responsible for ensuring that Fannie Mae and Freddie

Mac are adequately capitalized and operating safely.

The 1992 act which created OFHEO directed the agency to issue

a risk-based capital rule tied to an enterprise’s risk exposure, as

well as the current leverage or capital rule is a minimum percentage of assets.

5

I am pleased to welcome OFHEO’s director, Armando Falcon,

look forward to his presentation of the initial non-binding stress

test results for the enterprises.

And I encourage you to work, Mr. Falcon, with this committee

as OFHEO moves ahead later this year to implement and enforce

the risk-based capital rule. It is important that both the risk-based

and leverage capital requirements are in place and being implemented in tandem so that Fannie and Freddie can continue to perform their housing mission in a safe and sound manner.

In addition, I would like to hear from you about what actions

OFHEO will take in conjunction with the SEC to facilitate implementation of the voluntary compliance by Fannie and Freddie with

SEC disclosure requirements under the Securities and Exchange

Act of 1934, and to review the adequacy of information disclosures

related to mortgage-backed securities.

Mr. Chairman, this will be an important next step in the series

of hearings that you have conducted. And I look forward to the response from the director.

I yield back.

Mr. BAKER. I thank you, Mr. Chairman.

Mr. Israel, did you have an opening statement?

Mr. ISRAEL. Mr. Chairman, I will insert my statement for the

record.

[The prepared statement of Hon. Steve J. Israel can be found on

page XX in the appendix.]

Mr. BAKER. Thank you, Mr. Israel.

Mr. Shays?

Mr. SHAYS. Thank you, Mr. Chairman.

Mr. Chairman, thank you for holding these hearings. Mr. Oxley,

for your fine work as chairman of this committee.

I also welcome Mr. Falcon, director of OFHEO. I appreciate that

he is here and I look forward to his testimony.

I think with Mr. Falcon, we have, yet, another witness who recognizes that voluntary disclosure is not good enough, that disclosures need to be reviewed by the SEC for inadequacies. And, in

other words, Fannie and Freddie will no longer act as their own securities regulator. And I emphasize that.

The recent announcement that these two mortgage giants,

Fannie Mae and Freddie Mac, will come under the SEC as it relates to the 1934 law is a huge turning point in the debate. And

I congratulate them and the SEC and OFHEO for whatever involvement they had with this. But it does not relieve me of some

of the questions that I still have and the committee still has.

I think first and foremost, we need to know how these new disclosure requirements will be enforced and OFHEO’s role in the rule

making.

Second, we need to know what are the policy reasons behind the

continuing exclusion of Fannie Mae and Freddie Mac’s mortgagebacked securities and debt securities from the full registration and

disclosure requirements of the securities law.

Third, I think we need to know how did the administration reach

this agreement with Fannie Mae and Freddie Mac, since I know of

no precedent in which the publicly traded companies dictate to government regulators what laws they will comply with.

6

And finally, I look forward to discussing Fannie and Freddie’s

safety and soundness and the results of the risk-based capital

stress test with our director.

Thanks.

Mr. BAKER. Thank you, Mr. Shays.

Mr. Ford has reconsidered and would like to take advantage of

his time.

Mr. Ford?

Mr. FORD. It is just for 30 seconds, Mr. Chairman.

I, too, look forward—it was really Chairman Oxley’s comments

that spurred some thought on my part. So I appreciate his inspiration.

Last week, as all of know, we held a hearing on both Fannie and

Freddie’s voluntary agreement to register their common stock with

SEC. And I just wanted to point out—if someone already has not

today—I know both of them have taken the bold voluntary step of

announcing they will account stock option compensation as an expense against earnings. They are joining a growing number of companies in taking this step to enhance transparency and to inform

shareholders.

With these voluntary disclosures, Fannie and Freddie can focus,

or continue to focus, on their primary mission, which is making

home ownership available to all Americans. The home ownership

rate is now 68 percent, at its highest level ever. And this is due,

in no small part, to the liquidity that these two companies have

provided to the primary mortgage market.

I look forward to hearing from our witness today. And I look forward to doing all I can to ensure that Mr. Baker’s concerns are addressed and that these two organizations can continue to provide

home ownership opportunities for millions of Americans.

Thank you.

Mr. BAKER. Thank you very much, Mr. Ford.

Mr. Rogers?

Mr. ROGERS. Thank you, Mr. Chairman.

I want to thank you for having these hearings.

And I want to thank this committee, under the leadership of Mr.

Oxley and Marge Roukema, for already taking a huge step in home

ownership. And today we are going to talk about regulations. We

are going to talk about stress tests and common stock registrations,

maybe—I mean, we may touch on those issues.

But more importantly, when you get done with all of the technical parts of providing home ownership, the bottom line is what

are we doing to provide the opportunity, including access to capital,

for those who are trying to get into homes?

And if we cannot take this to the lowest common denominator,

we will never be successful.

And I appreciate Fannie Mae and Freddie Mac’s work in what

they do and try to penetrate communities, especially under-served

communities for having access to capital and getting into homes.

And I look forward to your comments. And I suppose it is for us

to wrestle over the details so that those individuals back home do

not have to, that they can walk to that place, get access to that

capital and have the joy of putting that key in the door and turning

the key.

7

And, again, under the leadership of this committee, as a whole,

under Mr. Oxley, Mr. Baker, Mrs. Roukema, we have taken a huge

step in improving the chances for most Americans to get into those

homes.

And I hope through the whole course of this we do not lose sight

of that and the good work that both Fannie Mae and Freddie Mac

have done and the better things that we can do to make sure that

they are a stable force in the community to keep providing the access to that capital.

And I would yield back the remainder of my time.

Thank you, Mr. Chair.

Mr. BAKER. Thank you, Mr. Rogers.

If there are no further opening statements, I wish to welcome

back—no stranger to the committee—the Director of OFHEO, Mr.

Armando Falcon.

Welcome, Mr. Director.

You will need to pull that microphone very close. We are having

a hard time. Check the little button right down on the bottom; see

if that does it.

Mr. FALCON. How about this?

Mr. BAKER. Now, you are cooking.

STATEMENT OF ARMANDO FALCON, JR., DIRECTOR, OFFICE

OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

Mr. FALCON. All right.

Mr. Chairman, Congressman Bentsen and members of the subcommittee, I am pleased to be here today to report to you on

OFHEO’s activities and the safety and soundness of Fannie Mae

and Freddie Mac.

This is an important time in the short history of the agency, as

OFHEO has just entered its 10th year. OFHEO began operating

when its first employee, the first director, took office on June 1,

1993.

The agency was built from the ground up and had to acquire

staff and address hundreds of administrative issues involved in establishing an agency infrastructure. OFHEO needed to procure office space, equipment, computers, telecommunications and other

logistical support for the lawyers, economists, examiners and administrative personnel who would carry out the duties of the agency.

In its early years, OFHEO’s experienced staff worked to develop

an in-depth understanding of the operations of the enterprises.

OFHEO grew from a one-person agency into a strong and wellrounded regulator, fully capable of meeting its regulatory responsibilities.

While the agency was being built, it was still obligated to fulfill

its mission of regulating two extremely large and complex financial

institutions. OFHEO’s mandate is to ensure that the enterprises

are safe and sound and adequately capitalized. In so doing,

OFHEO helps ensure that the enterprises are able to provide liquidity to the mortgage markets and promote home ownership.

I am pleased to report that OFHEO is meeting its mandates. We

have found the enterprises to be safe and sound and adequately

8

capitalized. The enterprises are providing unprecedented levels of

liquidity and stability to the mortgage and housing markets.

OFHEO looks forward to its second decade of pubic service.

OFHEO’s regulatory regime consists of three pillars. These are

examination, capital standards and research. I will refer the subcommittee to my written testimony for a discussion of these topics

and will use the remainder of my time to focus on the risk-based

capital rule and disclosure.

OFHEO’s risk-based capital standard is unique among financial

regulators. Unlike ratio-based capital standards, OFHEO’s standard is based on a 10-year stress test. A stress test measures risk

in the context of a company’s overall portfolio, including the company’s risk management activities. An enterprise can comply with

OFHEO’s risk-based capital standard by reducing risk or raising

capital or a combination of both.

The risk-based capital rule became effective last September. At

that time, I appeared before this committee—the subcommittee—

and was urged to consider whether refinements to the rule were

necessary and, if so, to act quickly. I subsequently determined that

modifications were appropriate and the rule was amended after a

public rule making during the fourth quarter of last year.

We will use the rule to classify the enterprises, beginning with

the third quarter of this year.

In the interest of public disclosure and regulatory transparency,

last month, OFHEO released the results of the risk-based capital

test using the first quarter 2002 enterprise financial data.

Attached to my testimony is the press release announcing the results.

Both enterprises passed the stress test, due to effective risk management, including extensive interest rate hedging and the first

quarter’s economic environment. Interest rates are low; home values are rising; and borrower defaults are minimal. An enterprises

risk-based capital requirements will vary from quarter to quarter,

depending on the enterprises risk management decisions and market conditions.

I have taken a very open approach to the implementation of

these stress tests. I decided to release the actual stress test computer model or source code to the public. In addition, I rejected an

interpretation of the one-year implementation period, which would

have precluded the release of any results during that time period.

And when I announced the stress results for the first quarter of

this year, I did not just issue a pass-fail notice. I released the full

results for both upright and downright scenarios.

However, that openness must be balanced with some caution to

ensure that no misleading information enters the public domain.

That is why OFHEO will not be releasing to the public any stress

test results other than the official quarterly announcements. That,

of course, does not override this subcommittee’s right to information.

And so, I have promptly, ahead of schedule, supplied the subcommittee with all of the information it has requested. My only request was that the subcommittee respect the confidentiality of the

information.

9

OFHEO considers this information confidential for a variety of

legal reasons. But superior to all those considerations is concern

about releasing misleading information about the enterprises financial condition that could disrupt the markets.

We have developed a strong, rigorous risk-based capital standard. Now, the enterprises have one year to adapt and be in compliance before we enforce it.

Congress wanted us to set up a new capital standard, not a trap.

That is why it would be inappropriate to release results before the

rule, as amended, was in place.

I will now turn to corporate disclosure. OFHEO safety and

soundness responsibility includes an obligation to ensure that the

enterprise financial disclosures are adequate. Our agency began

the comprehensive review of enterprise disclosure in April of 2002.

In May, OMB requested that OFHEO specifically consider a rule

that would ensure enterprise financial disclosures were comparable

to those of other publicly held companies.

In June, I responded to OMB’s letter. I agreed that voluntary

compliance was inadequate and that given the enterprises exemptions from the securities laws, OFHEO needed to promulgate enforceable rules in this area.

I am pleased that OFHEO’s objective will now be accomplished

in a most efficient manner. The enterprises voluntarily agreed to

subject themselves to mandatory regulation by the SEC under the

Securities and Exchange Act of 1934.

I would like to highlight several key points about the agreement.

The enterprises will become registered companies bound by the

1934 act. Absent the agreement, OFHEO would have adopted its

own disclosure regime, based on the securities laws.

Second, and most significant, the disclosures will be reviewed by

the SEC and OFHEO. Currently, it is the enterprises that determine what corporate information is material and must be disclosed.

Once registered, that will change and the ultimate arbitrator of

what must be disclosed will be the SEC and OFHEO, acting in the

public interest.

Finally, the disclosure reports will be available from the SEC essential repository for corporate disclosure reports of all registered

companies.

In order to facilitate the application of the 1934 act to the enterprises, OFHEO will promulgate the rule concerning the filing of all

required periodic reports. Registration with the SEC does not, in

any way, limit OFHEO’s ability to act in the interest of safety and

soundness. In fact, as part of the rule I have mentioned, OFHEO

is considering requiring supplemental disclosures beyond those required by the SEC.

In addition, OFHEO, the SEC and Treasury will conduct a review of disclosures relating to the offering of mortgage-backed securities by the enterprises and other issuers. The review will consider

the appropriate manner for creating a more level playing field and

greater comparability of disclosures that will enhance enterprise

safety and soundness.

I will note that OFHEO’s goal is disclosure, not registration.

After all, disclosure is the rationale underlying registration. Accordingly, OFHEO will not pursue a registration regime at this

10

time. if our disclosures can be met without registration, and I am

confident that they can be, then registration is unnecessary. However, until the review is completed, OFHEO, as the safety and

soundness regulator, cannot and should not rule out registration in

some form as a possibility.

In response to the subcommittee’s request last week, I have conferred with the SEC and Treasury and we have agreed to make

every effort to complete the review by year end.

Mr. Chairman, you have been a strong supporter of our budget

requests in the past and have indicated support for permanent

funding of OFHEO. OFHEO, as the agency responsible for the financial health of two companies with combined credit exposure of

a little over $3 trillion, should be permanently funded, as are the

other safety and soundness regulators. There is simply too much at

stake not to take this prudent step.

The administration supports this in its fiscal year 2003 budget

request for OFHEO. I urge the subcommittee to support legislation

that would bring about this result.

In conclusion, as I stated earlier, Fannie Mae and Freddie Mac

are safe and sound and well capitalized. We all can see their financial health at the beginning of any discussion about them. We are

able to have this discussion against such a healthy backdrop due,

in part, to the hard work of OFHEO’s employees. I do not mean

to minimize the efforts of the enterprises’ management, but

through our regulatory program we constantly probe for weaknesses and vulnerabilities and assure that the enterprises maintain

the highest standards of sound management.

We have a state-of-the-art risk-based capital rule in place. We

are expanding our examination program, building our regulatory

infrastructure and conducting valuable research. The OFHEO of

2002, which I am proud to direct, gets the job done.

Thank you, Mr. Chairman. And I look forward to answering any

questions the subcommittee may have.

[The prepared statement of Armando Falcon Jr. can be found on

page XX in the appendix.]

Mr. BAKER. Thank you, Mr. Falcon.

I do appreciate your willingness to appear here today and certainly understand the complexity and difficulty of establishing a

test for what are very large and complex organizations.

But I want to make it clear that my line of questioning today results from a great deal of frustration about the process and where

I think we find ourselves, as of this moment.

It took eight-and-a-half years and considerable encouragement

from the committee and others, including defense of appropriations

process, to make sure that OFHEO had the resources to ultimately

prepare the most professional analysis possible for this committee

and for the benefit of taxpayers.

I find it troubling that at the end of that eight-and-a-half year

period, we then had an approximately 60-day period, of which I am

told by the agency it was a result of my request asking you to be

thorough and thoughtful in the process, that it took as long as it

did to make the subsequent modification, resulting in the postamendment stress test, as we have it today.

11

As I understand it, the elements that were involved in that critical analysis related to the level of haircut, as opposed to AA

rated—AAA rated mortgage insurance companies; funding costs;

and certain multi-housing questions; and perhaps technical issues.

Were there any other elements in the modification to the eightand-a-half year test made by the 60-day test that I am not aware

of, other than those four principle areas? And I will recite them

again: AA, AAA haircut mortgage insurance companies; multihousing issues; funding costs; and technical issues.

Mr. FALCON. I believe that covers all of them, Mr. Chairman.

The technical issues: I want to get into more detail later about

what was in those technical details. Some might have risen to the

level of more than just technical. Others may have been truly technical.

Mr. BAKER. So it is your testimony that those, in general—and

I am using ‘‘technical’’ as defined by the agency in my discussions

with agency personnel.

Three principles were as outlined and then dogs and cats were

described as technical issues. And so I am saying in that context,

those are the four areas in which the modifications were made resulting in the test that is finally to be promulgated?

Mr. FALCON. Yes. I believe that is right.

Mr. BAKER. Did you have staff run the test prior to its final promulgation, prior to the modification? In other words, the September

developed test, which was then subsequently modified DecemberJanuary, was that test run by the agency and producing results before it was made public?

Mr. FALCON. The version that was final pre-amendment, Mr.

Chairman? Is that the one you are talking about?

Mr. BAKER. Pre-amendment.

Mr. FALCON. We had a—yes—a working version of the computer

code. We did.

Mr. BAKER. And what were the results, not in specific detail, but

in generic terms? Were there difficulties with the way in which the

test concluded its analysis? Were either of the GSEs or both GSEs

found to have difficulties with that test? What is your remembrance of what happened with that pre-amendment test?

Mr. FALCON. There were many bugs that were being worked out

at that time, Mr. Chairman.

Mr. BAKER. Was one of the bugs the result? Or be more specific.

Mr. FALCON. You could not get an accurate result if you did not

have the bugs worked out. The bugs were two times, primarily. The

bugs were with the computer code, itself, as well as getting the

data right so that it would plug into the computer code and then

produce an accurate number.

Mr. BAKER. So once you got the bugs of the computer code behind

you, let’s assume we have a de-bugged test, built on the principles

which you have enunciated, were there further modifications beyond the de-bugging?

Mr. FALCON. We have been doing some de-bugging for the past—

Mr. BAKER. I understand, but what—

Mr. FALCON. —beyond September.

12

Mr. BAKER. Let’s put the bugs on the shelf. We found the major

bugs and we might have had a small bug or two remaining that

were later to be discovered.

As of September 2001, bug issue principally resolved, were there

other elements that were of concern to the agency that needed to

be modified?

Mr. FALCON. Well, I would not say that the bugs were resolved

after September 1. We continued to resolve bugs after that point.

Mr. BAKER. Okay. Well, I give you bugs, too. Let’s assume there

are bugs and bugs B; were there other issues besides bugs and

bugs B that were of concern?

Mr. FALCON. As far as the computer model working?

Mr. BAKER. No.

Mr. FALCON. No?

Mr. BAKER. Forget the computer. We are off of computer. We are

off of bugs, bugs one, bugs two. We are now on to factual determinations beyond bugs, as in the case of the amount of haircut for

AA versus AAA, as in multi-housing adjustments, as in funding

cost adjustment, any other adjustment.

Mr. FALCON. I mean, there are a variety of issues and they are

referenced in the risk-based capital rule, both in the final rule

where we indicate areas of further research—

Mr. BAKER. Well, let me ask it a different way. Did you consult

or did the GSEs consult with you prior to the promulgation of the

final rule and such consultation resulting in any modification to

the final promulgated rule?

Mr. FALCON. When we announced that we were going to amend

this rule, we received comments from many interested parties

about the rule. That is pursuant to notice and comment process.

Mr. BAKER. Sure. No. I am not suggesting anything inappropriate. I am trying to find out the facts.

Did Freddie review the rule and its function and make recommendations to you for modification, on which you subsequently

acted?

Mr. FALCON. No.

Mr. BAKER. Okay. Thank you.

Is it your view that the changes made in the post-amendment

rule were primarily technical in nature and that did not have any

substantive change that would either detract or enhance the GSE’s

capital adequacy?

Mr. FALCON. It is a little difficult for me to track of the exact

time period and version of the rule you are making reference to,

Mr. Chairman.

Mr. BAKER. The final rule.

Mr. FALCON. The final rule, the post-amendment?

Mr. BAKER. Correct.

Mr. FALCON. And I am sorry, but the question regarding the

post-amendment rule?

Mr. BAKER. Were there any modifications made to the postamendment rule that, in your judgment, would result in a significant capital adjustment in the conclusions the test would reach?

Mr. FALCON. For which quarter?

Mr. BAKER. Any quarter, whatever makes you happy.

13

Mr. FALCON. Okay. There were still various modeling issues that

we were working out related to various activities of the enterprises.

There were some issues with respect to remmicks and swaptions,

I think was an area that we were working at, coming to the final

conclusion and getting the final bugs worked out in a few areas

like those.

Mr. BAKER. Okay. Well, let me go at it another way. When I

wrote you in February, I suggested that the test be run four ways:

pre-amendment; post-amendment; each test last quarter 2001; first

quarter 2002. You have achieved that; I got the results for fourth

quarter pre-amendment test yesterday. And for that I thank you.

In the letter responding to me on both instances, you indicated

that we should treat or your request of the committee was to treat

those calculations as confidential.

I direct your attention to the 1999 test in which Fannie was

found, under your promulgation, not to meet the minimum requirement. That is the 1999 data promulgated and published by your

pre-amendment rule discussion.

If you could print and publish that in 1999, showing there is a

deficiency, what is the distinction between releasing the information you have given to the committee today and the 1999 publication, which you issued?

Mr. FALCON. Mr. Chairman, at that time, it was essential. In

order to allow full notice and comment, it was essential to release

to the public some information about the way the rule works, the

release of not just results. In 1999 we released results based on

1997 data.

In order to allow robust notice and comment, we needed to give

the public some indication about not just results, but also sensitivity analysis.

And so what we had in the proposed rule was not just results,

but we broke it down for the public among various types of risk

and showed what the sensitivity of the stress test was as allocated

among different types of risk.

Mr. BAKER. One more question because I have exceeded my time.

Have you, prior to the hearing today, released the data to any

other third party, any members of Congress, anybody else besides

my office and yours?

Mr. FALCON. The enterprises have a working version of the code,

Mr. Chairman—

Mr. BAKER. The specific question is, the answer to the letter I

wrote in February, which you responded and said, ‘‘We will provide

you with the information,’’ which you provided the last piece of

which to the committee as of yesterday—

Mr. FALCON. Yes.

Mr. BAKER. —has that information—four parts—been released to

anyone else other than my office, as of this moment?

Mr. FALCON. No. It has not even been released to the enterprises,

Mr. Chairman.

Mr. BAKER. Well, I have been told other members of Congress

have it.

Mr. Bentsen?

Mr. FALCON. Mr. Chairman, may I correct myself in the form

that we did give the information to Congressman Kanjorski?

14

Mr. BAKER. Okay. And nobody else?

Mr. FALCON. No, sir.

Mr. BAKER. Thank you.

Mr. BENTSEN. Thank you, Mr. Chairman.

Mr. Falcon, the first quarter numbers that you released and the

fourth quarter numbers that Mr. Baker and Mr. Kanjorski have,

which I do not, under the post-amendment rules—well, the fourth

quarter would be commensurate with the first quarter of 2002, is

that accurate?

Mr. FALCON. Right. The chairman has numbers that he has requested and we have supplied to him which applies the stress test

to the fourth quarter. And we released, publicly, results applying

to the first quarter of this year.

Mr. BENTSEN. All right.

The chairman seems to be raising a concern about what numbers

pre-amendment versus post-amendment might look like with respect to Fannie or Freddie. I guess I would ask you from your interpretation of the law, the 1992 act and the administrative procedures act that governs your rule making process, I assume, the

post-amendment rule is the rule.

Mr. FALCON. Yes.

Mr. BENTSEN. And so for purposes of how OFHEO should conduct its stress test, under the law, it should use the post-amendment rule. Is that right?

Mr. FALCON. Yes, Congressman.

Mr. BENTSEN. And so the amendments that were made to the

rule are what those, you know, the haircuts and the servicing ratings and issues that you and the chairman conversed on; those are

the changes, some of which were brought up in an earlier hearing

before this subcommittee. So nothing, just to reiterate what you—

restate from what you responded to the chairman in the earlier

line of questioning, there is nothing new here, in the amendments,

that should be a surprise to anyone on this committee. Is that correct?

Mr. FALCON. All the changes we made to the rule were done pursuant to notice and comment. We issued a proposed amendment to

the rule as it stood in September. And, in fact, I was urged to make

any changes only pursuant to notice and comment, and I fully

agreed with that.

We put out for public comment the changes that we were contemplating, received comment from many parties and then proceeded with what we thought was the right thing to do in crafting

this risk-based capital rule.

Mr. BENTSEN. So to argue that numbers that are run using an

unfinished rule are somehow indicative of the financial condition of

one of the GSEs on their face would be inaccurate because that is

not what the rule is, right? I mean, the rule is what the final published rule, after the amendments, is—I mean, that is what it is,

right?

Mr. FALCON. Right. That is what is currently in effect.

Mr. BENTSEN. And that is the rule that the GSEs will be required to manage their operations accordingly. And then the third

quarter or after the third quarter when you begin to classify the

GSEs, then they will be required if they are not already, will then

15

be required to come into compliance at any time they are out of

that.

Mr. FALCON. Right.

Some might argue that the one-year implementation period

would mean that there should not be any results released until the

one-year period ends. I have taken a more open approach to that

and have said, in fact, and released numbers and that I would release numbers as soon as the rules were clearly in place.

And since the rule was subject to amendment in the fourth quarter of last year, the rules were not clearly in place. We published

the final rule in the fourth quarter of last year. so the rules were

in place at that time. And that is why I said that we would release

results for the first quarter of 2002.

Mr. BENTSEN. Upon issuance of the final rule, was there comment or much comment, subsequent to that, criticizing the standards that are being used? I mean, it is the accepted rule; it is under

the APA. It is the law or it is the regulation. But I mean, is there

still criticism of that, of the standards that are being used?

Mr. FALCON. Every so often you might hear some criticism about

the rules. Some think it is too lenient, some think it is too tough.

What we have done is craft a rule which closely ties capital to risk.

It is based on sound, historical analysis, historical data and our

best judgment about the risk associated with all the different activities at the enterprises.

I think it is a very strong, robust rule. And I am proud of the

work the agency did to put this together. It has never been done

before by any regulator.

Mr. BENTSEN. Thank you.

Thank you, Mr. Chairman.

Mr. BAKER. Thank you, Mr. Bentsen.

Mr. Ney?

Mr. NEY. Thank you, Mr. Chairman.

The question I had—I know you have had a lot of wrangling at

yourself by others for a delay of a risk-based capital standard. But

it was written in 1992. It was conceived on the heels of the savings

and loan and really was constructed to look at a financial collapse

of the like we have never seen. And I think that, you know, was

part of it.

The model measures depression-like credit risk fluctuations and

then adds another I think it is 30 percent for operational risk.

Are any other financial service companies subjected to a riskbased capital test comparable to what GSEs now face?

Mr. FALCON. Thank you, Congressman. That is a good question.

This is unique among capital standards for any regulator. It is one

that was mandated by Congress.

Other financial institutions like banks and thrifts have a riskbased capital standard, but that is more of a risk-weighted leverage

type standard. This is unique because it places the enterprises’ balance sheets under severe economic stress and requires, through a

financial simulation model, that they hold enough stress over that

10-year period, every quarter in that period such that they never

become under-capitalized at any point during the 10-year period.

This is unique. It has not been done by any other regulator up

to now. I am proud of what the agency has accomplished.

16

Mr. NEY. Well, like I said, I think you have done good. It is just

I know you got a lot of heat getting there.

Mr. FALCON. Yes.

Mr. NEY. So—

Thank you, Mr. Chairman.

Mr. FALCON. Thank you.

Mr. BAKER. Thank you, Mr. Ney.

Mr. Ford?

Mr. FORD. Let me sort of walk back through just one or two

things. They passed the test; is that what you are saying?

Mr. FALCON. Yes, Congressman. For the first quarter of 2002, the

only numbers we have released, they do pass the test.

Mr. FORD. And you will not release the fourth quarter numbers,

again, for what reason?

Mr. FALCON. The standard I have set is that I was going to release the results for the first quarter after which all the rules were

in place. Since this rule was subject to an amendment in the fall

of 2001, the first quarter for which the rules were in place would

be that first quarter of 2002. That is why that is the first quarter

that we have released.

Mr. FORD. So, in other words, you did not release the fourth

quarter because the rules have changed. And now that the rules—

now everyone is playing under the same set of rules and you feel

pretty confident this is the definite, that this is the set of rules that

everyone would have to play under. And based on that, they

passed.

Mr. FALCON. Yes, Congressman.

Mr. FORD. Let me ask you this, what more do you need to do

your job better, do you think, if anything?

Mr. FALCON. I appreciate that.

Mr. FORD. Let’s be honest, that is why we are here. I am just

wondering what more do you think you need, if anything?

Mr. FALCON. I appreciate that. Now that the agency has moved

forward, we have got the risk-based capital rule done, I am moving

to try to strengthen the agency for the long term. And we have got

several items we would like to undertake.

We would like to double the size of our examination staff. They

are very talented and capable. But there are new challenges for

them to meet. And to do so, they need to do their job with greater

depth and with more resources.

We need to continue to enhance our analytical resources so that

we can utilize the stress test not just as a capital standard, but

also as an analytical tool to help us do our probing for weaknesses

and vulnerabilities. And then that work, in turn, goes towards our

examination staff to our research staff to do their work.

So I think all that comes down to additional resources for the

agency. And the only sure way for us to do some long-term planning is for us to be permanently funded, as are every other safety

and soundness regulator. And I think that is especially critical to

the long-term success of the agency now that we have come this far

in the first nine years.

Mr. FORD. Let me ask you this just taking you back, do you believe you have been as—I know the chairman had some questions

about documents and materials, the request that has been furVerDate 11-MAY-2000 13:31 Nov 21, 2002 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 C:\DOCS\82684.TXT HBANK1 PsN: HBANK1
17

nished in a timely way. Do you feel that you have complied with

the law in terms of furnishing this committee with everything we

have asked for—or members of this committee or, for that matter,

the Congress—what they have asked for?

Mr. FALCON. Yes, Congressman. We supplied the committee with

all the information it has requested. In fact, our schedule was to

try to get the information to the committee by the end of July.

Given the fact that the hearing is taking place on the 23rd, we had

to re-double our efforts and work evenings and weekends to make

sure that we could meet the chairman’s deadline, which we have.

Mr. FORD. Do you feel like you will be able to meet that deadline

now that we have got these new rules and everybody is fine?

Mr. FALCON. Yes. We supplied the chairman with the information yesterday—the last part of it.

Mr. FORD. My last question may be outside of your realm and

you may not want to comment on it, but do you think it is a good

thing that Fannie and Freddie decided to expense these stock options since, obviously, part of what we are feeling here, in the Congress, is the need to respond to the accounting scandals and the

corporate fraud that—it is not as pervasive as the headlines suggest, but clearly has served to rock the markets in negative ways?

Do you believe that their efforts to do these things are

positives—if you can answer that question, if you feel comfortable

in your capacity answering that question as a witness representing

OFHEO this afternoon?

Mr. FALCON. Sure. I think it is a very positive step by the enterprises. I think it represents their desire to maintain best-in-class

standards of management at the enterprises. So I think it is a positive step. I certainly support the step they have taken today.

Mr. FORD. The zeal with which we do some of these, Mr. Chairman, I do also hope that we—the Congress, here, will act to get

this corporate accounting—this corporate governance bill real soon

and we will also even ensure that the SEC has what it needs. I

would imagine that would be helpful in some ways to our witness

today.

With that, I yield back the balance of my time, Mr. Chairman.

Mr. BAKER. Thank you, Mr. Ford.

Mr. Lucas?

Mr. LUCAS OF OKLAHOMA. Mr. Chairman, I do not have any

questions, but I would gladly yield my time to the chair.

Mr. BAKER. Well, I thank you for that courtesy.

Let me return to the point that a couple of members made. One,

Mr. Bentsen talking about the construction of the rule, as modified,

that there were no significant modifications of consequence, to

which I certainly agree, from a material financial calculation to Mr.

Ney’s comment that the rule was built to withstand depression-like

scenarios that no other financial institution must meet. I, perhaps,

agree with that.

And I think we have established in my first exchange that

changes were made independent of GSE influence, pre-amendment,

post-amendment; that the changes were minor; and that you do not

feel it appropriate to release the fourth quarter 2001 pre-amendment results because one, the GSEs were not managing to that

18

rule and secondly, it is somehow unfair to make that information

available.

In your March 21 response to me, you went on at length, indicating that you would comply with my request for the four differing

sets of standards, indicating a two date delivery promise, one early

for the post-amendment test analysis, one later for the pre-amendment analysis, but in no manner or measure did you indicate to me

in that letter of March 21 that that data should be treated as confidential.

Secondly, in light of the 1999 data—why don’t you move that?

Nobody can see that. It is like being in the bleachers at Tiger Stadium. Move that thing over here somewhere.

Watch yourself, now.

[Laughter.]

We are going to move it over here a little closer. But you can go

ahead and put the other one up. But move the whole thing over.

The 1999 data shows that Fannie Mae was not adequately capitalized for the purposes of the stress test. Now—

That is fine. Just tell him to come on in closer. I still cannot see

it. Come down over here, behind this row of chairs right in front

and kind of turn it toward the director so he can see, as well as

members.

That is good right there.

I do not know if that is close enough or not.

Mr. BENTSEN. Everybody on this panel, except Mr. Ford, is over

30 and so most of us cannot see that well.

Mr. BAKER. Yes. We are going to need binoculars. We may need

interpreters to understand it, too.

[Laughter.]

Now, this is the long-awaited challenge, not-to-be-released data,

which is historic in nature. And I want my two colleagues who remain to be comfortable with this.

There is nothing in the data that pre-judges current operating

condition or in any way impugns current management or in any

way says that either Fannie and Freddie are not properly managed. But let’s put this in its context.

They were operating in the last quarter of 2001, which was a

very volatile financial marketplace. And the eight-and-a-half year

test was then applied to the two enterprises.

What this says is that Fannie missed the mark by $600 million,

whereas if you use the post-amendment test, they were in excess

of the requirement by $2.4 billion.

Is that correct?

Mr. FALCON. Billion.

Mr. BAKER. Billion.

So it is a $3 billion swing from one test to the other.

Now, we have all heard that it was—the modifications were

made without GSE influence. The modifications were minor. They

are of no market consequence.

My view of the GSEs does not change as a result of this analysis.

My evaluation is changing with regard to the agency. That is my

point.

And now whether or not the enterprise was in any financial duress or not is only something probably the GSE knows. But if the

19

modifications to this test were made as a result of staff determination as to de-bugging—as to haircuts, as to multi-housing, as to

funding costs and it results in a $3 billion swing, you have got to

ask one of two questions. Is the test valid? Or were the changes

made as a result of some political involvement in the management

of the structure of this test?

And that is where I am.

And now I am not going to ask the director any more questions

on that point because you have made your case quite clear. You

have established the test based on what you believe to be the most

valid professional standards. You subsequently had staff modify

the test, based on what you believe to be professional standards.

And you stand by the test.

Now let’s go back to the fourth quarter of 2002 and Mr. Ney’s

comments. And I would certainly reserve time for Mr. Ney to come

back and speak if he chose.

But he said the rule was built to depression-like standards of

conduct.

Last quarter 2001 was a volatile financial quarter, but it was not

depression-like in its nature. There was nothing that changes in

the business structure of Fannie from the last quarter of 2001 to

the first quarter of 2002 that makes any structural difference.

I am just having a really difficult time in understanding how

that test applied to Fannie Mae in the last quarter of 2001 could

result in the analysis we get and the new test applied to the same

quarter results in a $2.4 billion capital surplus.

It does not make sense.

Jump in, Mr. Director.

Mr. FALCON. Sure. I would like to, Mr. Chairman.

First with respect to your point about me not asking in I think

the March letter that the information be confidential, your letter

to me requesting the information did not indicate that you intended

to make the information public, so I did not feel any need at that

point—

Mr. BAKER. Any time a member of Congress asks you anything,

you have got to assume there is a press conference in the offing.

I mean, you have been around here long enough.

[Laughter.]

Mr. FALCON. I know, Mr. Chairman, that—

Mr. BAKER. And let me say this, not to be frivolous, we debated

this a long time. From your first announcement that you wanted

us to keep this confidential, it caused me great angst. But we have

gone through all the public records documents for you, everything

we can come up with to determine whether it was or is not appropriate, and, basically, it was your request to me and that was it.

It is a public document, as a result of a government agency work

product, provided to a member of Congress that has been shared

with another member of Congress. So there is no question about it.

So let’s move on beyond the debate of whether we should or we

should not. The more important thing is about the facts.

Mr. FALCON. Right. And to that point, my request is certainly not

binding on the subcommittee, Mr. Chairman, all I can do is make

the request. And certainly it is—

20

Mr. BAKER. But historical analysis is not going to make any difference to the market.

Mr. FALCON. Let me address the issue of this chart here, please,

Mr. Chairman.

First off, this does not—this is not all the information. If we are

going to put this information out in the public, I think, so that this

is not taken out of context, this should be put in place with everything else that I sent you.

Now, what the stress test shows for Freddie Mac, I am not sure

if that is going to be released by the subcommittee, as well, but

there is essentially little change in the numbers for Freddie Mac.

Mr. BAKER. I would be happy to discuss that and I want to know

why the discrepancy.

Mr. FALCON. Well, Mr. Chairman, with respect to this data,

itself, if you are suggesting that we made any changes to the riskbased capital to try to effect the outcome for the enterprise in the

fourth quarter, I think that is just incorrect.

First, we did not have any fourth quarter information before us

when we made decisions about how to modify the stress test. So

there is no way that we could have tried to gauge the stress test

to try to make them pass.

And secondly, we had no idea of knowing which scenario would

be binding—the up or the down scenario—

Mr. BAKER. Well, let me ask you on that point, if you did not

have fourth quarter, that does not really matter. You could run the

test on any quarter and I suspect—

Mr. FALCON. You cannot run the test on any quarter, Mr. Chairman, each—that requires an extensive amount of data for each

quarter. The enterprises have to assemble vast amounts of data,

millions of points of data, parts of information are collected and are

aggregated to create what we call a risk-based capital report—

Mr. BAKER. That would lead me to ask this question, are you

then telling me that you did not run the test at all before you released it to the GSEs? You just said, ‘‘Here is the test, figure it

out.’’

Mr. FALCON. We had some idea, based on our understanding of

how the risk-based capital worked, about what might be some general—how the capital standard might be impacted by modification

of the risk-based capital rule. And at the time that we published

the final rule on this risk-based capital amendment, we said in the

amendment that our anticipation is that the effects of this will be

minimal and, in essence, a wash.

Now what you do not have up here is the up rate for Fannie

Mae.

Mr. BAKER. I am sorry, the what for Fannie Mae?

Mr. FALCON. The up rate; this is just the down rate scenario for

Fannie Mae. You do not have the up rate here, which shows that

we actually increased our capital requirement by $5 billion.

Now, here you are saying that we decreased it by $3 billion, well

we did not know which scenario would be binding. We did not even

have this information in front of us. so we could just as easily have

increased our capital requirement by $5 billion. Now you are suggesting we intentionally decreased it by $3 billion; that is not true.

21

Mr. BAKER. So you are telling me if you took the fourth quarter

of 2001 and ran the post-amendment test and took the same data

and ran the pre-amendment test, that the differences between the

two conclusions are what—minimal, not important, not clear?

Mr. FALCON. I am not sure how they are relevant.

Mr. BAKER. The same data, the same quarter, two different tests,

one gives one result, the other gives another. They are relevant.

There were modifications made to the test that caused the results

to be different.

Mr. FALCON. Oh, absolutely. I agree with that.

Now, did we know what the results of the modifications would

be? As I said, the fourth quarter was not even closed yet when I

made these decisions on what modifications to make to the stress

tests. So to suggest that we were results-oriented in making these

changes, it is just not correct.

Mr. BAKER. Mr. Lucas has expired his time.

Mr. Bentsen, we come back to your side.

Mr. Shays?

Mr. SHAYS. I am happy to listen to questions or ask them. Which

do you want me to do?

Mr. BAKER. Take off.

Mr. SHAYS. Okay.

I have already welcomed you, so I will not do that again. But it

is good to have you here.

And I would like to ask, you know, on April 8, OFHEO announced it would conduct a comprehensive review of the financial

disclosure policies and practices of Fannie Mae and Freddie Mac.

Can you advise this committee whether OFHEO was still pursuing

this review? And when can we expect its release?

Mr. FALCON. Yes. Thank you, Congressman.

We are still pursuing the review with the SEC and the Treasury.

And we are expecting to try to complete it by the end of the year.

Now, that is our goal. We are going to use our best efforts to see

if we can meet that goal. But we will see; maybe we will try to give

you a mid-term report about how it is going.

Mr. SHAYS. When you say join it with the SEC and Treasury,

who is doing the bulk of the work?

Mr. FALCON. That has not been established yet, Congressman. I

imagine—

Mr. SHAYS. Is the work being done now? Or is it still not—

Mr. FALCON. Oh, yes, the work is currently being done. We are—

Mr. SHAYS. Okay. So who is doing most of the work so far?

Mr. FALCON. Well, we are doing a lot of research on the various

types of mortgage-backed securities that are out there, the differential types of information that is released, along with each type of

mortgage-backed security. And that will form the basis for us to

undertake a comparison of the type of disclosures by issuer.

Mr. SHAYS. Can you explain to me why OFHEO has been

charged with promulgating a rule that will facilitate the implementation of Fannie Mae and Freddie Mac’s agreement to register and

disclose to another agency the SEC?

Mr. FALCON. As part of this arrangement where the enterprises

will voluntarily register under the 1934 act, OFHEO still maintains its safety and soundness authority. And it is not in any way

22

limited by this functional regulation, you could call it, of Fannie

Mae’s and Freddie Mac’s security disclosures.

In so doing, we will promulgate a rule to require that these disclosures that are filed with the SEC also get filed concurrently with

OFHEO. And there are two sections in the 1934 act, Sections 14

and 16, dealing with insider trades and proxies which, because of

the operation of some of the language in those sections, it is necessary for OFHEO to promulgate a rule requiring the application

of those sections to Fannie and Freddie. And then, in order to comply with our rule on those two sections, all they have to do is submit the reports to the SEC.

Mr. SHAYS. Is it unusual for one agency to basically, in essence,

write the rule for another agency?

Mr. FALCON. That is not what we will be doing, Congressman.

They would be required to submit, well, for the balance, for every

part of the 1934 act, except these two sections, they are voluntarily

submitting themselves to the jurisdiction of the SEC for purposes

of the 1934 act. And so we are not going to facilitate that implementation.

But there are two sections for which require a little bit of a special treatment. And we are not going to promulgate a rule that in

any way delegates OFHEO’s safety and soundness authority. In

fact, we will require compliance with Sections 14 and 16 and compliance would be through OFHEO. However, they would be able to

satisfy our regulatory requirement by submitting reports to the

SEC.

Mr. SHAYS. When do you expect the rule making to be completed?

Mr. FALCON. I am hoping we can get that done in just a couple

of months, Congressman.

Mr. SHAYS. So by October 1 do you expect to have it done?

Mr. FALCON. We will try—October 1.

Mr. SHAYS. Do you expect it to be open for public comment?

Mr. FALCON. Absolutely, Congressman.

Mr. SHAYS. And when is the latest it would likely to take effect?

Mr. FALCON. I think, depending on what else is in there, we

may—that will affect length of the comment period. As I said in my

testimony, we may include in this rule additional disclosures, supplements of those that would be required in the 1934 act. And if

we do so, we will want to be sure to allow sufficient time for notice

and comment.

It could be anywhere from 30 to 60 or 90 days.

Mr. SHAYS. What role did OFHEO play in arranging the agreement between the SEC and the two GSEs?

Mr. FALCON. We worked with the SEC and the Treasury to make

sure that this could and would work. Once we were all satisfied

that this would work, we then went about just making sure that

we had a meeting of minds between the three of us about how this

would work.

Mr. SHAYS. And what role will OFHEO continue to play to ensure the agreement has teeth?

Mr. FALCON. We will require that the reports they file with the

SEC also get filed with OFHEO. Our safety and soundness authorVerDate 11-MAY-2000 13:31 Nov 21, 2002 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\82684.TXT HBANK1 PsN: HBANK1
23

ity and responsibility is not, in any way, limited by the enterprises

voluntary registration under the 1934 act.

So we will continue to review them pursuant to our safety and

soundness authority and review those reports, as well. And should

we ever see any shortcomings, we would consult with the SEC

about that.

Mr. SHAYS. Last week, Fannie Mae’s quarterly analyst, Tim

Howard, the company’s CFO stated, ‘‘We sought and obtained written concurrence from the SEC that voluntary registration under

the 1934 act would not change the fact that, among other things,

securities issued or guaranteed by Fannie Mae are exempt securities under the Securities Act of 1933 and may be sold without registration under that act.’’

Is Fannie Mae trying to have it both ways by assuring the administration and Congress that it will submit to the government

regulation and assuring Wall Street that it will remain exempt

from government regulation?

And let me just ask this, is this an attempt by the company to

perpetuate its implicit government guarantee? What is your opinion?

Mr. FALCON. Well, what I think the statement is in reference to

is, it is a statement that the waiver of their exempt status under

the 1934 act does not mean that they are waiving their exemption

under the 1933 act. I think that is what the statement was going

towards.

Mr. SHAYS. Have you seen this written concurrence? If so, will

it be released to the public?

Mr. FALCON. I am not sure what the written concurrence is, Mr.

Chairman. And I am not sure I have seen it.

Mr. SHAYS. Okay.

Mr. Chairman, are we aware of what if there is anything in writing?

Mr. BAKER. I am not.

Mr. SHAYS. Okay.

You know, I would just make a request that we get access to

that.

I know my red light is on and so I will come back for a second

round. But I do want to acknowledge that in the questions that we

had asked before—and maybe this was pointed out—it was basically—maybe in your statement as well—I am happy that Fannie

Mae and Freddie Mac will have to restate earnings. And they

wanted our office to know that they were going to do that on August 14. And when we asked the Treasury, they did not know, but

evidently that is going to happen. And I think that is a positive

thing.

Mr. BAKER. Thank you, Mr. Shays.

Mr. Bentsen?

Mr. BENTSEN. Thank you, Mr. Chairman.

And Mr. Shays, I might recommend to you that in the testimony,

Mr. Falcon’s testimony on page six in the—I do not know if it is

the carryover—you know, it is the first paragraph—in the fourth

line it states that the ultimate arbiter of what must be disclosed

will be the SEC and OFHEO.

24

The testimony goes into great detail about what OFHEO is

doing. I think they are to be commended for that because they are

the congressionally mandated regulator for safety and soundness

over the GSEs. And, in fact, they seem to be working arm-in-arm

with the SEC on trying to figure out how to merge the financials

for purposes of disclosure—

[Laughter.]

Mr. BENTSEN. Our witness, I think, is very capable. So it is—but

he was on this side of the aisle before. And he is a Texan, also, Mr.

Shays, which is probably the main reason.

I want to go back to the line of questioning that the chairman

had on the comparison of enterprise capital requirements, pre and

post final rule amendment.

Let me restate, again, the rule went through the normal procedure. It went through the comment period. In fact, maybe even

more so than normal procedure. You came and testified before this

panel. You may have testified before a panel of the other body, I

do not know. And had all the hoops you have to jump through with

which to promulgate a rule under the laws of the United States,

right?

And so the rule is the final rule and that is what you are required by law, to calculate the risk-based capital and minimum

capital standards of the GSEs, right?

Mr. FALCON. Absolutely—that is right, Congressman.

Mr. BENTSEN. Now, Mr. Baker raises the concern—the broad variation in the fourth quarter Fannie Mae and first quarter—fourth

quarter 2001 and first quarter 2002 Fannie Mae numbers as opposed to Freddie Mac. And I appreciate your concern of laying out

unfinished work in a volatile marketplace and saying, ‘‘Well, gee,

if you looked at it this way, even though that is not what the rule

says, but if you made these assumptions for whatever reason,

things might look worse than they really are—’’

Mr. BAKER. Would the gentleman yield just a minute?

Mr. BENTSEN. I may have to yield.

Mr. BAKER. Just to clarify, the pre-amendment test was also promulgated. It was not a hip-pocket version that was short-circuited

and then later saved by 60-day amendment process. It was an

eight-and-a-half year product which was subsequently amended by

a 60-day process. Just for the sake of understanding.

Mr. BENTSEN. Fair enough. But nonetheless, all following the

APA and the enacting legislation. But nonetheless, back to my

point, I understand your concern about saying, you know, putting

out supplemental data, which, at least legally, and perhaps mathematically maybe has minimal value, but in a volatile marketplace

could have substantial effect.

The changes in the amendment were primarily the haircut rules

for derivative products and which would have affected the amount

of capital or the amount of derivatives that the amount of capital

set aside for purposes of the haircuts or the amount of derivatives

that might be used for hedging purposes, and thus, the amount of

capital that could be put at risk.

And I guess it affected the service, the ratings of the servicers

and the amount of capital that might have to be set aside to account for those ratings.

25

And I assume there were some other technical changes.

Are you able to tell us, you know, since we have now delved into

these numbers, perhaps more than we should, are you able to tell

us what were the main reasons for the changes in the final numbers? Was it the haircut rule? Was it the servicing rating rules?

Mr. FALCON. It was based on additional information. We ground

this rule very much in data and research and analysis and try to

assess the risk of the various activities of the enterprises, based on

our knowledge of how mortgages perform historically, based on differing loan characteristics, for instance. And as we get additional

information to better understand various risks of the enterprises,

we will undertake to make modifications to the stress tests.

And so this will be a dynamic stress test.

If a year or two from now we have more information which allows us to fine tune this even better, we may come out with an additional amendment. The idea is to continue to refine this.

We put out version 1.0 of this stress test. We will work towards

version 2.0 and 3.0 over time.

I think part of the difficulty for the agency in trying to get this

stress test done was trying to come out with version 5.0 at the beginning. So what we have got is a very robust, strong stress test.

Mr. BENTSEN. If I might, with the chairman’s indulgence, the

new information, is that information applied uniformly to both

GSEs? Or is it information that is specific to one portfolio or another?

Mr. FALCON. It is information that is general information; it

might be data, combined enterprise data. It might be research produced by either OFHEO or by some other third party about the

performance of mortgages as a better estimation of counter parties.

It does not necessarily have to be enterprise specific data or analysis. In fact, it usually is not.

Mr. BENTSEN. I yield back.

Mr. BAKER. Thank you, Mr. Bentsen.

Mr. BENTSEN. Thank you.

Mr. BAKER. I am going to go to Mr. Shays. He has schedule constraints.

Mr. Shays?

Mr. SHAYS. Thank you very much.

Thank you, Mr. Chairman, for yielding to me.

And I would like to turn our attention to mortgage-backed securities and have you share with us whether Fannie Mae and Freddie

Mac should continue to enjoy an exemption from disclosure in what

is their mortgage pools. You know these two companies better than

just about anyone. So I am particularly interested in your views on

this issue. And are you comfortable with the continued exemption?

Mr. FALCON. Mr. Chairman, I think rather than give any opinions at this point, that is, I want to have the best possible information in front of me before I form judgments like that. That is why

we are undertaking this study with the SEC and the Treasury.

Mr. SHAYS. Do you have a lean one way or the other?

Mr. FALCON. I cannot say right now, Congressman, because I

have not reviewed the information that is put out by non-GSE

issuers of mortgage-backed securities. So I would want to first compare what they put out versus what the enterprises put out.

26

Mr. SHAYS. But it is true that Wells Fargo, for instance, would

have to disclose when they put together a pool. So I mean, it is just

not some kind of strange activity for the business to have to do,

correct? I mean, we have certain parallels that we can look at, correct?

Mr. FALCON. Right. Any issuer of debt, just by virtue of what the

market will demand, will put out some level of disclosure that a

companies that debt. That is your—

Mr. SHAYS. Last week, Treasury Undersecretary Peter Fisher

testified, quote, ‘‘The time has come for Fannie and Freddie’s investors to be assured that the level and quality of the corporate disclosure they receive are the same as those that are made by any other

company that actively participates in our capital markets.’’

In your own testimony, you stated that OFHEO is, quote, ‘‘prepared to issue a rule requiring disclosure that would be, at a minimum, comparable to those of other trading companies’’, end of

quote.

I do not quite understand this. How can we profess to want to

treat Fannie and Freddie like any other publicly traded company

and then qualify these statements by talking of continuing their exemptions from one of the two major security disclosure laws?

Mr. FALCON. I think that is—what is important here is the disclosure. The benefit you get with registration is the disclosure. And

what we are trying to do with this study is ensure that there is

a level playing field and adequate information that accompanies

the issuance of mortgage-backed securities.

If we can, as I said in my testimony, if we can accomplish that,

and I am very confident that we can establish adequate information, as well as the level playing field, through the cooperation and

the joint study by ourselves and the SEC and Treasury, then registration is unnecessary. I am confident that we can get there with

the right disclosure rules.

Mr. SHAYS. Isn’t basically registration and disclosure somewhat

parallel?

Mr. FALCON. I think that is right.

Mr. SHAYS. Yes. So the question is do you stand by your statement that OFHEO is prepared to issue a rule requiring disclosures

that will be, at a minimum, comparable to those of other trading

companies?

Mr. FALCON. Which—are you reading from my testimony, Mr.

Chairman?

Mr. SHAYS. Yes.

Mr. FALCON. I think what I said—that at—prior to the enterprises’ voluntary registration under the 1934 Act, we were prepared to issue a rule which would place them under requirements

similar to the securities laws.

But since they have voluntarily submitted themselves under the

1934 act, we are not going to pursue a registration regime at this

time. And the issue, with respect to the application of the 1933 Act

and disclosures on their mortgage-backed securities—focus there

will be on the adequacy of disclosures and the level playing field.

Mr. SHAYS. Mr. Fisher made it very clear to us that he certainly

encouraged Fannie and Freddie to be under the 1934 Act. And I

27

am interested to know, did you play that same kind of role? Or

were you passive on this?

Mr. FALCON. We were certainly supportive of the enterprises

coming under a mandatory disclosure regime. And if it was not

going to be under 1934 Act, then OFHEO was prepared to issue

such a regulation. And I said so in response to an OMB prompt letter on the subject, as well.

Mr. SHAYS. Okay.

Can you explain—and I am pursuing this a little more deeply—

can you explain why Fannie and Freddie will continue to enjoy an

exemption from registering their MBSs? I would like for you to answer this question keeping in mind that companies in the jumbo

market, in which Fannie and Freddie do not participate, are required to register their mortgage-backed securities. What makes

Fannie and Freddie’s mortgage-backed securities different, for instance, than the mortgage-backed securities, again, of Wells Fargo?

Mr. FALCON. I am not sure I can answer, Congressman, that is

a judgment that Congress has made. And I would just defer to Congress’ rationale for doing that when it granted the enterprises that

exemption.

Mr. SHAYS. You that—you are on a little bit dangerous ground

only because that would imply that you do not have opinions that

you would present to Congress. Do you not ever have an opinion

or a suggestion that you would make to Congress?

Mr. FALCON. No, Congressman. It is just in this area where we

are studying the adequacy and the comparability of mortgagebacked security disclosures—it is just in this area where I am trying to approach this with an open mind and not pre-judging the

issues as we go forward with that study.

Mr. SHAYS. Just one other, may I, Mr. Chairman, just pursue one

other short line of questions?

Regarding the interagency review of mortgage-backed securities

that will be conducted by SEC and OFHEO and the Treasury, can

you tell me whether this study will examine both disclosure and

registration of mortgage-backed securities? If not, why not?

And I will put this question out on the floor, too, just so—will

the study investigate allegations that Fannie and Freddie cherrypicked the mortgage-backed securities, leaving lower quality mortgage pools for investors?

By the way, I want to say that Fannie Mae and Freddie Mac say

this does not happen. And I am just suggesting that there is a

question of whether it does or not and want to know if cherry-picking will be one of the issues you look at in your review.

Mr. FALCON. I think that is certainly an issue we will give some

review, Congressman.

Mr. SHAYS. Okay.

Thank you, Mr. Chairman, for your patience and for yielding to

me.

Mr. BAKER. Thank you, Mr. Shays.

Mr. Ford, please?

Mr. FORD. Thank you, Mr. Chairman.

This has become somewhat humorous, Director. We are glad you

are here, but we are debating something up here and you are just

caught in the middle of this thing. so we apologize for you having

28

to answer things that sometimes you feel uncomfortable and maybe

even inappropriate.

But I am going to try to ask you something that I think is appropriate. And, obviously, I am a little biased about it.

But if you would not mind, forgive me, to compare and contrast

the regulatory regime for Fannie Mae and Freddie Mac as it relates to safety and soundness. I imagine that you do not necessarily—at least not in this life you are not crafting things for

these private enterprises, but if you would not mind giving us a

sense, if you have a knowledge of that—if you could speak to that,

I would appreciate that.

Mr. FALCON. Sure. Our regulatory program, Congressman, is

very much identical to the type of regulatory program that banks

have. We have very talented and skilled examination program,

much like the bank regulators. We have a regulatory infrastructure

which sets standards and expectations that we have for the enterprises, along with other informal types of standards, guidances,

agency interpretations.

We have an active research group which helps us understand developments in the marketplace and the changing risk profiles of

the enterprises. You know, we have talented financial analysts that

can look at the enterprises balance sheets and results from the

stress tests and try to help us better understand their

vulnerabilities.

So our program is very comparable to that of any other bank regulator.

Mr. FORD. As it relates to—and this is a similar question, I am

just trying to get it all on the record here, but how would—under

this risk-based capital standard, how would other companies, primarily private banks, fair under this thing? I am not asking you

to grade my bank, or for that matter, any other bank, but just a

sense, because, again, we are—Chris Shays is my good buddy and

he is writing a lot of things, particularly campaign reform. Richard

Baker and I are good friends. He ’s writing is lot of things, too.

And I do hope the kinds of questions that we are asking Fannie

and Freddie—I hope at some point we can also bring in these

doggoned credit reporting agencies and ask them—put up some

charts like that and explain how they misreport peoples’ stuff and

how they go about fixing it.

But since they are not here, in terms of risk-based capital centers, how do you—how would they fair, some of these other companies fair in comparison to how Fannie and Freddie fair?

Mr. FALCON. I could not say without having, you know, a broad

range of financial information about those companies. We get very

deeply into Fannie and Freddie’s activities beyond just what they

might release in—

Mr. FORD. Forgive me for asking you to go beyond, but just, even

if you do not feel like answering it, do not answer it, I just thought

I would just put it out there because I think it—

Mr. FALCON. It is a very rigorous stress test. It imposes very

stressful economic conditions on their balance sheets. You know, it

is not the type of stress test that any other financial company has

to be able to withstand, as a capital standard.

29

It would, I think, pose a challenge to many institutions to try to

survive this.

Mr. FORD. I would if it would be appropriate, the chairman

knows a lot more about these issues than I do, but I would hope—

and I will yield back my time—I would hope that maybe we can

even add and not to put any of these institutions on the spot, including my own financial institutions.

But at the same time, if we are going to be as demanding on

these two organizations as we are—for good reason—and hopefully

what will come out of this hearing is a safer and sounder system,

then we should probably ask some of these other companies to provide or furnish us with this same kind of data.

I do not know if you want to, necessarily, do it, Director, but if,

indeed these tests are conducted. But I would ask the chairman if

we could take a look or if he would consider doing it. I know I

would support an effort to do that.

And with that, I yield back the balance of my time.

Mr. BAKER. Thank you, Mr. Ford.

I guess I can best express my situation this way, Mr. Falcon,

after eight-and-a-half years, we had a test. We gave the test; one

GSE passed; one GSE failed. Ninety days later, we have another

test. Amazingly enough, both GSEs passed.

Imagine what our public school system would look like if we gave

everybody in the class a test. And then 30 days later, we came back

and gave them exactly the same test with prior announcement. I

bet our test scores would go up.

Or if, before our children could go out to play in the afternoon,

we asked them, ‘‘Did you clean up your room?’’ ‘‘Oh, yes, dad, sure.

But could you come back about seven and check it out?’’

That is my problem here. We have a test that was developed

after eight-and-a-half years of very intense, very hard work with

congressional oversight, people fighting to protect your budget, get

you the staff you needed. And I feel, frankly, very let down. At the

end of the day, we have got a process, by virtue of haircuts on

mortgage insurance companies, multi-family housing treatment,

funding costs and some technical stuff I do not understand that we

find such an erratic swing in the financial adequacy in relation to

the stress test of one GSE.

I have just got to tell you that I am not comforted either by the

written or oral explanations of how we are where we are. Something has to be done about this.

Now, I am not faulting you, individually. I may be faulting the

process. I may be faulting the structure of OFHEO. It is, after all,

the only regulatory body in the financial world that is funded by

congressional appropriation instead of fees on the regulated enterprises.

There may be other regulatory powers you need you do not have.

But I have just got to tell you, this is unacceptable that—I do

not know where we go from here. But there has got to be another

place to land that can give the taxpayer of this country an accurate

honest assessment of the true risk exposure they face in the indirect support of two enterprises which have over $3 trillion of exposure to this economy. That is enormous.

30

And in light of the financial conditions of the market we face

today, giving all the allegations that are floating—thank goodness

we are not hearing any of that about Fannie or Freddie. I can only

imagine the consequences if one of these two corporations were to

report a financial irregularity.

I am not alleging today that either of the enterprises are mismanaged—that they are taking on risk that they should not take.

But I do not know what the road holds ahead. I do not know if the

current management is going to be there 10 years from now. I do

not know that the tools OFHEO has are going to be adequate as

the enterprises continue to grow and expand.

If we look back a decade and see what they looked like then and

look at them today, there is a dramatic change in the risk profile

of the two enterprises. One has a fairly significant amount of

hedges in relation to the debt issued. The other one does not. Does

that mean the other one is not appropriately managed? I do not

think so.

But we need to have a better, clearer insight which leads to less

debate.

I have not heard any explanation as to why the changes that

were made—one, were made; two, as to how they could result in

a $3 billion shift in the calculation resulting on the last quarter’s

calculations of 2001; and why I should be comforted in the manner

in which the discussions have resulted in this foster.

And, again, I say this having been in the trenches with you and

fought the appropriators for a long time to get you into the place

where I felt like we had the resources to at least stand toe-to-toe

with them.

I really do not have anything else to add. I just, over the August

recess, I am going to give this a lot of thought—try to come back

with something that is constructive. And I hope we can find a way

to, once and for all, answer the questions that I know every taxpayer has got to want to know—am I safe? Given the volatility in

the markets we face, we do not need this additional concern added

into the financial calculus.

And I, please, want to afford you the opportunity to make any

comments you wish.

Mr. FALCON. I appreciate that, Mr. Chairman. And you have always been the—supportive of OFHEO when we have needed it in

our budgets. It often feels like a form of tough love that you have

for the agency.

But it is, I think, you are well intentioned about trying to support the agency.

I would just suggest to you that the information that you put up

here on the chart—I do not think it is an accurate demonstration

of what we have done with this risk-based capital rule.

In addition, the reason I think this information is also somewhat

misleading about the enterprises’ financial condition and what we

have done is that I announced early in the fourth quarter that we

were not going to release fourth quarter data. Now, had the enterprises understood that I was going to release fourth quarter data,

would they have done something differently? Well, I do not know.

Mr. BAKER. But on that point—let’s take the issue—they did not

know, so they were not managing to it. They were taking risks we

31

did not understand? Are you telling me we should not give pop

quizzes? That we should drop in as a regulator—as an unannounced inspector of the credit files and see what is going on in the

inner-enterprise? Are you telling me we have to give them a certified notice, ‘‘We have coming June 14, 2003. Get your lipstick and

your hair done’’? I mean, come on.

Mr. FALCON. It depends on what you want out of the capital

standards. I do not use them as a game of ‘‘Gotcha.’’

Mr. BAKER. No, I do not either, but I want to know what real

risk is involved in the real world and what we are taking on. And

apparently—

Mr. FALCON. And I think this rule does that. You know, I would

like to have an opportunity, going forward, to try to persuade you

that we have promulgated a very robust and strong risk-based capital rule. And we will be glad to give you a more in-depth explanation about the changes we have made.

They are certainly well explained in the final rule that implemented the modifications—

Mr. BAKER. Well, the only—last point is that let’s assume for the

moment I am wrong on every point and that there is no merit to

any of the criticisms I have leveled here today—why are we waiting until the first quarter of 2003 to implement the rule—to make

it enforceable?

Mr. FALCON. That is what the statute provides, Mr. Chairman.

The statute says that this shall not be enforceable until one year

after it is effective. That is what the statute says.

Mr. BAKER. One year from September 2002 or—

Mr. FALCON. One year from September 2001.

Mr. BAKER. So that would be September 2002?

Mr. FALCON. Yes.

Mr. BAKER. So why are we waiting until the first quarter of

2003?

Mr. FALCON. We are not. this rule will be—

Mr. BAKER. Well, that is good news. I was under the impression

you were not going to have it enforceable in 2003.

Regardless, I am saying to you that there is significant problems

with the structure we now have. We need to make some modifications. We have got the August recess to see if we can figure out

some solutions.

I look forward to talking to you.

Unless Mr. Bentsen—yes—well, please, Mr. Bentsen?

Mr. BENTSEN. Thank you, Mr. Chairman.

And, again, let me thank you for calling this hearing. And even

when we do not agree, I appreciate the amount of time and effort

you put into this.

I think, though, we need to make clear that there may be two

issues here. One may be a process issue, although I would argue

that we followed the—you know, we have been going through this

with the APA. We had a hearing before this committee. Members

of this committee on both sides of the aisle raised concerns about

the proposed final rule. Amendments were made under the APA.

And that is the final rule.

And so on the one hand, we can raise concerns about the process.

And they are legitimate. But on the other hand—and on any ruleVerDate 11-MAY-2000 13:31 Nov 21, 2002 Jkt 000000 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 C:\DOCS\82684.TXT HBANK1 PsN: HBANK1
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making procedure. On the other hand, the question really has to

be are you satisfied with the formula for the risk-base analysis and

the minimum capital analysis? And if you are satisfied, then it is

what it is. And if you are not satisfied, then that is another matter

to look at.

Perhaps the committee ought to take a look at whether or not

we think, after all this work and the eight—10 years that the staff

and analysts have been looking at this—whether or not the math

is right or not, but the math is what it is.

And we have to live with that and then in September they will

begin to classify. And you have to pick markers in time with which

they meet.

I agree with you that—I mean, as I understand the laws and the

way it works, OFHEO is in the GSEs. They are, as in many respects, the same way that bank examiners are in the bank. But

they have to look at quarterly mileposts as they go through this to

determine where they are in terms of capital.

But, again, it is gone through the APA and maybe our debate has

to come down to we do not like what you finally came up with. But

you put a lot of time into it and we have not heard a lot of people

come back and say, ‘‘We think your formulas are wrong.’’

And maybe that is what they need to do, but they have not done

it yet.

Mr. BAKER. And I would suspect that there are not a lot of people

in the world who sit around their breakfast table in the morning

discussing the stress test adequacy of the government-sponsored

enterprises.

Mr. BENTSEN. Only in Baton Rouge, I think.

Mr. BAKER. I can assure you when I get home I turn into a real

person.

Let me express this perspective, just to keep it in its proper context. When I wrote the letter to Mr. Falcon asking for the four permutations of the test, I really had no anticipation—nobody could

have—as to exactly what the consequences. Because Mr. Falcon

has testified that he did not know what the results of the test

would be. It took considerable effort and time to run the test.

I was kind of hoping that they would all come out within margin

of error of each other and we could go on about our business. But

I thought it would be a great thing for this committee to have, as

a platform for future analysis, the four tests on two quarters run

and we could then judge future test results by that platform.

And I had a hint, when it took so long to get number four, that

there was something up. But I had no substantive knowledge that

the end result of that last test would be to show a GSE insufficient

in relation to the test standard.

That really was it.

But now that it has occurred and I am trying to understand why

and how, I am not at all happy with the consequences or the explanation as to how we got where we are. Because a $3 billion swing,

even in GSE light world, is a significant swing.

So for the record, I appreciate the long-standing effort.

I appreciate, certainly, the gentleman’s work from Texas in sitting through these hearings. You have been one of the few who has

been able to make it through all of these.

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I am sincere in my concerns. I do not feel I know today any more

about the true financial picture of the GSEs than I did five years

ago. And after time, money and effort spent in this effort, that is,

I think, rather disappointing.

So I thank the gentleman for his testimony, his willingness to be

here today. I am confident the release of this data has no consequence to the market performance whatsoever.

And I look forward to working with the members of the committee on resolution of these matters in the coming months.

Meeting adjourned.

[Whereupon, at 3:53 p.m., the subcommittee was adjourned.]

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A P P E N D I X

July 23, 2002

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