```

[Senate Hearing 107-]
[From the U.S. Government Publishing Office]

                                                       S. Hrg. 107- 303

                  THE HOUSING MISSION OF THE OFFICE OF
                FEDERAL HOUSING ENTERPRISE OVERSIGHT AND
                   THE FINANCIAL SAFETY AND SOUNDNESS
                     OF FANNIE MAE AND FREDDIE MAC

=======================================================================

                                HEARING

                               before the

               SUBCOMMITTEE ON HOUSING AND TRANSPORTATION

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                                   ON

 THE RESOURCES AND EFFECTIVENESS OF OFHEO AS A REGULATOR, THE CAPITAL 
STANDARDS REQUIRED OF HOUSING GOVERNMENT SPONSORED ENTERPRISES, AND THE 
  STATUS OF RISK-BASED CAPITAL STANDARDS REQUIRED BY CONGRESS IN 1992

                               __________

                              MAY 8, 2001

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

                                _______

                  U.S. GOVERNMENT PRINTING OFFICE
77-982                     WASHINGTON : 2002

____________________________________________________________________________
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      PHIL GRAMM, Texas, Chairman

RICHARD C. SHELBY, Alabama           PAUL S. SARBANES, Maryland
ROBERT F. BENNETT, Utah              CHRISTOPHER J. DODD, Connecticut
WAYNE ALLARD, Colorado               TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming             JACK REED, Rhode Island
CHUCK HAGEL, Nebraska                CHARLES E. SCHUMER, New York
RICK SANTORUM, Pennsylvania          EVAN BAYH, Indiana
JIM BUNNING, Kentucky                ZELL MILLER, Georgia
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN ENSIGN, Nevada                  DEBBIE STABENOW, Michigan
                                     JON S. CORZINE, New Jersey

                   Wayne A. Abernathy, Staff Director

     Steven B. Harris, Democratic Staff Director and Chief Counsel

           Geoffrey P. Gray, Senior Professional Staff Member

         Jonathan Miller, Democratic Professional Staff Member

                       George E. Whittle, Editor

                                 ______

               Subcommittee on Housing and Transportation

                    WAYNE ALLARD, Colorado, Chairman

                JACK REED, Rhode Island, Ranking Member

RICK SANTORUM, Pennsylvania          THOMAS R. CARPER, Delaware
JOHN ENSIGN, Nevada                  DEBBIE STABENOW, Michigan
RICHARD C. SHELBY, Alabama           JON S. CORZINE, New Jersey
MICHAEL B. ENZI, Wyoming             CHRISTOPHER J. DODD, Connecticut
CHUCK HAGEL, Nebraska                CHARLES E. SCHUMER, New York

                      John Carson, Staff Director

             Tewana Wilkerson, Deputy Legislative Assistant

                                  (ii)

                            C O N T E N T S

                              ----------                              

                          TUESDAY, MAY 8, 2001

                                                                   Page

Opening statement of Senator Allard..............................     1

Opening statements, comments, or prepared statements of:
    Senator Reed.................................................     2
    Senator Corzine..............................................     3
        Prepared statement.......................................    34
    Senator Stabenow.............................................     3
        Prepared statement.......................................    34
    Senator Sarbanes.............................................    23
    Senator Carper...............................................    26
    Senator Santorum.............................................    35

                               WITNESSES

Armando Falcon, Jr., Director, Office of Federal Housing 
  Enterprise Oversight...........................................     4
    Prepared statement...........................................    35
Franklin D. Raines, Chairman and Chief Executive Officer, Fannie 
  Mae............................................................    14
    Prepared statement...........................................    38
Leland C. Brendsel, Chairman and Chief Executive Officer, Freddie 
  Mac............................................................    18
    Prepared statement...........................................    55

                                 (iii)

 
                  THE HOUSING MISSION OF THE OFFICE OF

                  FEDERAL HOUSING ENTERPRISE OVERSIGHT

                 AND THE FINANCIAL SAFETY AND SOUNDNESS

                     OF FANNIE MAE AND FREDDIE MAC

                              ----------                              

                          TUESDAY, MAY 8, 2001

                               U.S. Senate,
  Committee on Banking, Housing, and Urban Affairs,
                Subcommittee on Housing and Transportation,
                                                    Washington, DC.

    The Subcommittee met at 9:30 a.m., in room SD-538 of the 
Dirksen Senate Office Building, Senator Wayne Allard (Chairman 
of the Subcommittee) presiding.

           OPENING STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Let me call the Committee to order.
    I like to start my Committee hearings on time. I know many 
of our witnesses that we call on our panels have very busy 
schedules. I think out of courtesy to them and, actually, out 
of courtesy to the other Members on the Committee, that we 
should get started on time. I always make a point of trying to 
do that. We are scheduled to start at 9:30 and it is now 9:30 
in the morning.
    I want to welcome everyone to the Housing and 
Transportation Subcommittee of the Banking Committee. Today, we 
will conduct a hearing on oversight of the mission of the 
Office of Federal Housing Enterprise Oversight-- otherwise 
known as OFHEO--and the financial safety and soundness of 
Fannie Mae and Freddie Mac.
    We have three witnesses. On the first panel we will hear 
from Mr. Armando Falcon, Director of OFHEO. On the second panel 
we will hear from Mr. Franklin Raines, Chairman and CEO of 
Fannie Mae; and also from Mr. Leland Brendsel, Chairman and CEO 
of Freddie Mac.
    The American mortgage finance system is the envy of the 
world. Fannie Mae and Freddie Mac are a vital part of this 
system. They are among the largest financial institutions in 
the world.
    While both Fannie Mae and Freddie Mac are New York Stock 
Exchange-listed companies owned by shareholders, they are also 
Government Sponsored Enterprises--commonly referred to as 
GSE's--with the specific mission to increase homeownership. Due 
to their GSE status, the Congress of the United States has a 
significant oversight responsibility for Fannie Mae and Freddie 
Mac.
    In 1992, Congress created the OFHEO, an independent 
regulator within the Department of Housing and Urban 
Development, to regulate the financial safety and the soundness 
of Fannie Mae and Freddie Mac. It has been 5 years since the 
Senate Banking Committee has conducted oversight of the OFHEO. 
This is our purpose here today. We will focus on the central 
question of the effectiveness of the OFHEO as a regulator.
    This is a very important question, for together, the 
housing GSE's hold mortgages and issue mortgage-backed 
securities that total over $2 trillion. They also have 
outstanding debt in excess of $1 trillion, much of this held by 
the U.S. commercial and savings banks. These numbers make it 
clear how important it is that there be a strong and effective 
safety and soundness regulator for Fannie Mae and Freddie Mac.
    Today, we have asked the OFHEO to submit testimony on the 
adequacy of its resources, the status of its risk-based capital 
regulations, and the safety and soundness of the housing GSE's. 
We will then ask the Chairmen of Fannie Mae and of Freddie Mac 
to testify to the effectiveness of OFHEO as a regulator, to 
discuss the financial safety and soundness of their 
institutions, and to provide an overview of the voluntary 
commitments made last year to provide greater public disclosure 
of their own risk assessments, implement a stress test system, 
increase liquidity, issue subordinate debt, and submit 
themselves to review by debt-rating agencies.
    I look forward to the testimony of our witnesses as we 
conduct oversight in this important area.
    Before I call on Mr. Falcon, I would like to recognize the 
Members of the Committee that we have here with us this 
morning. First, I would like to recognize the Ranking Member, 
Senator Reed from Rhode Island.
    I would also mention to the Committee Members, as well as 
the panel, that we have a vote scheduled at 10:15 this morning. 
My intention is to go through the first panel by 10:15 a.m., 
and then we have a series of three votes. We will return as 
soon as possible after those three votes to hear from the last 
panel, which will be Fannie Mae and Freddie Mac, if that sounds 
okay with the Members of the Committee.
    I want to recognize Senator Reed and I would ask if we can 
keep our statements relatively brief so we don't get into 
trouble with the business outline that I have put forth this 
morning.
    Senator Reed.

             OPENING COMMENTS OF SENATOR JACK REED

    Senator Reed. Thank you, Mr. Chairman. And thank you for 
holding this hearing on a very important topic. I am pleased 
that Mr. Falcon, Mr. Raines, and Mr. Brendsel will be here 
testifying this morning.
    We are in the process of a very important review of the 
Office of Federal Housing Enterprise Oversight and also of the 
two Government Sponsored Enterprises that it regulates--the 
Federal National Mortgage Association and the Federal Home Loan 
Mortgage Corporation. These are important institutions for our 
economy. They are institutions that we need to be concerned 
about in terms of both their safety and soundness and their 
interaction with the capital markets of our country.
    I hope that this hearing will provide perspective as we 
consider these important issues. I do believe these issues 
require study. This is the beginning of that study. It might 
require additional hearings and if that is appropriate, I know, 
Mr. Chairman, you would invoke such hearings.
    But I look forward to having an opportunity to begin today 
to look carefully at the operation of these institutions and to 
hear the testimony of our distinguished witnesses.
    Thank you, Mr. Chairman.
    Senator Allard. Senator Reed, we will work closely on 
follow-up after this hearing with you.
    The Senator from New Jersey.

           OPENING COMMENTS OF SENATOR JON S. CORZINE

    Senator Corzine. Thank you, Chairman Allard.
    I want to personally welcome the witnesses and thank them 
for taking the time to testify here today. I know a number of 
them personally and have a very, very high regard for them. I 
also compliment you, Senator Allard, and Senator Reed for 
holding this hearing.
    I think few would dispute that the mission of the GSE's in 
seeking to make housing more affordable and accessible is truly 
one of the important objectives and a very important one for 
our society.
    The results are terrific-- 68 percent homeownership rate in 
our country, rising African-American and Latino family 
ownership. It is really, I think, a terrific result.
    Today's hearing about this supervision and oversight by 
OFHEO I think is an important one which there has been 
questions and criticism that has arisen mainly from lengthy 
delays in getting to end results. I understand that Mr. Falcon 
inherited much of this problem. And so, I just look forward to 
hearing his comments on the credibility and performance of the 
effort.
    But I want to make very clear that my own experience with 
both Fannie Mae and Freddie Mac is that they are outstanding 
institutions performing their roles exceptionally well.
    Senator Allard. Thank you.
    The Senator from Michigan.

          OPENING COMMENTS OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Thank you, Mr. Chairman.
    Mr. Falcon, it is good to see you again and to see Mr. 
Raines out in the audience in his new and different capacity. 
It is a pleasure to see both of you here today.
    This is a very important topic, Mr. Chairman. I am pleased 
that you are holding this hearing today. This is an opportunity 
to discuss the vitally important function that Fannie Mae and 
Freddie Mac play in our housing market, and it is a chance to 
review their safety and soundness regulations.
    There is no doubt that the role Fannie Mae and Freddie Mac 
have played in creating a secondary mortgage market--
consequently promoting liquidity and mitigating risk--is key to 
much of the success in the housing market. These two 
corporations should be proud of the role that they have been 
playing in promoting homeownership.
    Although there is a strong record of achievement, much more 
needs to be done. There are still too many people for whom the 
dream of homeownership is out of reach. Good intentions are not 
enough. We must follow with concrete action, and there is 
obviously a vital role for the GSE's in achieving our common 
goal.
    One thing I would challenge the GSE's to do is to continue 
to increase their involvement in the subprime market. As the 
lending market has grown for consumers whose credit or income 
currently may prevent them from qualifying for a conventional 
loan, it has become all the more clear that we need the 
benefits of reputable actors like Fannie Mae and Freddie Mac. 
Aggressive GSE involvement in markets would surely help combat 
some of the outrageous predatory loans that are occurring in 
too many neighborhoods in Michigan, as well as around the 
country--by standardizing these loans and promoting 
competition--they would play a significant role. Indeed, 
failure to become involved in these markets could almost be 
considered counter to the GSE's mission for it would deprive 
too many working families the clear benefits that the GSE's 
bring to our housing system.
    I would submit my full testimony for the record, Mr. 
Chairman. But I am certainly pleased that you are doing the 
hearing today. I would simply add that on the issue of 
regulation of the GSE's, that I don't believe that now is the 
time to do anything that would disrupt or radically change the 
regulatory system.
    I certainly look forward to ways in which we can strengthen 
the system and work together.
    Thank you.
    Senator Allard. Thank you.
    We will proceed to the first panel. Mr. Falcon, welcome.

            OPENING STATEMENT OF ARMANDO FALCON, JR.

                            DIRECTOR

         OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

    Mr. Falcon. Thank you, Mr. Chairman.
    Chairman Allard, Ranking Member Reed, and Members of the 
Subcommittee, my name is Armando Falcon and I am the Director 
of the Office of Federal Housing Enterprise Oversight or OFHEO. 
Thank you for the opportunity to testify this morning. I 
commend the Subcommittee for conducting this oversight hearing 
on the safety and soundness of Fannie Mae and Freddie Mac.
    The OFHEO was established as an independent entity within 
the Department of Housing and Urban Development. The OFHEO was 
charged with ensuring the safety and soundness and capital 
adequacy of the Enterprises, while HUD was given the 
responsibility for regulating the Enterprises' activities--the 
so-called ``mission'' regulation.
    As the Director of OFHEO, I am pleased to report that 
Fannie Mae and Freddie Mac are currently in very good financial 
health. They are well-managed and have exceeded the minimum 
capital requirements every quarter since 1993, when the capital 
requirement was first imposed. These conclusions are based on 
the findings of our broad regulatory system, which includes a 
highly regarded examination, capital analysis, and research 
programs. While the current situation is good, I want to assure 
you that OFHEO remains vigilant. The OFHEO works every day to 
ensure that this financial strength and well-being will not be 
jeopardized by the changes in the economy, the markets in which 
the Enterprises operate, or even the Enterprises themselves.
    It may be useful to compare OFHEO's program with 
contemporary global thinking regarding large financial 
institution risk management and regulation. The Basel Committee 
on Banking Supervision is an obvious point of reference. The 
Basel Committee, which is a group of central bankers and 
international financial regulators, has endorsed ``three 
pillars'' of banking supervision. They consist of supervisory 
review, capital requirements, and market discipline. Our 
regulatory structure is consistent with those pillars.
    Specifically, OFHEO conducts comprehensive annual risk-
based examinations of both Enterprises, ensures compliance with 
minimum capital requirements and will soon impose a risk-based 
capital standard, conducts financial research on the 
Enterprises and the markets in which they operate, and has 
developed a formal regulatory infrastructure to ensure 
transparency and enforceability of its rules and regulations.
    Allow me to expand on our regulatory program.
    The 1992 Act establishing OFHEO directs the Office to 
conduct annual on-site examinations to determine the 
Enterprises' financial condition. OFHEO reports the results and 
conclusions of these annual examinations in our annual ``Report 
to Congress.'' This is unique among financial regulators and is 
a powerful tool in influencing the behavior of the companies we 
regulate. While that report is not due until June 15, I am 
pleased to tell you today that both Enterprises have met or 
exceeded safety and soundness standards in all examination 
program areas.
    OFHEO's examiners maintain a physical presence at the 
Enterprises and have unlimited access to all levels of 
management and to highly sensitive corporate records.
    Each quarter, the OFHEO examination staff updates 
conclusions relating to more than 150 separate components of 
financial safety and soundness, thereby providing me with a 
comprehensive picture of the Enterprises' financial condition. 
Our examiners identify the opportunities for improvements in 
Enterprise risk-management practices and work directly with 
management to enhance financial safety and soundness.
    Quite simply, our examination group provides me with an 
accurate and timely understanding of the Enterprises' financial 
condition and provides the Congress with an annual report card 
on how well the Enterprises are managing their risk.
    While examinations are an important part of oversight, it 
is by no means the only area in which Congress provided OFHEO 
with significant regulatory responsibility. The 1992 Act also 
directed OFHEO to establish and to enforce two major capital 
tests for the Enterprises--a minimum capital test and the risk-
based capital stress test.
    OFHEO implements and enforces a statutory minimum capital 
requirement. This requirement is a leverage-based test similar 
to the existing capital requirements for banks and thrifts. If 
the Enterprise's core capital exceeds the requirement, the 
Enterprise is considered adequately capitalized. As I stated 
earlier, both Enterprises continue to exceed their minimum 
capital requirement.
    The 1992 Act also called for a second capital test to be 
applied to both Enterprises--a sophisticated risk-based capital 
requirement using a stress test. The stress test simulates 
dramatic changes in interest rates and the highest historical 
declines in property values to determine capital requirements.
    This approach is consistent with the Basel proposal, which 
is designed to increase the risk-sensitivity of capital 
requirements. Our risk-based capital regulation will more 
accurately tie capital to risk than any other current or 
proposed standard.
    I recognize that OFHEO is overdue on this rule. So when I 
took office in October 1999, I made finalizing the rule my top 
priority. Last fall, we finished the rule. And I took the extra 
step of having the stress test independently tested and 
verified by an accounting firm. In addition, we continue to 
assist Fannie Mae and Freddie Mac in meeting their 
responsibility to process a vast amount of data in the form 
needed to run the stress test.
    Early last month, we formally submitted the rule to the 
Office of Management and Budget for review. Once the rule is 
cleared by OMB and the rule is published in the Federal 
Register, Fannie Mae and Freddie Mac will be subject to the 
most sophisticated regulatory capital standard of any financial 
institution in the world.
    As with all financial regulators, research is an area of 
great importance to the OFHEO's ability to fulfill its mission. 
Upon taking office, I set out to ensure that the Office had 
sufficient research capacity to provide me with an independent 
analysis of regulatory issues.
    Our independent research is critical to the fulfillment of 
our core mission. We must fully understand the industry, the 
marketplace in which the Enterprises operate, and the stresses 
of economic events on the Enterprises.
    Finally, OFHEO is undertaking a regulatory infrastructure 
project designed to fully implement the statutory mandates of 
OFHEO, to provide greater certainty for the regulated entities, 
and to produce greater transparency for the public in 
understanding OFHEO's administration of its responsibilities.
    To date, this project has resulted in the issuance of 
policy guidances on minimum safety and soundness requirements 
and the management of the Enterprises' nonmortgage liquidity 
investments, as well as final regulations on enforcement 
procedures and the OFHEO's annual funding assessments. Still 
pending are rules dealing with prompt supervisory response and 
corrective action, executive compensation, and updating the 
Enterprises' minimum capital requirements.
    In conclusion, OFHEO is aggressively fulfilling its 
Congressional mandate. The Enterprises are subject to an 
ongoing oversight through our examination program, must meet 
quarterly minimum capital requirements, will soon be subject to 
a state-of-the-art risk-based capital stress test, and can be 
held accountable through our enforcement powers if found 
lacking in any of these areas. I assure you, Mr. Chairman and 
Members of this Committee, that OFHEO will remain vigilant in 
continuing to fulfill its mission.
    Let me again thank Chairman Allard, Ranking Member Reed, 
and the other Members of the Subcommittee for the opportunity 
to be here and testify on this important issue.
    Senator Allard. Thank you, Mr. Falcon.
    In 1996, the Senate Banking Committee held a similar 
hearing to that which we are having here today. At that time, 
there was much discussion about OFHEO's progress in the 
development of risk-based capital stress test for Fannie Mae 
and Freddie Mac.
    Your predecessor, who was the first director of OFHEO, 
stated that a final stress test was expected to be completed by 
the end of 1996. Here we are, 5 years later, and still, we do 
not have those before us. What happened? How is it possible 
that it has been 5 years later than what was anticipated? How 
long have the proposed regulations been at OMB?
    Mr. Falcon. Mr. Chairman, the agency, OFHEO, has not met 
Congresses' expectations with respect to the timetable for 
finishing this rule. I agree with you that that is 
unacceptable. That is why I made it my first priority when I 
came to OFHEO to get the rule completed.
    The rule is the first of its kind. It will be a state-of-
the-art, risk-based capital regulation which more accurately 
ties capital to risk than any other proposal which is out 
there.
    Now, I would like to say that I don't like to make excuses 
for the fact that the agency has had this lapse. It is more 
important just to get the job done. And we have gotten the job 
done. We are just working closely with OMB to make sure that 
they understand the rule and so that they can clear it with 
confidence.
    The agency started from scratch. It had administrative 
issues that had to be dealt with. The agency did not have any 
other model to work off of. This is the first time any 
regulatory agency has had to devise a risk-based capital stress 
test.
    So it was not a task that could be done realistically in 
the 18 months that was laid out in the statute. But then, 
again, I agree with you that it should not have taken this 
long. However, we have gotten it done now, Mr. Chairman, and I 
look forward to OMB clearing it soon so that we can put it in 
place.
    Senator Allard. How long has it been at OMB?
    Mr. Falcon. It has been at OMB since--I think March 29th is 
the date when we officially sent it over to OMB, Mr. Chairman.
    Senator Allard. And apparently, we are expecting some kind 
of a report back from OMB here shortly?
    Mr. Falcon. OMB will just convey to us when they have 
cleared the rule and then we will be authorized to publish it 
in the Federal Register as a final rule. I don't know whether 
or not they will be submitting to Congress any formal report 
with respect to the rule.
    Senator Allard. After you get that, then that is going to 
go through administrative procedures. There will be public 
comment and what not. Is that right?
    Mr. Falcon. I think that there will be a 60-day 
Congressional review period.
    We concluded the comment period and what is in the process 
here is getting the final rule cleared. But we have gone 
through several rounds of public comment on this rule.
    Senator Allard. When is your best guess as to when this 
rule will become fully effective?
    Mr. Falcon. I expect this summer that the rule will be 
published as a final rule. The statute, the 1992 Act, which 
required this rule, states that there is a one-year delay. It 
is effective upon publication, but there is a one-year delay 
before OFHEO can enforce the risk-based capital standard. That 
was done in order to give the Enterprises a chance to 
transition into the rule during that one-year period.
    Senator Allard. I would like to take a moment to compare 
the OFHEO's resources to those of other regulators.
    OFHEO has approximately one hundred employees and a budget 
of $20 million. By comparison, the Comptroller of the Currency 
has nearly 3,000 employees to oversee bank assets. Obviously, 
the Comptroller has many more institutions to regulate, but a 
recent article in The American Banker estimated that the 
Comptroller of the Currency would assess fees of $71 million to 
cover the cost of regulating Fannie Mae and Freddie Mac.
    Mr. Falcon, does the OFHEO need more resources? Do you have 
sufficient personnel and resources to do the job?
    Mr. Falcon. Thank you for asking the question, Mr. 
Chairman.
    I think it is important that OFHEO have adequate resources 
to conduct its oversight responsibilities. There are two points 
that I would like to make here.
    The first point is that we have requested additional 
resources and in fact, this year, the President's budget gave 
OFHEO a 23 percent increase in its budget. That will be a very 
useful increase in our budget. And for the last 3 years, 
Congress has given us an increase in our budget. I think it is 
important that we continue to receive increases in our budget 
so that we can continue to oversee the Enterprises with 
adequate debt.
    The lack of more resources at this point has not hindered 
OFHEO's ability to do its job. We leverage technology in a very 
experienced and talented staff in order to oversee the 
Enterprises. So it is important that the trend continue as far 
as OFHEO obtaining resources. We have to manage our growth 
properly, so we could not just double overnight in size. But 
the trend has been positive.
    The second point, if I could make it, is I think it is 
important that OFHEO also have the flexibility to set its 
resource needs on a real-time basis.
    Right now, OFHEO is the only safety and soundness regulator 
which is subject to the appropriations process. I have asked 
before that OFHEO be removed from the appropriations process so 
that we have the flexibility, should the need ever arise, to 
increase our resources. If we ever needed to hire additional 
examiners in response to any changes that the Enterprises, I 
would have to wait until the next appropriations cycle to do 
that.
    I think, like all safety and soundness regulators, OFHEO 
needs to have the flexibility to adapt its budget needs to the 
situation that it faces on a quick basis.
    Senator Allard. Just as a quick follow-up on that--with the 
tolerance of the Committee, I would like to step over my 
allotted time a bit with this follow-up question.
    Some have proposed a new safety and soundness regulator for 
Fannie Mae and Freddie Mac and have even suggested the Treasury 
Department or the Federal Reserve Board or some new entity. In 
the alternative, what changes would you recommend to strengthen 
OFHEO as a regulator? You have partially answered that 
question, but I wanted to get a specific answer from you. Then 
I will yield to the other Members.
    Mr. Falcon. Thank you, Mr. Chairman.
    Let me say, first of all, that OFHEO is an effective and 
strong regulator with or without any changes to its statutory 
regime. However, like any other regulator, there are always 
modifications that can be made to enhance our authorities. I 
mentioned the appropriations issue. I think that is a very 
appropriate one.
    In addition, there are things that could be done to our 
statute to enhance our independence, such as independent 
litigating authority, as well as other modifications to our 
statute to clarify our safety and soundness powers, including 
our enforcement powers.
    Last year, I submitted to the House Banking Committee a 
package of proposed modifications. I think those modifications 
would enhance OFHEO's ability to fully do its job. But the lack 
of those changes has not hindered us from doing our job, Mr. 
Chairman.
    Senator Allard. Thank you.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman. Thank you, 
Mr. Falcon.
    Let me follow up on your testimony where you make reference 
to the Basel guidelines.
    For most banking institutions, they develop their own 
internal risk-based capital model, subject to supervision by 
their regulatory authorities. But you have developed your own 
regulatory models outside of Freddie Mac and Fannie Mae. Can 
you comment about that approach? Does that give you more 
confidence? Why did you take that direction?
    Mr. Falcon. Thank you, Senator.
    I think as a matter of law and as a matter of public 
policy, we have taken the right approach with respect to the 
risk-based capital requirement. I think the 1992 Act requires 
that we implement the risk-based capital requirement with 
respect to the Enterprises. So if there were to be another 
approach taken, that would require a change in the 1992 
statute.
    Second, as a matter of policy, I think if OFHEO did not 
implement the risk-based capital requirement, you would very 
likely have two different capital requirements for each 
Enterprise.
    There are hundreds of little decisions which, individually 
and cumulatively, could have a major impact on the capital 
requirement of the Enterprises. The statute only identifies a 
handful of those parameters. And so, the way those hundreds of 
other issues are resolved could have a huge impact on the 
capital requirement.
    In order for there to be one capital standard that applies 
to both Enterprises, it is important that OFHEO be the entity 
that decides how those issues get resolved and ensures that 
they apply equally to both Enterprises.
    Although the Basel Accord leans toward some internal models 
approach, I think that is in recognition of the reality of the 
situation banking regulators face. They regulate hundreds and 
thousands of individual banks. It is not quite practical to 
devise one stress test that could apply to hundreds and 
thousands of different banks with different types of 
portfolios.
    Here we regulate two entities and they are virtually 
homogenous in nature. So, we are able to implement one stress 
test for both of the entities that we regulate.
    Senator Reed. Let me just follow up. There are two, among 
many, but two critical items in terms of safety and soundness. 
First is the capital adequacy levels; and the second, as you 
just mentioned, is the stress test.
    With respect to the capital adequacy levels, Mr. Raines and 
Mr. Brendsel will testify later this morning about the very low 
losses that they have experienced in the last several years. 
And yet, there is a statutory requirement for a much higher 
multiple in terms of the capital reserve.
    My first question, do you think that that statutory level 
is adequate? Too high? Should it be reconsidered or relooked 
at?
    My second question, with respect to the stress test, you 
have taken a regional meltdown, more or less, and applied it 
nationally as your stress test. Is that, in your view, a valid 
approach? Can you comment on those two things, Mr. Falcon?
    Mr. Falcon. Yes, Senator. The statute required that we take 
the worst regional historic loss experience and apply it to the 
entire portfolio of the Enterprises.
    Now that is a very stressful economic condition for the 
Enterprises to have to survive. But I think Congress made the 
correct judgment in 1992 that, having come out of the savings 
and loan crisis, Congress wanted to be sure that there was an 
appropriately conservative stress test that applied to the 
Enterprises. And this stress test is a very conservative stress 
test.
    You referenced a couple of other items in the 1992 Act.
    I think, on balance, what we have done is sufficiently 
stressful for the Enterprises. And when you look at the capital 
requirements as part of a broader package of what we do, I 
think we have a very strong conservative regulatory regime with 
respect to the Enterprises. It consists not just of risk-based 
capital, but also of our examination program. It consists of 
our research agenda. It consists of our regulatory 
infrastructure and our constant analysis of their capital and 
their balance sheets.
    So, I think, as a whole, we do have a very strong 
regulatory program and the judgments that Congress made in the 
1992 Act are appropriate.
    Senator Reed. Obviously, from your testimony, you do 
believe you have very strict and stringent rules for safety and 
soundness. Do you feel you have adequate staff ? And 
particularly with respect to being able to timely review the 
institutions.
    One of the problems--you might have great standards but if 
there is an inability to process information on a real-time 
basis nowadays, you could find yourself suddenly going from a 
very good situation to a very bad situation.
    So assuming, as you say, that you have good standards, do 
you have the resources to, in a timely way, review the 
institutions?
    Mr. Falcon. I would like additional resources, Senator. 
That is why it is important that the President's budget, which 
gives us a 22 percent increase, does get adopted by the 
Congress. And I think it is very important that the trend 
continue in the following years.
    We want to grow, but we need to manage our growth 
prudently. But it would be important for us to make sure that 
we continue to increase the resources so that we can always 
oversee the Enterprises with adequate depth.
    Senator Reed. Thank you.
    Senator Allard. Thank you.
    Senator Corzine.
    Senator Corzine. Mr. Falcon, how do you stay current with 
such a complex risk-based system? I know we just got out a 
rule, but new instruments are invented. Different elements of 
them. How do you keep this system that your risk-based 
assessment, current with the changing conditions and those 
multiple variables that you are talking about?
    One of my fears is that these things are static and not 
attendant to changing risks that can occur through time.
    Mr. Falcon. Senator, the risk-based capital rule has a 
provision for new activities and new products at the 
Enterprises. The rule gives us the flexibility to incorporate 
new activities into the risk-based capital stress test.
    I agree with you--if the stress test did not accommodate 
new activities and new products, it would be obsolete the 
moment that it became published. So it was very important to us 
to make sure that it was flexible. At the same time, we have to 
balance that with the need that the Enterprises have to have 
predictability in their capital requirement.
    So when a new activity or product comes on line, even well 
before it comes on line, we will be working with the 
Enterprises to ensure that we understand the nature of the 
product, the nature of the risk involved, how they manage those 
risks, and we will decide what the potential risks are and what 
the capital requirements should be.
    If we need additional time to understand the product and 
the risks involved, we will impose a temporary capital 
requirement on the activity until we can do the research 
necessary to decide what the appropriate capital treatment is 
for the activity.
    Senator Corzine. Have you had some examples of that having 
occurred as you were building this model in your 18 months?
    Mr. Falcon. The proposed rule looked at the balance sheets 
of the Enterprises as of the second quarter of 1997. And since 
that time, there are additional products that have come on 
line, certainly, one of which is Swaptions, which was not on 
the balance sheet at that time. We have had to look at that 
derivative in order to make sure that we incorporate it 
properly into the stress test when it becomes final.
    Senator Corzine. Okay. Now, you said that there are about a 
hundred people, I think, on staff. How many of those people are 
market professionals? How many research, quantitative types? 
Rocket scientists, if you would? How does your staff break out?
    Mr. Falcon. I think because OFHEO started in 1993 from 
scratch, OFHEO did not have the luxury of hiring junior-level 
people and then training them in what we need to do. We hired 
very experienced people from other regulatory bodies. We hired 
people with experience on Wall Street. Our examiner corps has a 
great deal of experience. About 65 percent are examiners and 
come from other regulatory agencies and have a great deal of 
experience in examining institutions, large complex financial 
institutions. I think the average length of experience for 
examiners was about, when they came on board, 12 or 13 years. 
In addition, in order to build this stress test, we hired a 
great deal of people from Wall Street.
    Senator Corzine. That is dangerous, by the way.
    [Laughter.]
    Mr. Falcon. They came with a great deal of experience in 
writing sophisticated financial simulation models to process 
cash flows for various products.
    Senator Corzine. So, these people had worked with the kind 
of instruments that you are now assessing the risks of.
    Mr. Falcon. Absolutely, Senator.
    Senator Corzine. Who's the accounting firm?
    Mr. Falcon. Deloitte & Touche.
    Senator Corzine. They have a specialized practice in 
mortgage-backed securities?
    Mr. Falcon. Yes, Senator.
    Senator Corzine. One final question. The debt of the GSE's 
is growing fairly significantly and there are some that are 
critical and others think it is the right strategy to expand 
housing opportunities. Are you at all concerned about the 
growing element of debt on the balance sheet of the GSE's? And 
how do you assess that?
    Mr. Falcon. As the safety and soundness regulator, we look 
at this question from the standpoint of can they manage that 
growth prudently? We focus on whether or not that growth poses 
a safety and soundness concern to us. As of today, we are 
comfortable that they do very prudently manage the risks 
associated with their growth. And so, we have not taken any 
steps as the safety and soundness regulator to do anything with 
respect to their growth.
    Now, I understand that their growth raises other issues. 
And there are other concerns about whether or not it is growing 
too fast and too large.
    We have undertaken a study of the systemic risks that may 
or may not be posed by the Enterprises and we expect to finish 
that by the end of the year. So while we focus on the safety 
and soundness of the Enterprises, we also are cognizant of the 
bigger picture issues that arise with respect to the 
Enterprises.
    Senator Corzine. Mr. Chairman, may I ask one follow-up?
    Senator Allard. You may.
    Senator Corzine. How would you distinguish the difference 
between systemic, which I understand the definite of, and the 
safety and soundness considerations as you look at the balance 
sheet?
    Mr. Falcon. Safety and soundness goes to whether or not 
they can manage the risk inherent in the growth. Systemic risk 
concerns involve what kind of disruptions to the broader 
financial markets might occur if there were financial problems 
at the Enterprises? Or do financial problems external to the 
Enterprises, can the Enterprises manage any collateral effects 
from those shocks? I think that is the easiest way that I can 
think of to distinguish between the two.
    Senator Corzine. Thank you, Mr. Chairman.
    Senator Allard. Thank you.
    I have a brief question. Then if any of the Members have 
any more questions, I think we can get through this easy 
enough. I want to go to a question on derivatives.
    In the last decade or so, some of the strategies in how 
Fannie Mae and Freddie Mac manage their secondary market 
securities has changed, and it involves the use of derivatives. 
What is the amount of derivatives held by the two companies?
    Mr. Falcon. I don't know that figure off the top of my 
head, Mr. Chairman. I can get it for you.
    Senator Allard. Okay. The Committee would be interested in 
having that figure, if you would provide that to the us.
    How does the OFHEO regulate the derivatives activities of 
the GSE's? And what risks might be imposed by those 
derivatives?
    I realize that when we get into derivatives it is a very 
specialized area. It is something that takes a pretty well-
trained individual to work with. So, I am anxious to hear how 
you regulate the derivative activities of GSE's and those 
risks.
    Mr. Falcon. Let me state that the Enterprises use 
derivatives in order to manage the risk. They use them in a 
positive way. They did not use derivatives for speculative 
purposes. In fact----
    Senator Allard. For what purposes?
    Mr. Falcon. They don't use them for speculative purposes.
    Senator Allard. Speculative. Okay, yes.
    Mr. Falcon. They use them for hedging. They are a very 
important part of the Enterprises' method of mitigating the 
interest rate risk that they face.
    So, we look to make sure that they always use them as a 
hedging device and that they are very useful in managing 
interest rate risks by adding call features to noncallable 
debt, for instance.
    Senator Allard. I think that is a very important point 
because hedging is used by many sound enterprises, in the 
private sector, particularly, and banks. When properly managed, 
it is a necessary management system. But if they get into the 
speculative area, then that is when I think this Committee gets 
particularly concerned. I am glad to hear your response in that 
regard.
    Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    First, let me say that Senator Sarbanes very much wanted to 
be here for your testimony, Mr. Falcon. He was delayed in 
Baltimore. He will be here later for the second round.
    Let me ask one additional question. One of the human 
aspects of regulation, particularly with a small organization 
and two regulated entities, is the potential for relationships 
to develop between the regulator and the regulated entities 
that get to be so routine and so comfortable, that you don't 
challenge assumptions and you don't sometimes realize when the 
train is going slightly off the track. How do you, in your role 
as the leader of this organization, guard against that kind of 
natural inertia or natural tendency to identify?
    Mr. Falcon. Thank you for the question, Senator. I think it 
is a very appropriate question.
    I think OFHEO, like any other regulator, has to have a good 
working relationship with the entities that it regulates. On 
the other hand, we are very guarded about not allowing any kind 
of relationship to develop where we cannot take an objective 
approach to any issue. In fact, I think that has to start from 
the top down within the organization. And I think OFHEO has a 
culture within it that wants to have a good relationship, but 
at the same time, has an arm's-length relationship with the 
Enterprises.
    I tell everyone within OFHEO to just always do the right 
thing. Do what is the best public policy. I think that is 
something that I did not just bring to the agency, it was 
always there. And if we do the right thing, I think we can 
always defend ourselves in any forum. We do have a good 
relationship with the Enterprises, a good working relationship. 
Our examiners are in there day in and day out. They rotate 
among different offices, so they don't always get too 
comfortable in one particular area. We do maintain a healthy 
arm's-length relationship with the Enterprises, but one which 
is a good working relationship.
    Senator Reed. Thank you.
    Senator Allard. Senator Corzine.
    Senator Corzine. I am fine, Mr. Chairman.
    Senator Allard. Okay. We are right on schedule. We are not 
sure just exactly when that vote is supposed to come up. Maybe 
as soon as 3 minutes.
    Mr. Falcon, I want to thank you for your testimony. I think 
it is very helpful for the Committee. I want to thank the 
Committee Members. I think we will just go ahead and proceed 
with the next panel. If the bell rings for the vote, then we 
will stop at that point and go vote.
    Thank you, Mr. Falcon.
    We will go ahead and bring up the second panel.
    [Pause.]
    We just started the vote. I cannot believe it is working 
out this smoothly this morning.
    [Laughter.]
    It usually doesn't work that way. I think we will go down 
and vote, get back as quickly as we possibly can after these 
series of votes, and then we will hear from the panel.
    [Recess.]
    Senator Allard. I call the hearing back to order.
    I want to apologize to everybody for the delay in the 
Committee hearing. We were trying to get votes out of the way 
on the floor of the Senate.
    It gives me pleasure to welcome our next guests on panel 
two: Mr. Franklin D. Raines, Chairman and CEO of Fannie Mae; 
and Mr. Leland C. Brendsel, Chairman and CEO of Freddie Mac.
    I know you are both very busy and I appreciate your taking 
the time to show up before our Committee.
    I think we will start with you, Mr. Raines.

            OPENING STATEMENT OF FRANKLIN D. RAINES

              CHAIRMAN AND CHIEF EXECUTIVE OFFICER

                           FANNIE MAE

    Mr. Raines. Thank you, Mr. Chairman. I am delighted to be 
here. We appreciate the opportunity to appear before the 
Subcommittee and appreciate the oversight that the Subcommittee 
is providing in this area.
    This hearing is happening at a propitious time for housing 
in America, a time that demonstrates the stunning success of 
the U.S. housing finance system.
    More Americans own their homes than ever before. Home sales 
in the first quarter of this year set a new all-time record. 
Housing starts and home values are robust. And the mortgage 
debt outstanding is growing at a healthy rate of 9 percent per 
year. This year, mortgage originations are expected to reach an 
all-time high of over $1.5 trillion.
    Millions of homeowners are taking advantage of lower 
interest rates to refinance their homes and save hundreds of 
dollars a month. We estimate that mortgage refinancings this 
year will put $40 billion in the pockets of consumers. The 
process of financing a home on affordable terms has never been 
faster, simpler, or more available to more families in more 
communities.
    Quite simply, the U.S. housing finance system is the best 
in history and certainly the best in the world.
    We all know that homeownership strengthens families, 
communities, and the Nation as a whole. But it also strengthens 
the economy. A generation ago, when the economy declined, so 
did housing. Today, the strength of the housing sector and the 
success of the housing finance system is helping to keep the 
entire economy on a steady course. A great deal of credit for 
this goes to the Congress and the work of this Subcommittee for 
its stewardship of the U.S. housing finance system. In my 
experience, support for housing has always been strong, deep, 
and bipartisan.
    When I first came to Fannie Mae in 1991, after 11 years on 
Wall Street, we had a Republican Administration and a 
Democratic Congress. When I left Fannie Mae to serve as Budget 
Director, we had a Democratic Administration and a Republican 
Congress. Today, we have a Republican President and the 
political margin in the Congress is the closest in recent 
history. But what continues to unite this Capitol city is what 
unites our country, and that is a belief in the American dream. 
And Fannie Mae's mission is to extend the American dream to 
more Americans.
    Mr. Chairman, I have submitted written testimony for the 
record which describes how we do that and I would like just to 
summarize that testimony this morning.
    Fannie Mae began as a Federal agency in 1938. In 1968, the 
Congress chartered Fannie Mae as a private company. In 1992, 
the Congress strengthened our housing mission and our financial 
oversight.
    Last year, Fannie Mae and Freddie Mac announced a series of 
voluntary initiatives to further bolster our liquidity, capital 
and market discipline, making our companies a new global model 
for financial institution safety and soundness.
    Today, Fannie Mae is a successful Fortune 50 financial 
services company with a billion shares trading on the New York 
Stock Exchange. Fannie Mae is one of the highest credit-rated 
financial institutions in the country for the strength of our 
business and risk management.
    Indeed, one way to understand Fannie Mae is to compare us 
with other major financial companies in America of similar 
asset size. Like major national banks, for example, Fannie Mae 
operates under a Federal charter that provides for certain 
benefits, obligations, and limitations.
    Unlike banks, Fannie Mae does not offer credit cards, 
commercial lending, insurance, investment banking, or consumer 
services. We focus strictly on funding mortgages that lenders 
originate with homebuying consumers.
    Fannie Mae is a private company, but we do have a compact 
with the Government. We use the benefits of our charter to make 
sure that consumer-friendly mortgages are available every day 
in every part of our country under all economic conditions at 
the lowest rates in the market.
    With our charter also comes obligations, especially in the 
area of affordable housing. We meet and exceed the toughest 
affordable housing goals in the industry. In fact, Fannie Mae 
is now the Nation's largest source of mortgage funds for 
underserved families, including minorities and lower income 
families.
    We achieve our mission by operating two businesses, using 
100 percent private capital without a penny of public funding.
    First, we operate a mortgage credit guarantee business. To 
replenish their capital to lend, mortgage lenders bring loans 
to Fannie Mae, swap them for mortgage-backed securities, and 
then the lenders sell these into the market. Fannie Mae 
guarantees the creditworthiness of the loans behind these 
securities, and for that we receive a guarantee fee. But the 
mortgage-lender controls and benefits from the sale of the 
mortgage-backed securities.
    Second, we operate a mortgage portfolio business. Fannie 
Mae buys mortgages and mortgage-backed securities from the 
market and then manages the interest rate risk in our 
portfolio. Fannie Mae's portfolio is almost entirely made up of 
mortgage assets, including hold loans and mortgage-backed 
securities. To purchase mortgages and mortgage-backed 
securities for our portfolio, Fannie Mae sells debt securities 
to investors on Wall Street and around the world.
    Let me highlight three points about our businesses.
    First, Fannie Mae's expertise is managing the credit risk 
and the interest-rate risk on mortgages, particularly long-
term, fixed-rate mortgages. That is our special role in housing 
finance. We mitigate and disburse mortgage risk by sharing it 
with mortgage insurance companies, lenders, and investors. And 
thus, our credit losses are at historic lows, the lowest in our 
industry, and we are regarded among the best interest-rate risk 
managers in the world.
    The second point to understand about our businesses is by 
helping lenders create mortgage-backed securities to sell, and 
by selling our own debt securities, Fannie Mae gives investors 
two additional attractive options for investing in housing.
    If they don't want the credit risk of mortgages, they can 
buy our mortgage-backed securities. If they don't want the 
interest rate risk on mortgage-backed securities, they can 
invest in Fannie Mae's debt securities. Either way, additional 
investment comes into housing, lower costs for consumers.
    The third point to understand about our business is that 
Fannie Mae specializes in one particular kind of mortgage--the 
long-term, fixed-rate loan, with an embedded option to 
refinance. By financing these loans in large volume, we have 
created a large, vibrant, and robust market for them. That is, 
in fact, the reason that Fannie Mae was created in 1938--to 
ensure the nationwide availability of the self-amortizing, 
long-term, fixed-rate mortgage, which was then a very bold and 
new instrument.
    Sixty-three years later, Fannie Mae is still doing the very 
same thing. The long-term, fixed-rate mortgage is still Fannie 
Mae's bread and butter. It is 95 percent of the single-family 
mortgages that we finance.
    The main thing that has changed in 63 years is that we now 
use private business practices, international capital markets, 
information technology, and billions of dollars of private 
capital to create a more efficient market for these essential 
mortgages.
    It is no wonder that 75 percent of homeowners choose this 
kind of mortgage. Americans take it for granted that they can 
get a 30-year, fixed-rate mortgage. But outside of America, you 
can rarely obtain such a mortgage.
    A few weeks ago I was in Europe, meeting with a group of 
investors in equity in our debt. And at one of these meetings, 
I asked a group of young analysts--how many of you have 30-
year, fixed-rate mortgages? Now most of them in that room owned 
homes, but none of them raised their hand. None of them had a 
30-year, fixed-rate mortgage available to them.
    In most of the world, the mortgages that are available are 
adjustable-rate mortgages and balloon mortgages. With down 
payments of from 20 to 40 percent. In order to refinance, you 
have to pay a stiff refinance prepayment penalty. It is simply 
harder to get a mortgage.
    In the United States, you can get a 30-year, fixed-rate 
mortgage, down payments as low as 3 percent, with an option to 
refinance any time that rates fall. You can see the benefit 
that we provide every week in your newspaper. This week, our 
loans that we buy are up to $21,000 cheaper over the 30-year 
life of the mortgage than a jumbo mortgage.
    To sum up, Mr. Chairman, two questions capture how Fannie 
Mae's business carries out our compact with the Government. Are 
long-term, fixed-rate mortgages available every day in all 
communities? Do the ones we finance have the lowest rate in the 
market?
    The answer to both these questions is demonstrably yes. 
Fannie Mae brings over $21 billion of private equity capital to 
the housing market and the results have been spectacular. We 
have the best housing finance system in the world. Mortgages 
consumers prefer are widely available. And mortgages cost less.
    Mr. Chairman, I am delighted for the opportunity to be able 
to testify before the Committee. We are delighted that we have 
been able to be a participant in this growing and effective 
housing finance system. And we are certain that, as we move 
forward, particularly with items such as our $2 trillion 
American Dream commitment to assist an additional $18 million 
underserved Americans become homeowners, that we will continue 
to have the kind of success that we have had over the previous 
decades.
    Thank you.
    Senator Allard. Mr. Brendsel.

            OPENING STATEMENT OF LELAND C. BRENDSEL

              CHAIRMAN AND CHIEF EXECUTIVE OFFICER

                          FREDDIE MAC

    Mr. Brendsel. Thank you, Mr. Chairman.
    Good morning, Chairman Allard, Senator Sarbanes. It is a 
pleasure to be here. I am Chairman and Chief Executive Officer 
of Freddie Mac. I certainly appreciate the opportunity to 
appear here this morning, along with Frank Raines of Fannie 
Mae, to, in my case, talk about Freddie Mac's financial 
strength and how it enables us to bring real benefits to 
America's families.
    Freddie Mac is among the strongest, best capitalized, and 
most transparent financial institutions in the world. We are 
fiercely committed to maintaining the confidence of Congress, 
of investors, and of the public in our financial strength. 
There can be no doubt that Freddie Mac will meet our vital 
mission for generations to come, which depends on that 
financial strength.
    Freddie Mac is a Congressional success story. We are at the 
heart of the best housing finance system in the world. Today, I 
think the mortgage market in many ways works so well, that we 
take it for granted. Let me summarize some of the key benefits 
that we bring.
    First, there is never a shortage of mortgage money to 
finance America's homes. That is because Freddie Mac has 
developed high quality securities that attract global investors 
throughout the world. As a result, when other markets are 
rocked by turmoil, there is no disruption in the mortgage 
market that we serve.
    Second, as Chairman Raines has discussed, America's 
homebuyers enjoy the lowest possible mortgage rates. In the 
real estate section of the newspaper, two rates are always 
listed--the low rate for the loans that Freddie Mac buys, and 
the higher rate for the jumbo loans that we cannot buy. 
Consumers save real money--currently up to $23 billion a year, 
according to former OMB Director Jim Miller.
    Third, in the market we serve, America's families choose 
from a broad array of mortgage products. These include the 30-
year, fixed-rate mortgage with a low down payment, which is 
simply not available in most other countries. In addition, even 
in the jumbo market in the United States, it is far less 
available.
    Fourth, Freddie Mac is at the forefront of innovation. Our 
technology and our underwriting systems enable lenders to make 
fast, fair, and accurate decisions to serve the growing 
diversity of America's homebuyers. Our innovations enable even 
the smallest lenders, and the newest ones, to compete and to 
substantially reduce costs to consumers.
    Fifth, Freddie Mac protects consumers from predatory 
lending. The sad stories about abusive lending practices do not 
come from our segment of the market. We buy loans from 
reputable lenders and we standardize lending and servicing 
practices. In addition, we foster competition so that consumers 
have more choices among reputable lenders. Our goal is to drive 
responsible lending throughout the mortgage market.
    Sixth, Freddie Mac brings strength to housing and the 
economy. In a downturn, Freddie Mac transmits lower interest 
rates to the mortgage market. Refinancing puts real money in 
borrowers' pockets. Plus, the boost to housing is often just 
the spark that the economy needs. Certainly, low mortgage rates 
have made housing one of the bright spots on today's economic 
horizon.
    Seventh, by financing homes for millions of families, 
Freddie Mac has helped the Nation reach the highest 
homeownership rate ever.
    In sum, Freddie Mac brings tremendous benefits to the 
Nation. These benefits are tangible and they are significant. 
They far outweigh any value that we derive from our 
Congressional charter. America's homebuyers can depend on 
Freddie Mac continuing to meet our vital mission because we are 
safe, sound, and strong.
    We are in a single line of business that is inherently 
safe--the mortgages on people's homes. Our risk management is 
disciplined, skilled, and second to none. And we hold enough 
capital to withstand a severe economic recession that would 
last for 10 years.
    Now Standard & Poor's recently provided an independent view 
of Freddie Mac's financial strength. They gave us a risk-to-
the-government rating of AA-. To put this in perspective, only 
five bank holding companies have a rating this high on their 
senior debt, and none has a higher rating.
    Freddie Mac operates under the continuous oversight of 
Congress and our regulators--both the Office of Federal Housing 
Enterprise Oversight and the Department of Housing and Urban 
Development. We also operate under the constant scrutiny of the 
marketplace. Freddie Mac discloses comprehensive information 
about our exposure to risk--and our effectiveness in managing 
it.
    This high degree of transparency subjects us to the rigor 
of market discipline every minute of every day. Freddie Mac has 
long been at the vanguard of world practices in risk and 
capital management and information disclosure.
    Last October, we raised the bar with six voluntary actions 
or commitments. Fannie Mae joined us in making them. As a 
result, we will provide more information to the marketplace, to 
investors than any other financial institution in the world. We 
implemented all six commitments in just 6 months. The details 
about each are provided in my written statement.
    In developing these commitments, we sought out the best 
thinking of international regulatory experts, particularly the 
Basel Committee on Banking Supervision. I believe our six 
commitments are a model for all financial institutions. In 
fact, Moody's called them ``new standards . . . for the global 
financial market.'' They added, and I quote: ``The leadership 
shown by Fannie Mae and Freddie Mac could prove difficult for 
other firms to ignore and could usher in a wave of enhanced 
financial risk disclosure.''
    The importance of all of this is the future. Over the next 
decade, America's families will need an additional $6 trillion 
to finance their homes. There are many doors to homeownership 
to open for families that do not have that opportunity today. 
Freddie Mac's strength and vitality will enable us to open 
those doors to the homebuyers of the future.
    Mr. Chairman, Members of the Subcommittee, I look forward 
to working with you to secure the future of America's housing 
finance system and, with it, the dreams of millions of 
families.
    Thank you very much.
    Senator Allard. Thank you. I want to start off with a 
question that is directed to both of you.
    We have had an opportunity for the regulator, OFHEO, to 
comment about you. I want to give you an opportunity to comment 
about OFHEO. I would like to hear how you rate OFHEO. Do you 
believe that they have adequate resources to do the job?
    Mr. Raines. Well, Mr. Chairman----
    Senator Sarbanes. In case you were not here, they said nice 
things about you.
    [Laughter.]
    Mr. Raines. I have some nice things to say about them as 
well.
    It is always treacherous for the regulatee to be rating 
your regulator. But I think there are a couple of things that I 
can say that might be of use to the Committee.
    First, I think that OFHEO, from its beginning, when it 
first organized, put a great emphasis on its supervision role, 
which most safety and soundness regulators do. In fact, with 
most of them, all you really hear about, is their bank 
examination and supervision role. They hired very experienced 
examiners. We currently have 13 examiners dedicated full time 
to Fannie Mae alone. To put that into perspective, that is the 
same number of examiners that are dedicated to CitiCorp by 
their bank examiners, to cover a company that operates in 100 
different countries. We operate in one country, and one asset, 
and all of our records are in one place.
    So it is a larger amount of effort they put in and we think 
that they do a very professional job. I think it can stand up 
to scrutiny against any other regulator.
    With regard to their implementation of the minimum capital 
standards, again, they have been quite efficient and effective 
in doing that. I think the market has been very appreciative of 
their timely assessment of our meeting our minimum capital 
standards.
    With regard to the risk-based capital standard, as the 
Committee Members have noted, it has taken too long. It has 
taken too long and it has not been of benefit, either to OFHEO 
or to the two companies. It would be better for us to have the 
standard in place and operating because we think it is a world-
class approach to managing interest rate and credit risk in an 
Enterprise.
    We wish it had taken less time. If we had any suggestions 
for how to speed it up, it's to more actively engage with the 
companies. We think we can be helpful in that process. But when 
it is done, when there is an effective standard in place, it 
will be world-class. It is a standard that we would be eager to 
have other financial institutions subject to. And I think it is 
one that should give great comfort to the Congress because it 
does require us to hold capital against one of the most 
unlikely scenarios you can imagine, interest rates rising or 
falling up to 600 basis points and staying that way for 10 
years.
    The largest credit losses in history, not just in one 
region, but applied nationwide, and those losses go on for 10 
years. We have to have 100 percent of the capital to survive 
that scenario, plus 30 percent in additional capital, to handle 
what is called management risk. I often say I am not sure what 
I could do to the company that this risk scenario hadn't 
already done to it. But we need 130 percent of the capital to 
survive that scenario.
    When that is in place, it will be a world-class risk-based 
capital standard, giving the correct incentives to the 
companies to manage risk and hold risk down, and at the same 
time ensuring that we are able to carry out our mission.
    Senator Allard. Mr. Brendsel.
    Mr. Brendsel. Thank you.
    I think there are many things that OFHEO has done very 
well, extremely well. Certainly, as Chairman Raines has said, 
if I look at the examination staff, the supervision is really 
excellent. I think they have hired a great group of people. 
They have a lot of experience coming from banking, regulatory 
agencies. From my perspective, they do an excellent job of 
examination and reviewing us. And they are with us every day in 
doing that.
    Certainly, there are many aspects of the regulation that 
they have implemented on a timely basis. As has already been 
said here at this hearing, the risk-based capital rule has been 
tardy. My hopes are that it is finalized soon and that it be a 
sensible rule and one that meets the requirements of the 1992 
Act.
    I believe they do have enough resources to perform their 
regulatory activities today. Particularly, when you consider we 
are just two Enterprises that they have to focus on in one line 
of business.
    Senator Allard. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman. And thank 
you, Mr. Raines and Mr. Brendsel, for your excellent testimony 
this morning.
    There are two significant issues we are grappling with. 
First, safety and soundness, and the other issue is one that 
has been raised, the advantages of GSE's, in general, and to 
whom these advantages specifically accrue.
    First, with respect to safety and soundness, what I have 
heard from the regulator and what I have heard from you is that 
the legislation has established very rigorous safety and 
soundness standards and that your organization is responsive to 
those standards.
    In addition, you are conscious of the potential volatility, 
as things can change very quickly in this area. But, in 
general, might you make another summary comment, Mr. Raines and 
Mr. Brendsel, on the safety and soundness of your institutions.
    You feel you are well-positioned, I presume.
    Mr. Raines. I think we are very well-positioned, indeed. As 
Moody's said, both companies are leading the world in terms of 
the measures, both those that are mandatory in the statutes and 
through our regulation, and our voluntary initiatives, which 
take us far beyond what others have done.
    When we looked at this, there was a lot of theory about 
these things. And we said, well, why don't we just do them all? 
Let's not debate whether it should be more disclosure or 
subordinated debt or implementing the risk-based capital 
standard on our own or liquidity. Let's do them all.
    I believe that these two companies are the only companies 
in the world that are subjected to all of these means of 
maintaining safety and soundness.
    Senator Reed. Mr. Brendsel.
    Mr. Brendsel. I think we are in excellent financial shape. 
I think the current results show it. Beyond that, though, the 
information that we are providing to investors and to the 
marketplace, our standard disclosures, as well as the enhanced 
disclosures, as well as the additional ratings, all confirm the 
outstanding financial condition of the company.
    Again, to emphasize, we start from a basis that both 
companies are in essentially one line of business--not many, 
not spread throughout the world--we are focused on providing 
mortgage credit secured by American homes. A homeowner makes 
their mortgage payment among one of the first obligations that 
they meet beyond, I think, putting food on the table for their 
families. So when you start from that, it is not surprising 
that the company should be in such strong financial condition.
    Second, we carefully manage the risks that are ever present 
in the residential mortgage market--very carefully, whether it 
is credit or default risk or whether it is interest rate risk.
    In order to ensure the long-term future of the housing 
finance system, of the availability of mortgage credit, and 
indeed, the viability of the Enterprises' ability to meet our 
public mission must start from the basis and the foundation of 
running an extremely strong institution.
    Senator Reed. Mr. Brendsel, you have hit on the public 
mission, which is important. But you also have obligations to 
your private shareholders which are equally compelling to any 
CEO.
    In terms of this public mission, first, Mr. Brendsel, and 
then Mr. Raines, what are you doing to, one, ensure that this 
public mission benefits consumers and homeowners; and second, 
continue, and in fact is expanded, with respect to Freddie Mac 
and Fannie Mae?
    Mr. Brendsel. First of all, it is our only mission. It is 
our singular mission. And it is the one that is dictated in our 
charter. So every one at Freddie Mac, starting with me, is 
singularly focused on ensuring that we meet the purpose and the 
mission for which Freddie Mac is chartered and created, and 
that we are expected to attract private capital from our 
shareholders and investors around the world to fund housing in 
the United States.
    That is why sometimes people have a sense that there might 
be a tension between our public mission and our shareholders. I 
don't believe so. The two have to go hand in hand. You have to 
serve your mission in order to meet your public purpose. In 
order to do that, you must have the confidence of your 
shareholders and continue to attract private capital.
    What we are doing is continuing to innovate every day to 
continue to find new ways to drive down costs, to increase the 
availability of mortgage money throughout the Nation, and to 
find new ways to attract capital from throughout the world. 
There are no boundaries other than the boundaries provided by 
our charter.
    We are using technology to find new ways to qualify 
homebuyers, to drive down the costs for closing a loan. It is 
just one example. We are expanding into more parts of the 
subprime mortgage market, trying to find better ways to finance 
those mortgages than the ones traditionally that have been 
available to homebuyers who are in that market today.
    Senator Reed. Thank you.
    Mr. Raines, if you could comment.
    Mr. Raines. Yes. Thank you, Senator.
    Just two points that I would make. First, from the 
standpoint of our shareholders and our mission. There is a very 
close congruence. By being in the U.S. housing market and the 
mortgage market, it is an enormous market. It is a market of 
$5.6 trillion outstanding. It is a market that is growing for 
the last 3 years at 9 percent.
    I have no problems going to my shareholders and saying, 
where we are chartered to operate is an area where we can do 
good things for our shareholders while carrying out our 
mission. They need not worry about there being a conflict.
    The second point is Fannie Mae has a tradition of 
establishing big goals for ourselves when it comes to our 
mission--to ensure that there is no doubt that we are doing 
everything we can to achieve that mission.
    We just completed last year a trillion-dollar initiative 
that was begun by my predecessor to focus one trillion dollars 
on affordable housing for 10 million families.
    I announced last year a new American Dream commitment--a $2 
trillion commitment over this decade to try to move up the 
homeownership rate of those people who have not yet broken the 
50 percent homeownership rate--minority Americans, young 
Americans, female-headed families, urban Americans. We want to 
move up their homeownership rate by investing $2 trillion. And 
that includes commitments of over $400 billion now aimed on an 
area-by-area basis, and where our partnership offices are now 
sponsoring investment plans, focused on individual communities 
to ensure that we are not simply operating at a very high level 
out of Washington, but having an impact in local communities.
    Senator Reed. Thank you very much.
    Senator Allard. The Senator from Maryland.

         OPENING STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Mr. Chairman.
    I was not here at the outset and I want to take just a 
moment or two to make a short statement before I pose a 
question.
    First of all, Mr. Chairman, I want to commend you and 
Senator Reed for holding this hearing.
    I looked at the hearing notice and it said, a hearing on 
oversight--oversight, I underscore that--of the mission of the 
Office of Federal Housing Enterprise Oversight and the 
Financial Safety and Soundness of Fannie Mae and Freddie Mac.
    It did not have any bill number with respect to which this 
hearing was going to be held. And I must say that this is a 
very welcome, as it were, initiative because I think we don't 
do enough oversight and we are always gearing everything to a 
new piece of legislation.
    I am frank to say I don't think we need any new legislation 
in this area. What we need is appropriate oversight. And so, I 
commend you and Senator Reed for, in a sense, perceiving that 
and holding this hearing.
    Senator Allard. Thank you.
    Senator Sarbanes. It is a very good departure, I have to 
say.
    Fannie Mae and Freddie Mac have been strong engines of 
homeownership in this country. Homeownership continues to be at 
the heart of our Nation's housing policy because of the 
benefits it brings, not just to the homeowners, but to the 
entire community. We, in effect, perceive it as very important 
to community stability, and I think there have been studies 
which will substantiate that.
    The GSE's continue to be a crucial link in bringing this 
important benefit to millions of Americans. Now given their 
size, and they have been, in my view, very effectively managed, 
but obviously, they need to be regulated and supervised in a 
thorough and appropriate manner.
    OFHEO has now come forward, or is about to come forward, I 
gather, with its risk-based regulation. It has been forwarded 
to OMB for final review and publication and we await its final 
publication, and then I am sure we will examine it and receive 
the benefit of comments and so forth.
    The other functions that OFHEO is required to perform, it 
seems to be doing well. It is regarded as having an examination 
staff that is qualified and experienced. The staff is devoted 
full time to overseeing the two housing Enterprises that are 
now at the table.
    I am told that if you compare the insured financial 
institutions and their supervision and examination, that the 
two GSE's are as closely supervised and examined as any of 
those insured financial institutions.
    OFHEO has invested considerable time and resources. It has 
developed significant expertise. And I think one of our charges 
is, of course, to make sure that it has the resources necessary 
to do the job and it is carrying through on its statutory 
mandate.
    In the meantime, Fannie Mae and Freddie Mac have decided to 
take a number of steps to increase the transparency of their 
operations, including their risk management, and to get 
continuous reviews of their financial conditions by Standard & 
Poor's.
    These are obviously important steps that will allow the 
market to exercise considerable discipline on these 
institutions, which should increase our confidence as well.
    I look forward to the final regulations publication and its 
review, and again, redirecting our attention, then, to the 
goals Fannie and Freddie have been chartered to support, 
increased homeownership and more affordable rental housing.
    I am pleased to welcome these two witnesses before us, to 
thank them for the leadership they are providing, and for their 
responsiveness to many of these public policy and public 
interest concerns. I just have a couple of questions. I think I 
still have a little bit of time.
    As we said, we regard homeownership, affordable rental 
housing as important to building strong communities, increasing 
civic engagement, laying the foundation for educational 
attainment for our children. And these two institutions have 
played a central role in advancing that cause.
    There is, however, still a significant differential in the 
homeownership rates among whites and minorities. Minority 
homeownership rates have risen in the past several years, but 
they continue to lag significantly behind those of white 
Americans. Maybe you could outline for us what steps you have 
taken and perhaps even more, what further could be done to try 
to close this gap.
    Mr. Raines. Well, Senator Sarbanes, thank you for that 
statement. Thank you for that question.
    There is no more important issue facing the housing finance 
system than how do we bring the benefits of housing ownership 
to more Americans?
    You are correct that about 74 percent of white Americans 
own their own home. And less than 50 percent of everybody else, 
including young white Americans own their own homes.
    We have established an effort to focus attention on 
bringing up these homeownership rates, particularly among 
minority Americans. We have made progress in the last several 
years. Homeownership has risen faster among both Hispanic 
Americans and African-Americans than other groups.
    We have established a new program, a $400 billion effort 
over this decade to move up the minority homeownership rate. 
And we will do that through the creation of new products. We 
will do that by penetrating markets that have not been 
adequately served. We will do it by reducing the cost of 
homeownership. Let me give you just one example.
    The subprime lenders have done a phenomenal job in 
penetrating minority communities. They have brought credit to 
those communities that did not have credit before. But that 
credit has come at a cost.
    For many people in those communities, they deserve lower-
cost mortgages. And so, we have developed products and programs 
to try to increase competition in those communities to bring 
lower-cost products, such as our timely payment reward 
mortgage, which is a mortgage that, if you make your payments 
on time for 24 months, we will reduce the interest rate. But 
many of these communities are very suspicious of conventional 
lenders and have not been served well by them in the past.
    And so, we are going to have to work with community groups, 
with our lenders and with others, to try to convince these 
communities that mainstream lenders will provide them with 
service so that they will, in fact, go to those lenders and 
obtain much more cost-effective products. We are working across 
the board on each of the problems, whether it is down payment, 
whether it is credit, whether it is affordability, to try to 
knock down these barriers and to raise the minority 
homeownership rate.
    Senator Sarbanes. Mr. Brendsel.
    Mr. Brendsel. Thank you, Senator.
    Increasing homeownership is a major goal of Freddie Mac and 
particularly reducing the homeownership gap that confronts 
African-Americans, Hispanic Americans. We think that there are 
many things that we can do and we are committed to doing. And I 
will mention five.
    First is improving underwriting qualifying decisions that 
families face. Certainly, over the course of the last 5 years, 
Freddie Mac has been an innovator and a leader in developing 
new underwriting systems that are fair for borrowers.
    Second, lowering costs, finding ways to lower costs, 
particularly costs of qualifying for a mortgage loan and 
closing on that loan.
    Third is the design of new products that are more 
attractive and better fit the needs of underserved borrowers 
today. Whether it is products that reduce down payments or 
allow borrowers to qualify for a mortgage loan, we have 
instituted many new products--too many to list.
    Fourth is education and counseling. This is an important 
part, I think. We recently completed a couple of studies that 
demonstrate the importance of financial education and 
understanding of how to qualify for a mortgage loan, how to 
improve credit if you have blemishes on your credit today. In 
addition, another study confirmed the success that homeowner 
counseling has in improving homeownership opportunities.
    Fifth, we are building more alliances with organizations 
that help us to penetrate minority neighborhoods and 
communities.
    I am really pleased with the results that we are showing 
and, certainly, as I mentioned before, we are continuing to 
penetrate more parts of the mortgage market, the subprime 
market, to drive out practices of predatory lending by bringing 
in more qualified quality mortgage lenders. I think this is an 
important activity that Freddie Mac is currently engaged in.
    Senator Sarbanes. Thank you very much.
    Mr. Chairman, I see that my time is up. I was going to ask 
about predatory lending, but since the time has run out, I 
won't do that.
    Just let me make this observation.
    I know you both made constructive contributions in 
addressing that problem. I would hope that you would continue 
to try to be as active as possible, including whether there is 
some way to provide more liquidity to reputable subprime 
lenders who avoid these predatory practices and products. And 
thereby, by doing that, strengthen their position and perhaps 
bring greater quality assurance into the subprime market.
    They are all being tainted by the outrageous actions of a 
few. Most of the lenders in that market should also be 
interested in finding ways to cut these offenders, as it were, 
out of the market and the rest of them can go on doing their 
business in a responsible way.
    Thank you very much, Mr. Chairman.
    Senator Allard. Thank you, Senator.
    Senator Carper.

          OPENING COMMENTS OF SENATOR THOMAS R. CARPER

    Senator Carper. Thank you, Mr. Chairman.
    Welcome, gentlemen. It is especially nice to see our old 
OMB Director back here wearing his new hat. I was fortunate 
enough to be able to talk with you earlier this year, Mr. 
Raines--I don't know if you recall this part of our 
conversation. We were talking about whether there is some 
things that we could do within the Congress to help promote not 
just homeownership, but decent housing, in ways that involve 
the relationship between Fannie Mae and HUD.
    We talked about constraints to partnerships that existed, 
either through regulation or just through attitudes. We talked 
a bit about how we might eliminate some of those barriers, 
either regulatory, through statute, or just through attitudinal 
changes.
    I have thought a good deal about that since. You may not 
have thought about it at all. But if you have, and if you have 
any thoughts or examples that you might share with us today, I 
would be grateful. And if not, I would just ask you to submit 
something to us in writing.
    Mr. Raines. No, I would be delighted to. I have thought 
about it quite a bit since our conversation, and I have talked 
actually to Secretary Martinez about it as well. I think that 
the key to our success going forward is how do you have 
effective risk-sharing? Not risk-shedding, but risk-sharing.
    Very often, when HUD enters into partnerships, they get the 
raw end of the deal because people want to simply shift risk 
from themselves over to HUD. And HUD often is not in a position 
to adequately measure that risk and to assess it, and then we 
all get disappointed that yet another program did not work.
    And so, my thoughts are, and I have mentioned this to the 
Secretary and I will be meeting with him again to discuss it, 
is how can we have a collaboration between the kinds of 
technology, risk management, risk assessment, product 
development skills that we bring and the Government's ability 
to take on risk that perhaps is beyond our ability to do that, 
but to do it in a way in which there is a fair sharing of the 
risk and a fair sharing of the revenue.
    I think that has to work because we engage in risk-sharing 
with lots of players today. We engage in risk-sharing with the 
mortgage insurance companies, where they are our partner in 
managing credit risk. We engage in interest-rate risk-sharing 
with counterparties around the world. We have Wall Street every 
day coming up with new ideas of how we can share risk, mitigate 
risk, move risk around the system so that there is no systemic 
problems.
    There has to be a way for us to do that with FHA and with 
HUD if each of us goes into this where the goal is to be able 
to serve more people. I think if we put our resources together, 
our private capital together with the Government's capital, we 
can serve more people and we can do that without shifting risk 
onto HUD that HUD is not in a position to undertake, or simply 
take loans that otherwise were going to be made and simply put 
them into a new guise. I think we can reach out to more people 
if we put the resources together and work hand-in-hand in a 
professional manner.
    Senator Carper. My guess is that what you just described 
here could have been at least begun in the last couple of 
years, but it wasn't. And I presume that among the reasons why 
it did not was that people had concerns about this particular 
course. What are those concerns and how do we address them?
    Mr. Raines. Well, we have had discussions since I have been 
at Fannie Mae, 1991, we have had discussions with Secretary 
Kemp along this line, with Secretary Cisneros. Unfortunately, 
in the last Administration, there was less interest in this 
sort of partnership.
    Senator Carper. Why do you think that might have been? Any 
idea?
    Mr. Raines. I don't know. One time, Ginnie Mae and Fannie 
Mae were part of one organization. And I think from that time 
on, there has been this sort of silly competition that has gone 
on, as opposed to looking at a partnership. I think, 
periodically, that raises its head and gets in the way of 
really sitting down and trying to figure out how you can work 
better together. This should not be about who is better than 
the other one or who is more dedicated than the other. It 
really ought to be about how can you put resources together and 
do more than you can if they are separate.
    Senator Carper. Thank you very much. I am glad I was not 
the only one thinking about that.
    And you gave us the name of a person within your team to 
follow up with. I think we have him. We certainly will after 
today.
    Mr. Raines. Right. Terrific.
    Senator Carper. I wasn't here earlier for the testimony. Is 
it Mr. Falcon or Mr. Fal-cone? How does he pronounce it?
    Senator Allard. Mr. Falcon.
    Senator Carper. Mr. Falcon. I understand that he may have 
made a comparison between the regulatory regimen established by 
the statute, the proposed rule and your voluntary commitments, 
and the Basel Accords that are applied to internationally 
active financial institutions. I would just ask, and let me 
address this to Mr. Brendsel--is it Brendsel?
    Mr. Brendsel. Yes.
    Senator Carper. Mr. Brendsel, in your view, what are the 
similarities and what are the differences?
    Mr. Brendsel. Between our capital regime and the regulation 
and the Basel Accord?
    I think the Basel Committee established three basic 
principles for sound regulation and supervision. First is 
market discipline. Second is capital related to risk. Third is 
effective supervision.
    If you stack up the legislation of 1992 passed by Congress 
that OFHEO is charged with implementing, it stacks up extremely 
well. In fact, in many ways, it goes beyond the principles 
outlined by the Basel Committee.
    Specifically, our risk-based capital rule that is in 
process now, as directed by Congress, is very innovative, very 
forward-thinking, and goes beyond anything that banking 
regulators have developed for banking institutions, or even 
that the Basel Committee describes.
    Second, in terms of market discipline, which contemplates 
having information out there that allows investors to judge, 
that allows the public to judge the activities of the 
Enterprises and whether we are safe and sound. Certainly, with 
the six commitments, the amount of information that we disclose 
to the marketplace exceeds anything disclosed by even the 
largest banking institutions.
    Finally, as we have already commented earlier, I think that 
the examination and supervision staff is professional. They are 
focused on two Enterprises and do an outstanding job.
    Senator Carper. Good. Thank you very much.
    Senator Allard. I want to direct the next question to you, 
Mr. Brendsel. Then, I have one for Mr. Raines.
    The main line of business for Fannie Mae and Freddie Mac is 
to grant pools of mortgage-backed securities. However, in 
recent years, you have dramatically increased your own 
investment in mortgages. This is done in two ways, I 
understand. By the direct purchase of mortgages from lenders 
and the purchase of mortgage-backed securities that have your 
guarantee on them. Is this line of business riskier than the 
guaranteed business? And how do you protect against these 
risks?
    Mr. Brendsel. That line of business is not riskier than the 
guaranteed business.
    All risks in mortgage finance, particularly the two 
principal risks of credit risk and interest rate risk that are 
involved in the guarantee and the portfolio businesses, are 
risks that, number one, we understand extremely well, 
understand better than anyone else. I was going to pay a 
compliment to Fannie Mae here--they almost understand it as 
well as we do.
    Let's put it that way.
    [Laughter.]
    In any case, we don't take those risks and just put them on 
our balance sheet. We intermediate the risks. We use mortgage 
insurance and reinsurance, for example, on credit risk. In 
addition, on interest rate risk, we use callable debt options 
to redistribute that risk to other investors. And so, the fact 
is that we take very little risk. We are extremely well-
capitalized relative to that risk.
    Finally, both activities are ways of attracting the 
broadest range of investors to finance housing in the United 
States. Some prefer to invest in mortgage-backed securities. 
Others prefer to invest in debt. We try to provide as broad a 
range of financing options that we can that are attractive to 
investors that will provide those funds. And then we manage 
that in an extremely conservative and sound way.
    Senator Allard. Thank you.
    Mr. Raines, you purchase a significant amount of mortgage-
backed securities for your own portfolio. When you purchase 
these certificates, this is financed with short-term borrowing. 
Does this increase your risk and how do you guard against the 
risk of an increase in the short-term interest rates?
    Mr. Raines. Well, Mr. Chairman, first, Fannie Mae has been 
in the mortgage portfolio business for our entire 63 years. So 
this is the way Fannie Mae first began doing business. This is 
not a new business for us. Indeed, the mortgage-backed 
securities business came much, much later. We have been in the 
business of managing mortgage risk on our balance sheet for 
quite some time.
    Second, there is no difference, really, in the risk of 
owning what we call a whole loan or a mortgage-backed security. 
It is exactly the same risk that is there. Lenders now prefer 
to put all of their loans into mortgage-backed securities 
before they sell them into the market because they can get a 
better price. But that is a decision the lenders make to put 
them in the mortgage-backed securities.
    The third point is, we don't buy long-term mortgages and 
fund them short. Indeed, we match the funding of the expected 
duration of the mortgage with our debt. We have a very close 
match. And that is why in the new disclosures we have made on 
our interest rate risk, even significant changes in interest 
rates in the short term have very little effect on our income, 
because of this very close match.
    We don't match it exactly because if we matched it exactly, 
there would be no way to make any income with running the 
portfolio. But we have a very, very low level of risk in that 
business and that is shown by our success over the last 14 
years of solid earnings increases as interest rates have risen 
or fallen, and by very large amounts over time.
    The other factor that is important in understanding this is 
not just what you think the duration of the mortgage will be 
when you put it on your books, but it is also the option that 
we provide to the homebuyer to refinance the mortgage. That is 
an enormous consumer benefit, that if rates go down, they can 
refinance their mortgage. And that option risk we also manage 
by putting options into our debt. So, we will sell callable 
debt or we will structure the equivalent of callable debt.
    If we think the mortgage, for example, is going to last 7 
years, interest rates fall and the consumer says, I would now 
like to refinance, we don't say, as they say in other 
countries, well, you cannot. Or you have to pay us a big fee. 
What we say is fine, you are going to send us back the mortgage 
early. We will call back our debt early. And by that way, we 
can keep this close match of duration, even if the consumer 
undertakes their option to refinance.
    A tremendous benefit to consumers, as I mentioned, is we 
are going to put as much as $40 billion in the pocket of 
consumers just this year alone.
    Senator Allard. Mr. Raines, how do you respond to the 
criticism that the derivatives are necessary only because of 
the higher risk associated with your direct purchase of 
mortgages and mortgage-backed securities?
    Mr. Raines. Again, we have two businesses. One business is 
to manage credit risk and the other business is to manage 
business-rate risk. And we have been in the interest-rate risk 
management business for our entire history.
    The reason we have the use of derivatives is that the 
American people want more long-term, fixed-rate mortgages than 
any group of investors by themselves are willing to finance.
    If investors are willing to finance all the long-term, 
fixed-rate mortgages that Americans want, then they would all 
go into mortgage-backed securities. They would all be sold into 
the market. And there would be no opportunity for us to own 
any.
    We only own mortgages when other investors don't want to 
own them. In fact, we can only own a mortgage if investors are 
willing to buy our debt because we sell our debt to investors 
and use that debt to buy mortgages. If the investors wanted to 
buy the mortgages themselves, they could just do that.
    Clearly, we have more Americans who want long-term, fixed-
rate mortgages with an option to refinance than we have 
investors willing to do that directly. So, we will issue debt 
so that we will buy those mortgages and the investors can own 
our debt because they believe that our debt, either our 
callable debt or our bullet debt, is a better match for them.
    But it also turns out that there are people who are in the 
derivatives market--particularly large financial institutions. 
It is dominated by banks in the derivatives market--who say, 
well, we will help you put together debt in a way that will 
attract even more investors, who may be short-term investors 
who don't want to provide long-term funds.
    We have other investors over here who are willing to extend 
the maturity of that short-term debt. And we say, great. If we 
can bring in more investors to help us own these mortgages that 
consumers want, that is terrific.
    Over our lifetime, we have gone from financing just with 
bullet debt, to then financing with callable debt. Now, we are 
able to put together debt that uses derivatives. All of which 
is simply expanding the range of people around the world 
willing to invest in American mortgages.
    Last year, 30 percent of the money we raised to buy 
mortgages came from outside the United States. Much of that 
from countries who have homeownership rates lower than ours. 
But they would rather invest in the U.S. mortgage system than 
invest in anything else. And so, I believe that this array of 
products that we offer on the debt side give us the ability to 
provide Americans with what they want.
    Seventy-five percent of Americans have chosen in the 
marketplace, they want a long-term, fixed-rate mortgage. And it 
is been our job to go out and scour the world to find the 
equity, to find the capital, to make that possible.
    Senator Allard. Now let me understand this. You have 
provisions on your debt so that, if somebody pays off their 
loan early, then you can recall the debt in early. Is that 
right?
    Mr. Raines. That is right. In the first quarter of this 
year, for example, we called in $80 billion of debt because of 
the number of refinancings that have happened.
    Senator Allard. And they all understand that with the 
contract.
    Mr. Raines. That is the contract we have with them. Of 
course, they charge us more. They charge us more for that 
callable debt.
    Senator Allard. We are familiar with that.
    Mr. Raines. So every feature, there is an expense. But it 
is worth it because these are the mortgages Americans want. If 
the American people said, all I want is an adjustable-rate 
mortgage, which is the mortgage that is available in most of 
the world, then this would all be a lot simpler because we 
would simply say, we will borrow short and we will lend to you 
short.
    You take the interest rate risk, consumer.
    In England, if interest rates go up, if the short-term 
rates go up, they simply announce to you that your rate has 
gone up, with no cap, no limitation. Your interest rate could 
double.
    Well, that is not what Americans have wanted. Americans, 
since Fannie Mae was created in 1938, for the purpose of buying 
long-term, fixed-rate mortgages, have said with their actions--
we want long-term, fixed-rate mortgages. We want to lock in 
this.
    Somebody else should manage interest-rate risk. But we 
should not put that burden onto the American family.
    Senator Allard. Senator Reed.
    Senator Reed. Thank you, Mr. Chairman.
    Mr. Raines, let me follow up on a line of questions that 
Senator Sarbanes opened up with respect to trying to increase 
the minority homeownership.
    Typically, you find, and my experience in Rhode Island is 
that they are very hard-working individuals. They want to buy a 
home and they have stable employment. They just cannot afford 
an interest rate comparable to what you would find in the 
market.
    When lending institutions try to provide a subsidized 
interest rate, it runs afoul of your underwriting rules. Is 
there anything that we can do in Congress or anything you can 
do to try to identify those worthy credit risks who will pay, 
but just run afoul of your rules?
    Mr. Raines. Well, certainly, we are constantly modifying 
our rules in order to ensure that we can penetrate markets and 
serve more people.
    Our research shows that there are a number of reasons why 
minority homeownership rate is low. The first problem has been 
information, the lack of knowledge of how the system works. And 
the Fannie Mae Foundation has led with the largest information 
campaign ever run. They have been doing it since 1994. Eleven 
million people have reached out to the foundation for 
information about homeownership and how do I get through all 
the hoops and requirements.
    The second problem we have found has been lack of money, 
lack of wealth for down payments. In the 1990's, Fannie Mae led 
the way in reducing down payment requirements from 20 percent 
down to 3 percent, and in some cases, down to zero. So that we 
are able to help people who can make the monthly payments, but 
who don't have the wealth.
    A third problem has been credit. There are many people who 
have lacked the knowledge of what determines good credit. We 
have done a lot of research and we found, for example--and this 
is not just minorities. But a majority of Americans do not know 
that if they don't pay their bills on time, that that can 
affect their credit rating.
    Many people believe that if I pay it late, but pay the late 
penalty, then it is okay. And it is only when they apply for a 
mortgage, that they find that they now have all of these lates 
on their record.
    The Fannie Mae Foundation has launched a campaign to try to 
improve knowledge of credit. I hope that you have seen some of 
their commercials, asking people to reach out and to get 
information before they try to become a homeowner.
    The final item as you mentioned that affects minority 
homeownership has been the ability to afford even the market 
rate, even after they have gotten over all those hurdles.
    We have done a number of things in that regard.
    First, to try to hold down all of the ancillary and other 
costs that drive up that rate. Our technology and other means 
are making it less expensive for lenders to lend.
    Second, we are the largest buyer of mortgage revenue bonds 
in the country. And through mortgage revenue bonds, your State 
housing finance agencies are able to make available below-
market interest rates.
    One of the limitations they have is that there is a cap on 
the amount of mortgage revenue bonds that they can buy. Indeed, 
there is a cap on the amount we can buy.
    Certainly, in terms of the most efficient way to get lower 
cost finance available would be to expand the availability of 
mortgage revenue bonds through the State housing finance 
agencies. We would be delighted to have an opportunity to 
invest in more of these. It is an extraordinarily efficient 
mechanism that has been created.
    Another one, the President has a proposal for a new tax 
credit to provide an incentive for investors to provide funds 
for rehabilitation, particularly in older communities where the 
rehabilitation costs are so high. It drives the cost of the 
house so high, that people who live there cannot afford it.
    We are strong supporters of that credit and would be 
investors in that credit because that would, again, make it 
possible, particularly in our older areas, for minorities and 
others who live there to be able to afford to buy the house.
    Senator Reed. Thank you, Mr. Raines.
    My time is running out, Mr. Chairman, would it be 
appropriate to submit written questions so that we can cover 
some other areas that have not been addressed?
    Senator Allard. Absolutely. In fact, I was going to point 
that out to the Committee. We are going to give a 10-day period 
of time for them to get questions and then we will submit it to 
them. Hopefully, they can respond back promptly.
    Senator Reed. Thank you.
    Senator Allard. In fact, I am getting ready to adjourn the 
Subcommittee.
    Senator Reed. I sensed that when I raised the issue of 
written questions.
    [Laughter.]
    Senator Allard. I want to apologize for the interruption 
that we had in the middle because of our series of three votes.
    Before we adjourn the hearing, I want to announce that the 
record will remain open for 10 days for Members to submit 
statements and for the Committee to receive any written 
questions for our witnesses.
    Finally, I would just like to state that I will be 
following up with the Office of Management and Budget to 
determine when the proposed risk-based capital regulations are 
likely to be released and made final.
    Also, you will be asked from time to time to show up before 
this Committee for no other purpose than we just want to hear 
from you. We have not decided how frequently that would be, but 
as I mentioned earlier I am known for oversight. We will 
probably be spending a good deal of our oversight on agencies 
such as HUD and those problems, but on occasion, we will want 
to hear from you.
    Thank you very much for showing up.
    Mr. Raines. Thank you.
    Mr. Brendsel. Thank you.
    Senator Allard. The hearing is adjourned.
    [Whereupon, at 12:37 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]

              PREPARED STATEMENT OF SENATOR JON S. CORZINE

    I want to welcome the witnesses and thank them for taking the time 
to testify before the Committee today. I also thank my colleagues, 
Senators Allard and Reed, for holding this important hearing on the 
regulatory oversight and the safety and soundness of Fannie Mae and 
Freddie Mac.
    Few would dispute that the mission of the GSE's--in seeking to make 
housing more affordable and accessible --is an important one.
    One need only look to our Nation's 68 percent homeownership rate --
the highest it has ever been--and the increasing number of African-
American and Latino families who own their own homes to see that Fannie 
and Freddie have helped improve the quality of life for American 
families.
    However, this hearing is about the regulatory role of OFHEO and 
whether our Government Sponsored Enterprises (GSE's) operate in a safe 
and sound manner. The central role that they play in America's capital, 
finance and housing markets requires Congress to periodically assess 
whether they are being well-managed, well-regulated, and held to the 
highest of standards.
    Last fall, Fannie and Freddie reached an agreement with Congressman 
Baker of the then-House Banking Committee to voluntarily implement six 
initiatives that would provide additional safety and soundness 
protections. And it is my understanding that both institutions are well 
on their way to fully implementing these initiatives. On that note, I 
applaud the efforts of Mr. Raines and Mr. Brendsel for exercising their 
leadership and working with Members of Congress.
    Regarding OFHEO--well, I think one can safely say that this is an 
agency that has been subject to a lot of questioning and criticism. 
There are many questions regarding their proposed risk-based capital 
requirements, and even more questions about the lengthy delay in their 
release.
    While aware that Mr. Falcon inherited much of this problem, I 
nonetheless look forward to his testimony and his views on what, if 
any, measures he believes the Congress could take to enhance his 
agency's performance and credibility.
    Again thank you, Mr. Chairman, for holding this hearing and 
allowing me to present my opening remarks.

                               ----------

             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

    Mr. Chairman, I am pleased we are holding a hearing on this 
critical topic. This is an opportunity to discuss the vitally important 
function that Fannie Mae and Freddie Mac play in our housing market and 
it is a chance to review their safety and soundness regulation.
    There is no doubt that the role Fannie Mae and Freddie Mac have 
played in creating a secondary mortgage market-- consequently promoting 
liquidity risk--is key to much of the success in the housing market. 
These two corporations should be proud of their role in promoting 
homeownership.
    Although there is a strong record of achievement, much more needs 
to be done. There are still too many people for whom the dream of 
homeownership is out of reach. Good intentions are not enough. We must 
follow with concrete action, and there is obviously a vital role for 
the GSE's in achieving our common goal.
    One thing I would challenge the GSE's to do is to continue to 
increase their involvement in the subprime market. As the lending 
market has grown for consumers whose credit or income currently may 
prevent them qualifying for a conventional loan, it has become all the 
more clear that we need the benefits of reputable actors like Fannie 
and Freddie. Aggressive GSE involvement in this mark would surely help 
combat some of the outrageous predatory loans that are occurring in our 
neighborhoods, by standardizing these loans and promoting competition. 
Indeed, failure to become involved in this market could almost be 
considered counter to the GSE's mission for it would deprive too many 
working families the clear benefits that the GSE's bring to our housing 
system.
    On the issue of regulation of the GSE's, I do not believe that now 
is the time to do anything that would disrupt or radically change the 
regulatory regime. The GSE's and their regulator have the opportunity 
to serve as a model for how risk-based capital rules can work 
effectively. Our Committee should follow the implementation of OFHEO's 
rule carefully. The rule has been 8 years in the making and now is 
clearly not the time to create undue uncertainty. Instead, we should 
try to support OFHEO's effort and do what is necessary to ensure that 
the rule is strong, effective, and well-implemented.
    I welcome our witnesses and I look forward to an interesting and 
informative hearing today.
    Thank you.

              PREPARED STATEMENT OF SENATOR RICK SANTORUM

    Mr. Chairman, thank you for holding this oversight hearing on the 
Office of Federal Housing Enterprise Oversight (OFHEO) and the two 
largest housing GSE's, Fannie Mae and Freddie Mac. I appreciate any 
opportunity to learn more about these companies and their regulator.
    This hearing is particularly important because the three 
institutions we are examining today are major partners in the effort to 
open the door of homeownership to low- and moderate-income Americans. 
Congress chartered Fannie Mae and Freddie Mac to purchase U.S. 
residential mortgages at or below the conforming loan limit. As a 
result, the secondary mortgage market was born. Although Fannie and 
Freddie do not originate mortgages, the resources that their mortgage 
purchases send back into the primary market provide lenders with more 
money to offer more mortgages. On the other hand, Congress entrusted 
OFHEO with the task of monitoring the financial safety and soundness of 
the housing GSE's. Considering the size of the GSE's portfolios, OFHEO 
has an enormous responsibility. As Members of the oversight committee, 
it is our job to make sure that these institutions succeed in 
fulfilling their statutory missions.
    Congress and the Administration will continue working to increase 
homeownership opportunities, particularly for low-income families and 
minorities. In order to achieve this goal, the continued health of the 
secondary mortgage market is essential. I am pleased that reports by 
the OFHEO and other private-sector evaluators indicate Fannie Mae and 
Freddie Mac are in good financial health. I encourage the GSE's to 
continue to be mindful of sound management and financial practices as 
they strive to meet the higher affordable housing goals that HUD, their 
mission regulator, has set for them.
    Mr. Chairman, homeownership rates are at record levels in the 
United States. These numbers are encouraging, but we can do better. 
Less than half of African-American and Latino families own their own 
homes. Secretary Martinez is committed to raising the level of 
homeownership among minority families. I look forward to working with 
the Secretary and with the housing GSE's to make the dream of 
homeownership, and the economic security it provides, a reality for 
these families.
    Again, Mr. Chairman, thank you for holding this important hearing.

                               ----------

               PREPARED STATEMENT OF ARMANDO FALCON, JR.

      Director, Office of Federal Housing Enterprise Oversight \1\
---------------------------------------------------------------------------
    \1\ This testimony represents the views of the OFHEO Director, 
which are not necessarily those of the President or Secretary of 
Housing and Urban Development.
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                              May 8, 2001

    Chairman Allard, Senator Reed, Members of the Subcommittee, my name 
is Armando Falcon and I am the Director of the Office of Federal 
Housing Enterprise Oversight, or OFHEO. I commend the Subcommittee for 
conducting this oversight hearing on the safety and soundness and 
capital adequacy of the Federal National Mortgage Association and the 
Federal Home Loan Mortgage Corporation (or Fannie Mae and Freddie Mac) 
and thank you for the opportunity to testify this morning.
    As you know, following the savings and loan crisis and other 
disruptions which occurred in the Nation's financial system in the late 
1980's, Congress determined that it was prudent to establish a formal, 
full-time safety and soundness regulator for Fannie Mae and Freddie Mac 
to protect against similar events occurring at the Enterprises. To 
achieve this objective, OFHEO was established as an independent entity 
within the Department of Housing and Urban Development (HUD). OFHEO was 
charged with ensuring the safety and soundness and capital adequacy of 
the Enterprises, while HUD was given responsibility for regulating the 
Enterprises' activities--so called ``Mission'' regulation.
    As the Director of OFHEO, I am pleased to report that Fannie Mae 
and Freddie Mac are currently in good financial health, are well-
managed, and have exceeded minimum capital requirements every quarter 
the requirements have been in place. These conclusions are based on the 
findings of our broad regulatory system, which includes a highly-
regarded examination program and quarterly minimum capital 
requirements. While the current situation is good, I want to assure you 
that OFHEO remains vigilant to ensure that this financial strength and 
well-being will not be jeopardized by changes in the economy, the 
markets in which the Enterprises operate, or even the Enterprises 
themselves.
    As you conduct oversight hearings, it is important to do so with an 
understanding of the responsibilities Congress gave OFHEO. As I 
mentioned earlier, OFHEO's primary mission is to ensure the capital 
adequacy and financial safety and soundness of Fannie Mae and Freddie 
Mac. In fulfilling this mission, OFHEO helps ensure the Enterprises are 
positioned to fulfill their Congressionally-mandated missions.
    When considering OFHEO's oversight, it may be useful to compare our 
program with contemporary global thinking regarding large financial 
institution risk management and regulation. The Basel Committee on 
Banking Supervision is an obvious point of reference. The Basel 
Committee, which is a group of central bankers and international 
financial regulators, has endorsed the ``three pillars'' of banking 
supervision, consisting of: (1) supervisory review; (2) capital 
requirements; and (3) market discipline. While the nature of the 
institutions OFHEO regulates necessitate some adaptations to Basel's 
recommendations, our regulatory structure implements contemporary 
global risk management thinking. Specifically, OFHEO:

 Conducts comprehensive annual examinations of both 
    Enterprises.

 Ensures compliance with minimum capital requirements and will 
    soon impose a risk-based capital standard.

 Conducts financial research on the Enterprises and the markets 
    in which they operate.

 Has developed a formal regulatory infrastructure to ensure 
    transparency and enforceability of its rules and regulations.

    I believe it will be useful to expand on these areas and report, 
where appropriate, on what we have found.
Examinations
    The 1992 Act establishing OFHEO directs the Office to conduct 
annual on-site examinations to determine the Enterprises' financial 
safety and soundness and requires OFHEO to report the results and 
conclusions of these annual examinations in our annual Report to 
Congress. This is unique among financial regulators and is a powerful 
tool in influencing the behavior of the companies we regulate. While 
that report is not due until June 15, I am pleased to tell you today 
that both Enterprises have met or have exceeded safety and soundness 
standards in all examination program areas.
    OFHEO regulates just two institutions, but arguably two of the most 
sophisticated financial institutions in the world. This has allowed us 
to attract very talented individuals who are experts in their fields. 
Our examiners, who are OFHEO's front line in ensuring the Enterprises' 
safety and soundness, possess impressive skills and backgrounds, and 
bring to OFHEO broad experience from banking and thrift regulatory 
bodies, as well as from many sectors of the financial services and 
mortgage industries. These experts maintain a physical presence at the 
Enterprises, and have unlimited access to all levels of management and 
to highly-sensitive corporate records. By staying apprised of the 
Enterprises' risks and business activities on a timely basis, the 
examiners are able to evaluate an extensive array of risk-related 
factors and to assess the Enterprises' financial safety and soundness.
    Each quarter, the OFHEO examination staff updates conclusions 
relating to more than 150 separate components of financial safety and 
soundness, thereby providing me with a comprehensive picture of the 
Enterprises' financial condition. These conclusions pertain to such key 
risk management areas as credit risk, interest rate risk, liquidity 
management, information technology, internal controls, business process 
controls, internal and external audit, management information and 
process, and board of director governance and activities.
    Our examiners meet frequently with management to discuss and assess 
business strategies and plans, financial performance results, risk 
management framework and practices, and each Enterprise's overall risk 
profile. These discussions include future trends and management's 
controls and practices to anticipate and prepare for potentially 
adverse trends in any risk area, or combination of risk areas. 
Examination teams identify opportunities for improvements in existing 
Enterprise risk management practices and work directly with management 
to address identified opportunities to enhance financial safety and 
soundness. Through our risk-focused examination framework, OFHEO 
constantly evaluates such critical areas as:

 The Enterprises' overall risk management strategies and 
    practices.

 The composition, risk profile, and significant trends in their 
    retained, and guaranteed, mortgage portfolios.

 The Enterprises' ability to effectively manage interest rate 
    risk and other key financial exposures.

 The Enterprises' ability to efficiently issue debt and hedge 
    financial exposures, and effectively manage liquidity.

 The quality of financial performance and the quality of 
    information on which the Enterprises' boards and management rely in 
    reaching key business and risk management decisions.

    Quite simply, our examination group provides me with an accurate 
and timely understanding of the Enterprises' financial condition on an 
ongoing basis and provides the Congress with an annual report card on 
how the Enterprises are managing their risk.

Capital
    While examinations are an important part of oversight, it is by no 
means the only area in which Congress provided OFHEO with significant 
regulatory responsibility. The 1992 Act also directed OFHEO to 
establish and enforce two major capital tests for the Enterprises--a 
minimum capital test and risk-based capital stress test.
    Minimum Capital--Since its inception, the OFHEO has ensured that 
both Fannie Mae and Freddie Mac have maintained a capital base 
sufficient to meet statutory minimum capital requirements. These 
requirements utilize a leverage test which is similar to existing 
capital requirements for banks and thrifts.
    The statutory leverage test is quite simple. Each quarter, OFHEO 
aggregates the Enterprises' assets and places off-balance-sheet 
obligations into buckets based on their characteristics. Then, each 
group is multiplied by the capital ratios required in the statute. 
Generally, an Enterprise's assets are multiplied by 2.5 percent and 
outstanding guarantees of mortgage-backed securities and other off-
balance-sheet obligations are multiplied by .45 percent.
    This number is then compared to the Enterprises' core capital--or 
the sum of their (1) common stock, (2) preferred stock, (3) other paid-
in capital, and (4) retained earnings. If core capital exceeds the 
requirement, the Enterprise is considered adequately capitalized. 
However, if a capital shortage exists, the Enterprise is classified as 
either undercapitalized, significantly undercapitalized, or critically 
undercapitalized, based on the size of the deficit and OFHEO's 
enforcement regime is triggered.
    I am very pleased to report that for each quarter the test has been 
applied to the Enterprises, both companies have exceeded their minimum 
capital requirement and thus, have always been classified as adequately 
capitalized.
    Risk-Based Capital--The 1992 Act called for a second capital test 
to be applied to both Enterprises--a sophisticated risk-based capital 
requirement using a stress test. The stress test simulates dramatic 
changes in interest rates and the highest historical declines in 
property values to determine capital requirements.
    This approach is consistent with the Basel proposal, which is 
designed to increase the risk-sensitivity of capital requirements. 
However, due to the homogeneous nature of the Enterprises' business--
and the fact that there are only two--OFHEO is able to take bank-like, 
risk-based capital regulation to a higher level.
    Our risk-based capital regulation will more accurately tie capital 
to risk than any other current or proposed standard. Once calculated 
using the stress test, the statute requires an additional 30 percent 
capital charge for management and operations risk. This add-on is also 
consistent with the opinion of the Basel Committee, which also calls 
for a provision for operations risk.
    I recognize that the OFHEO is long-overdue on this rule. So when I 
took office in October 1999, I made finalizing the rule my top 
priority. Last fall, we finished the text of the rule, continued work 
on having the computer code, which effectualizes the rule, 
independently tested and verified by an accounting firm. In addition, 
we continue to assist Fannie Mae and Freddie Mac in meeting their 
responsibility to process a vast amount of data in the form needed to 
run the test.
    Early last month, we submitted the rule to the Office of Management 
and Budget (OMB) for review. Once the rule is cleared by OMB and the 
rule is published in the Federal Register, Fannie Mae and Freddie Mac 
will be subject to the most sophisticated regulatory capital standard 
of any financial institution in the world. With that in mind, it is my 
view that OFHEO has gone further in its capital regulation--both in 
determining capital levels, as well as ensuring capital adequacy 
through prompt corrective action--than the risk weighted leverage 
approach employed by the banking regulators.
    I don't mean to imply that the banking standard is inappropriate--
not at all. Many banks and thrifts have asserted that their standard 
requires greater capital than that which applies to the Enterprises. 
But the proposed new Basel Accord, like OFHEO's risk-based capital 
standard, recognizes the need to more closely tie capital to risk. And 
because these approaches give institutions credit for risk-mitigation 
activities, the institutions that manage risk well will be rewarded 
with a lower capital requirement. Thus, everyone can benefit if this is 
done right. As the first agency to implement such a capital standard, I 
have made sure that we got it right, even under the tight deadlines I 
have imposed on our staff to finish the job.

Research
    As with all financial regulators, research is an area of great 
importance to the OFHEO's ability to fulfill its mission. Upon taking 
office, I set out to ensure the Office had sufficient research capacity 
to provide me with the independent analysis necessary to consider our 
examination and capital findings in the broader context of the economy 
and the markets in which the Enterprises operate. I am very pleased 
that this initiative has resulted in the OFHEO employing a group of 
talented researchers with expertise in areas including economics, 
financial regulation, and policy analysis.
    From our periodic research on policy matters impacting the 
Enterprises and the routine internal research on the economic and 
financial environment in which the Enterprises operate, I find our 
independent research critical to fully understand the industry, the 
marketplace in which the Enterprises operate, and the stresses of 
economic events in order to meet our Congressional mandate. Without the 
benefit of economic, policy, and other research, it is clear that 
decisions I must make would be done in a vacuum. Thus, although much of 
our research is consumed by an internal audience, it is no less 
critical to fulfilling our mission.

Regulatory Infrastructure
    Finally, I want to briefly touch on the legal apparatus OFHEO has 
put in place to deal with any problems which may occur at either 
Enterprise. Last summer, I announced that OFHEO would be conducting a 
regulatory infrastructure project, designed to provide a comprehensive 
review of and increased transparency into OFHEO's regulatory 
authorities. The project is designed to fully implement the statutory 
mandates of OFHEO, to provide greater certainty for the regulated 
entities and to produce greater transparency for the public in 
understanding OFHEO's administration of its responsibilities.
    This project builds on the existing body of rules and, in many 
cases, formalizes that which the Office already does. To date, this 
project has resulted in the issuance of policy guidances on minimum 
safety and soundness requirements and the management of the 
Enterprises' nonmortgage liquidity investments, as well as final 
regulations on enforcement procedures and OFHEO's annual funding 
assessments. Still pending are rules dealing with prompt supervisory 
response and corrective action, executive compensation, and updating 
the Enterprises' minimum capital requirements. I would also note the 
creation of an internal policy mandating that OFHEO, not less than 
every 5 years, review its regulations for inefficiencies and 
unnecessary burden. The policy sets forth a procedure and even the 
criteria for internal and external review and comments. Once the 
project is complete, OFHEO's regulatory infrastructure will be an open 
book for anyone to comprehend.
    In conclusion, OFHEO is meeting the mission Congress gave us. The 
Enterprises: (1) are subject to on-going oversight through our 
examination program, (2) must meet quarterly minimum capital 
requirements which are similar to existing capital requirements for 
banks and thrifts, (3) will soon be the only entities subject to a 
risk-based capital stress test which closely ties capital to risk, and 
(4) can be held accountable if found lacking in any of these stated 
areas. I assure you, OFHEO will remain vigilant in continuing to 
fulfill our Congressionally-mandated mission.
    Let me again thank Chairman Allard, Senator Reed, and the other 
Members of this Subcommittee for the opportunity to provide my views on 
this important topic.

                               ----------

                PREPARED STATEMENT OF FRANKLIN D. RAINES

            Chairman and Chief Executive Officer, Fannie Mae

                              May 8, 2001

    Good morning, Chairman Allard, Ranking Member Reed, and Members of 
the Subcommittee. My name is Franklin D. Raines, and I am the Chairman 
and Chief Executive Officer of Fannie Mae. I appreciate the opportunity 
to speak to the Subcommittee about Fannie Mae, our role in the 
marketplace, and our regulatory structure. I would also like to commend 
the Subcommittee for the very active role it has played in its 
stewardship of our housing finance system.
    The last time I appeared before the Banking Committee was in March 
1996, when as Vice Chairman of Fannie Mae I testified on the 
implementation of the Federal Housing Enterprises Financial Safety and 
Soundness Act of 1992 (``the Act''). In preparing for today's hearing, 
I reviewed my testimony from 1996 to see where we are relative to the 
course we articulated 5 years ago.
    In 1996, I reported to the Subcommittee on Fannie Mae's progress in 
meeting the statutory housing goals, expanding homeownership and 
affordable rental housing, and strengthening the company's capital 
reserves and risk management. I told the Subcommittee that Fannie Mae 
would invest in technology to reduce the costs of buying a home, help 
lenders provide services to underserved areas of the country, and help 
small lenders succeed in a competitive market. Interpreted by any 
measure the 1992 Act was a success because it recognized that American 
homebuyers, and particularly the first-time homebuyers, are the 
beneficiaries of the careful balance of obligations and benefits that 
defines Fannie Mae's unique role in the housing finance system.
    Today, I am pleased to report to the Subcommittee that Fannie Mae 
has made tremendous progress in each of the areas on which I reported 
to you 5 years ago:

 Since 1996, Fannie Mae has provided $1.45 trillion in home 
    financing for 15 million American families. We have met or exceeded 
    the statutory housing goals every year, and for 2001, HUD has 
    raised the housing goals significantly. In 2000, we met our own 
    1994 goal to invest $1 trillion in targeted housing finance. We set 
    a new goal to invest $2 trillion to help 18 million families 
    achieve homeownership. As part of this goal, our National Minority 
    Homeownership Initiative aims to invest at least $420 billion to 
    serve more than three million minority households over the next 
    decade.

 We have $21.5 billion of private equity capital, up from $13.5 
    billion at the end of 1996. Our single-family credit losses have 
    fallen from 5.3 basis points (0.053 percent) in 1996 to 0.7 basis 
    points (0.007 percent) in 2000.

 Last October we announced a set of path breaking voluntary 
    initiatives to further strengthen our safety and soundness. Our 
    liquidity management, market discipline, and disclosure practices 
    are now at the vanguard of such practices globally, and we and 
    Freddie Mac are the only U.S. corporations to commit to creating a 
    deep and liquid market for our subordinated debt.

 Our indisputable safety and soundness means that Fannie Mae 
    serves as a shock absorber for the entire financial system. In the 
    fall of 1998, the commercial credit markets contracted sharply in 
    response to global financial instability. Because Fannie Mae and 
    Freddie Mac stepped up their mortgage purchases, U.S. homebuyers 
    had ready access to fixed-rate financing at some of the lowest 
    rates in a generation.

 Since 1996, technology has revolutionized the mortgage finance 
    industry. Our technology investments have reduced a lender's cost 
    of originating a loan by more than $1,000 and have helped smaller 
    lenders compete and thrive in a business environment of increasing 
    consolidation. Technology has also allowed us to work more 
    efficiently with smaller lenders in rural communities to expand 
    homeownership opportunities. As Senator Ensign said of a 
    partnership we recently formed with Nevada Bank and Trust, ``With 
    e-commerce, no bank is too small to help its customers realize the 
    dream of homeownership.''

    In all, our record over the last 5 years shows that the compact 
that Congress designed in 1992 between private investors and the 
Federal Government to achieve the public goal of expanded homeownership 
using private capital continues to be a spectacular public policy 
success.

Fannie Mae: A Private Company with a Public Mission
    Congress articulated Fannie Mae's specific public mission clearly 
in the 1992 Act:

 To provide stability in the secondary market for residential 
    mortgages.

 To respond appropriately to the private capital market.

 To provide ongoing assistance to the secondary market for 
    residential mortgages (including activities relating to mortgages 
    on housing for low- and moderate-income families involving a 
    reasonable economic return that may be less than the return earned 
    on other activities) by increasing the liquidity of mortgage 
    investments and improving the distribution of investment capital 
    available for residential mortgage financing.

 To promote access to mortgage credit throughout the Nation 
    (including central cities, rural areas, and underserved areas) by 
    increasing the liquidity of mortgage investments and improving the 
    distribution of investment capital available for residential 
    mortgage financing.\1\
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    \1\ Title XIII of the Housing and Community Development Act of 
1992, Pub. L. No. 102-550, 106 Stat. 3672.

    The business defined by our charter is designed to attract private 
capital to achieve these public purposes. The private individuals and 
firms that hold 1.038 billion shares of Fannie Mae common and preferred 
stock invest their capital in a company with a limited, specific public 
and business mission. In exchange, the Federal Government embraces that 
mission--through Fannie Mae's Congressional charter--and oversees 
companies to ensure they operate in a safe and sound manner.
    The charter includes certain specific benefits that support the 
efficiency of the business venture and indicate the Government's 
commitment to the specific public purposes it has asked Fannie Mae to 
pursue. These benefits in and of themselves are not sufficient to 
attract the private capital necessary to achieve the public goals. It 
is also necessary for Fannie Mae's management to translate the public 
mission into a profitable and sustainable business proposition. We do 
that through expert risk management, constant innovation in every part 
of the business, a tight rein on expenses, and dedication to a 
strategic business plan aimed at expanding homeownership and affordable 
rental housing.
    Because Congress wanted to focus Fannie Mae's use of its benefits 
on reducing costs for low-, moderate-, and middle-income homebuyers and 
on improving market liquidity, Congress defined how Fannie Mae may use 
these benefits. We are in a single line of business--U.S. residential 
mortgages at or below the conforming loan limit (currently $275,000 for 
single-family homes). Within that business, we participate in the 
secondary market; we do not originate mortgage loans. We have specific 
authorizations to deal in Government-insured and conventional single-
family mortgages, second mortgages, and energy efficiency loans.\2\ We 
operate under a rigorous risk-based capital standard, one that most 
banks and thrifts could not meet. We are affirmatively obligated by law 
to operate in all markets under all economic conditions and to meet 
three specific percent-of-business affordable housing goals. Congress 
also requires Fannie Mae to tell investors explicitly that our debt and 
MBS securities are not guaranteed by the Federal Government.
---------------------------------------------------------------------------
    \2\ Fannie Mae Charter Act, 12 U.S.C. Sec. 1717(b).
---------------------------------------------------------------------------
    The focus of Fannie Mae's charter is reflected in the composition 
of our assets, which are dominated by single-family mortgages. Of our 
$701 billion in on-balance-sheet assets at the end of the first quarter 
of 2001, 89 percent were single-family mortgages, 3 percent were 
multifamily mortgages, 6 percent were cash and other liquid assets, and 
2 percent were other assets. In contrast, commercial banks hold a much 
greater variety of assets.

    To ensure we pursue our mission and do so in a safe and sound 
manner, Congress established a comprehensive regulatory regime for 
Fannie Mae and Freddie Mac. That regime places responsibility for 
safety and soundness oversight with the Office of Federal Housing 
Enterprise Oversight (OFHEO) and responsibility for mission oversight 
with the Department of Housing and Urban Development (HUD).
    OFHEO has been conducting a comprehensive, continuous, on-site 
examination program since 1994, the scope and rigor of which equals or 
exceeds that to which any other regulated financial institution is 
subject. OFHEO devotes more staff resources to its examination program 
of Fannie Mae and Freddie Mac than the OCC and the Federal Reserve 
devote to large and far more complex banking institutions. In addition, 
Congress required that the results of OFHEO's examinations be made 
public in OFHEO's Annual Report to Congress. Other financial regulators 
issue annual reports to Congress, but only the OFHEO reports on 
individual companies' exam results.
    OFHEO is also responsible for implementing the minimum and risk-
based capital standards in the 1992 Act. The 1992 Act requires that 
Fannie Mae meet a ratio-based minimum capital standard, as well as a 
stress-test requirement. Under the leverage requirement, we must have 
capital equal to 2.50 percent of on-balance-sheet assets. We must also 
hold capital equal to 0.45 percent for off-balance-sheet assets. Fannie 
Mae must meet this minimum capital requirement using ``core capital''-- 
common stock, perpetual noncumulative preferred stock, paid-in capital, 
and retained earnings.
    The 1992 Act also includes a forward-looking capital standard for 
Fannie Mae and Freddie Mac. The risk-based capital standard requires 
the two companies to be able to withstand severe economic conditions 
that are far more catastrophic and persist far longer than those of the 
thrift crisis in the 1980's. As stated in the statute, the standard 
requires each company to hold enough capital to withstand a 10-year 
stress period characterized by unprecedented interest rate movements 
and credit losses occurring simultaneously, with an additional capital 
requirement to cover management and operations risk. The standard is 
truly extraordinary, and Fannie Mae and Freddie Mac are unique in 
having to meet such a test. Fannie Mae designed its own stress test 
from the specifications in the statute in 1993 and has complied with 
that risk-based capital test ever since. OFHEO is in the final stages 
of promulgating regulations to implement the standard in the 1992 Act. 
The agency has made a great deal of progress recently on the rule, and 
we hope to see the final risk-based capital standard in place as soon 
as possible.
    With regard to mission regulation, HUD is responsible for ensuring 
that Fannie Mae and Freddie Mac carry out their housing missions and 
comply with their charters. HUD sets the annual percent-of-business 
housing goals for our service to low- and moderate-income borrowers, to 
residents of central cities and other underserved areas, and to very 
low-income borrowers. Regulations promulgated by HUD last year take 
effect in 2001 and have raised all three goals substantially. HUD also 
regulates the companies with regard to the fair lending laws, and must 
give its prior approval to new conventional mortgage programs that are 
significantly different than those in place before 1992.

Fannie Mae's Business
    Fannie Mae achieves the purposes in our Congressional charter 
through our two primary lines of business. In our credit guaranty 
business, we create mortgage-backed securities (MBS) from pools of 
mortgage loans originated and owned by lenders. We guarantee timely 
payment of principal and interest on the loans in the MBS, which 
enables lenders to sell the MBS more easily to investors. For taking on 
this credit risk, Fannie Mae earns a guaranty fee on the MBS from the 
lenders who originate the loans. As of March 31, 2001, Fannie Mae's 
outstanding MBS--the MBS on which we provide a credit guarantee but do 
not hold in the portfolio--totaled $726 billion.
    Our second business is our mortgage investment business, in which 
we buy mortgages from lenders in order to replenish the lender's supply 
of cash to make new mortgage loans. We fund these mortgage purchases by 
issuing debt in the global capital markets, and we earn income on the 
spread between our cost of debt and the yield on the mortgages we buy. 
As of March 31, 2001, Fannie Mae's mortgage portfolio investments 
totaled $641 billion.
    Fannie Mae's credit guaranty and mortgage investment businesses 
draw additional investment capital from around the world to the U.S. 
mortgage market, which increases the funds available for homeownership 
and reduces mortgage rates for consumers:

 When Fannie Mae guarantees the credit risk on lender-
    originated MBS, the potential market of investors for mortgages 
    widens substantially. The vast majority of institutional investors 
    do not purchase individual mortgage loans because they are 
    unwilling to take the credit risk on such loans. Instead, they 
    purchase MBS enabling them to avoid the credit risk but still 
    receive compensation (in terms of higher yields) for taking the 
    risk that the loans will prepay if interest rates fall.

 When Fannie Mae purchases mortgages for its investment 
    portfolio, we also greatly expands the range of investors 
    supporting the U.S. mortgage market. We fund those purchases with a 
    mix of four types of debt: short-term debt, and long-term bullet, 
    callable, and subordinated debt. These debt securities appeal to 
    investors who are unwilling to accept the prepayment risk that 
    comes with MBS, but want a yield higher than that on Treasuries. 
    Our short-term debt is safe, highly-liquid, and has stable prices; 
    investors purchase this debt to match short-term obligations and 
    for cash management purposes. Investors who want long-term 
    investments and are prepared to accept some repayment risk, but 
    less than the prepayment risk of MBS, purchase our callable debt 
    securities. Callable debt is debt that Fannie Mae can redeem 
    earlier than its stated maturity. Long-term investors who want more 
    predictable cash flows and no repayment risk purchase our bullet 
    debt, which Fannie Mae may only redeem at the stated maturity date. 
    Investors who want to avoid repayment risk but who want a higher 
    yield than is available on our bullet debt buy our subordinated 
    debt, and in return accept the risk that interest payments will be 
    deferred under certain circumstances.\3\
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    \3\ Prepayment risk is the risk to the investor that the borrower 
will prepay their mortgage before the mortgage is due, causing a 
disruption in cash flow to the investor and causing the investor to 
reinvest their funds in potentially lower yielding investments because 
of declining interest rates. Repayment risk for callable debt is the 
risk to the investor that the issuer will repay (call/redeem) the debt 
before the maturity date, also causing a disruption in cash flow and 
reinvestment risk to the investor. Both risks typically are associated 
with declining interest rates.

    It is important to note that Fannie Mae's debt securities draw 
investors to the U.S. mortgage market who would not otherwise invest in 
mortgages. Investors who purchase Fannie Mae debt want securities with 
less prepayment risk than MBS and are willing to accept lower yields to 
avoid such risk. Without Fannie Mae debt in the market as an available 
investment, these investors would turn to other instruments. The result 
would be lower demand for less capital available to the U.S. mortgage 
market and higher mortgage rates for U.S. homeowners.
A Housing Finance System That Is The Envy Of The World
    The unique combination of obligations and benefits in Fannie Mae's 
charter has given rise to a housing finance system that is the envy of 
the world-- one that is safe, sound, and extraordinarily stable. The 
system also provides U.S. consumers with the types of mortgages they 
prefer: long-term, fixed-rate mortgages with a refinancing option. We 
estimate that, of the $5.2 trillion in U.S. single-family mortgage debt 
outstanding at the end of 2000, 75 percent was in the form of first-
lien, fixed-rate mortgages with terms of at least 5 years. In most of 
the world, the predominant mortgages available to consumers are 
adjustable-rate or balloon mortgages.

    American consumers can obtain mortgages with lower down payments 
and lower interest rates than their counterparts in the rest of the 
industrialized world. In the United Kingdom, down payments are 
generally more than 20 percent, and in Japan and France, they are more 
than 30 percent. In the United States, homebuyers can put as little as 
3 percent down, and increasingly zero-percent down payment mortgages 
are becoming available. In the United Kingdom, the majority of 
homebuyers' monthly mortgage payments change as mortgage rates change, 
and most U.K. homebuyers do not know from 1 month to the next whether 
they will be paying more or less than the month before. In Spain, 
approximately 90 percent of mortgages have variable rates. In the 
Netherlands, where fixed-rate mortgages with low down payments are 
available (although the rate may be fixed only for an initial period), 
homebuyers may pay a penalty if they prepay or refinance their 
mortgages. Prepayment penalties in the U.K. can be as high as 6 percent 
of the unpaid balance of the loan or 6 months of interest. In the 
United States, very few mortgages outside of the subprime market carry 
prepayment penalties. The contrast with our system could not be more 
stark.
    In countries other than the United States, mortgage finance systems 
developed in different ways to solve the same problem: Who should 
accept the prepayment, or interest rate, risk? In the United Kingdom, 
homebuyers take the risk--and see their payments change as rates 
change --because the financial institutions that fund mortgages have 
historically not had access to long-term funding. In Germany, the 
government takes the interest rate risk, and in return requires that 
homebuyers make down payments of 40 percent on their first liens. In 
Mexico, homebuyers bear some or all of the interest rate risk because 
lenders and the government will not accept the rate uncertainty 
stemming from inflation; if rates rise quickly, the extra interest 
homebuyers owe as a result is added to their unpaid balances.
    The housing finance system that Congress designed works very 
differently. Our ability to issue debt across the yield curve, combined 
with our expertise in matching the durations of our debt liabilities 
with those of our long-term, fixed-rate mortgage assets, has allowed us 
to build a specialization in managing the risk on the fixed-rate 
mortgages U.S. consumers prefer. In contrast, banks and thrifts 
specialize in the short-term adjustable-rate and home equity loans that 
match the short-term Federally insured deposits that make up half of 
their liabilities.
    To see this difference in specialization, one only has to contrast 
the composition of the mortgages held by Fannie Mae and commercial 
banks. Nearly all--95.7 percent-- of the single-family mortgages Fannie 
Mae holds in its portfolio are fixed-rate. Another 4.1 percent are 
adjustable-rate, and only a very small amount--0.2 percent--are home 
equity or second mortgages.

    In contrast, our estimates show that commercial banks and thrifts 
hold a considerably lower percentage of fixed-rate mortgages (58.0 
percent) than Fannie Mae, and more adjustable-rate mortgages (28.3 
percent) and home equity and second mortgages (13.8 percent). This 
reflects the advantage in short-term funding that depositories have 
over Fannie Mae and Freddie Mac by virtue of their access to low-cost 
deposits insured by the Federal Government and advances from their own 
Government Sponsored Enterprise, the Federal Home Loan Bank System.

    The difference in specialization between Fannie Mae and 
depositories becomes even more apparent when looked at by mortgage 
type. Reflecting their short-term funding advantage, depositories have 
an 83.8 percent share of the market for home equity loans and second 
mortgages, compared with Fannie Mae's 0.8 percent share. For 
adjustable-rate mortgages, depositories have a 67.5 percent share 
compared with Fannie Mae's 2.9 percent share. Only in the fixed-rate 
segment is Fannie Mae competitive--with a 14.3 percent share compared 
with depositories' 32.8 percent share.

    Because of our presence in the market, consumers can not only get 
the mortgage the long-term, fixed-rate mortgage they prefer, but they 
can also choose among many innovative products to find the fixed-rate 
mortgage that best fits their financial profile. For example, Fannie 
Mae's Flexible 97 is a 30-year, fixed-rate mortgage that requires a 
down payment of as little as 3 percent, and those funds may be in the 
form of grants, gifts, and secured loans. Likewise, many of the 
products under our Community Home Buyers Program offer fixed-rate 
mortgages under more flexible underwriting criteria including lower 
income requirements, lower cash reserve requirements, and lower closing 
costs. Timely Payment Rewards is a mortgage option that allows 
borrowers with slightly impaired credit the chance to finance their 
home at a mortgage rate as much as 2 percent lower than what credit-
impaired borrowers typically pay, with an even lower rate after 24 
months of on-time payments.
Safety and Soundness
    Because Fannie Mae and Freddie Mac play a critical role in 
providing consumers access to the long-term, fixed rate financing they 
prefer, it is essential that the two companies remain at the forefront 
of global safety and soundness practices.
    In 2000, we recognized that there were additional measures we could 
put in place that would assure policymakers that our safety and 
soundness protections are at the forefront of evolving world practices. 
To formulate these measures we turned to the experts: The reports and 
studies of the Basel Committee on Banking Supervision, OFHEO, the 
Federal Reserve, and other policymakers and market participants who 
analyze risk in the financial markets.
    After a comprehensive review of these recommendations, Fannie Mae 
and Freddie Mac, in conjunction with policymakers, crafted a set of 
initiatives designed to place the two companies at the leading edge of 
safety and soundness practices. These commitments were announced with 
Congressman Richard Baker, Congressman Paul Kanjorski, and other 
Members of the House of Representatives last October. Fannie Mae 
committed to issue subordinated debt, obtain an annual credit rating, 
enhance our liquidity planning, disclose more information about 
interest rate risk and credit risk sensitivity, and implement and 
disclose the results of an interim risk-based capital standard. 
Together, these initiatives will give investors and policymakers more 
information about Fannie Mae's risk exposure --and confidence that 
Fannie Mae can manage that exposure --than they can get from any other 
financial institution. I am happy to announce that Fannie Mae has 
implemented all six of these commitments.
    These six new voluntary measures, combined with the regulatory 
mechanisms Congress enacted in 1992, place Fannie Mae at the vanguard 
of risk management and disclosure practices worldwide, with cutting-
edge regulatory discipline bolstered by cutting-edge market discipline.
    Subordinated Debt. In October, we committed to issue publicly 
traded and externally rated subordinated debt. We included subordinated 
debt because it offers real benefits to the market and policymakers. 
First, it is an important way to crystallize the views of thousands of 
investors into a clear signal to policymakers, as to how investors view 
the company's financial condition. Second, it provides an incentive for 
subordinated debt holders to monitor our risk position very carefully. 
Because subordinated debt interest is suspended in the event of 
significant capital erosion, large shifts in the yield of Fannie Mae 
subordinated debt will signal to the OFHEO that the company may have 
increased its risk position. Last, it serves as an additional cushion 
of capital on top of Fannie Mae's required equity capital as defined by 
our statutorily-required minimum levels and our risk-based capital 
stress test.
    In January 2001, Fannie Mae issued $1.5 billion of subordinated 
debt with a maturity of 10 years, and last week we priced our second 
issue of $1.5 billion in 5-year subordinated debt. We also signaled our 
intention, consistent with our commitment in October, to issue 
subordinated debt quarterly during 2001 and on at least a semiannual 
basis thereafter. We expect that by 2003 we will have $12 to $15 
billion in subordinated debt outstanding, with an average maturity of 
at least 5 years.
    Our first two subordinated debt issues received Aa2 ratings from 
Moody's Investors Service and AA- ratings from Standard and Poor's 
(S&P). The rating agencies rated the subordinated debt separate and 
apart from Fannie Mae's relationship with the Federal Government. In 
assigning its AA- rating, S&P stressed that they did not regard the 
Subordinated Notes as being backed by the Government. They wrote:

          Unlike Standard & Poor's triple `A' rating on the senior 
        obligations of Fannie Mae, which incorporates implied 
        Government support, the rating on the subordinated debt assumes 
        that the government would not intervene to prevent payment 
        default on the instrument.\4\
---------------------------------------------------------------------------
    \4\ Standard and Poor's CreditWire, Rating Assigned to Fannie Mae 
Subordinated Benchmark Notes, January 24, 2001.

---------------------------------------------------------------------------
    Moody's said that:

          The debt ratings assigned to the GSE's have the exact same 
        meaning as those assigned to all other firms in the USA and 
        elsewhere. They express Moody's opinion of the ultimate credit 
        risks of a particular debt instrument taking into consideration 
        all relevant factors.\5\
---------------------------------------------------------------------------
    \5\ Fannie Mae and Freddie Mac Subordinated Debt Rating Rationale, 
Moody's Investor Services Special Comment, March 2000, at 3.

    By the terms of the subordinated debt Fannie Mae issued, interest 
payments will automatically suspend if certain capital tripwires are 
activated and, should the company experience difficulties, holders of 
subordinated debt securities will stand in line behind senior debt 
creditors and MBS investors to recover their principal. Unlike other 
subordinated debt issues, the interest deferral cannot be delayed by 
Fannie Mae or any other party if the defined conditions occur. For 
these reasons, the consensus of market analysts was that Fannie Mae 
subordinated debt would be regarded by the market as different from its 
senior debt and would trade at a discount to our senior debt. This has 
proven to be the case.
    The prices at which our subordinated debt has traded indicate that 
the market is behaving consistently with analyst expectations. Our 
first issuance was initially priced at 98 basis points over the 10-year 
U.S. Treasury and 22 basis points over the November 2010 Fannie Mae 
Benchmark Note. Since issuance, our 10-year subordinated debt has 
traded actively in the secondary market, with pricing ranging from 18 
to 28 basis points higher in yield than our senior debt.\6\ Our second 
issuance of 5-year subordinated debt was priced on May 2, 2001, at 71 
basis points over the 5-year U.S. Treasury and 18 basis points over our 
February 2006 Fannie Mae Benchmark Note.
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    \6\ More information on Fannie Mae's subordinated debt is available 
in Fannie Mae's Funding Notes publication, Further Development of 
Fannie Mae's Subordinated Benchmark Notes Program, Volume 6, Issue 4 
(April 2001), at http://www.fanniemae.com/markets/debt/fundingnotes/
pdf/fundingnotes-4-01.pdf.
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    Moody's summarized the beneficial results from subordinated debt, 
emphasizing the difference between it and Fannie Mae's and Freddie 
Mac's senior securities:

          The subordinated debt issued by Freddie Mac and Fannie Mae 
        will, in combination with common and preferred equity, improve 
        senior debtholders' position in the highly unlikely event of a 
        liquidation or similar event. This should help to alleviate 
        concerns about the systemic risks from GSE failure and help to 
        provide an early warning signal to the marketplace in times of 
        stress. . . . The GSE's proposed subordinated debt also would 
        not benefit from the same degree of implied support that senior 
        enjoys and could face mandatory interest payment suspension.\7\
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    \7\ New Freddie Mac and Fannie Mae ``Open Book'' Policy: A Positive 
Credit Development, Moody's Investor Services Special Comment, October 
2000, at 4.

    Our planned, regular, and large-size issuances of subordinated debt 
validate the idea of a dynamic and active subordinate debt market as a 
means of market discipline. Fannie Mae expects that the market will use 
its collective expertise in measuring our risk profile, capital 
adequacy, and financial health each time we bring new issues of 
Subordinated Benchmark Notes to market, as well as in ongoing trading 
in the secondary market. In doing so, Subordinated Benchmark Notes will 
truly be the ``canary in the coal mine'' that is crucial to 
establishing Fannie Mae at the forefront of financial institutions 
globally in adhering to the highest standards of market discipline.
    As Morgan Stanley wrote recently:

          Spreads between the Subordinated Benchmark Notes and its 
        senior Benchmark Notes will provide a real time indicator of 
        investors' perceptions of the adequacy of Fannie Mae's capital 
        relative to the risks it faces. Going forward Fannie Mae will 
        have an additional yardstick with which to gauge the success of 
        its capital policies. In striving to keep these spreads stable, 
        Fannie Mae will have an incentive to communicate more 
        extensively about the risks it faces and how it manages its 
        capital in relation to these risks. This increased transparency 
        to which Fannie Mae is already committed will enable investors 
        to better assess Fannie Mae's risk and the adequacy of its 
        capital.\8\
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    \8\ Morgan Stanley Product Note on Fannie Mae Subordinated 
Benchmark Notes, January 2, 2001.

    Annual Rating. We also committed in October to obtain an annual 
rating from a nationally recognized statistical rating organization of 
our ``risk to the government'' or independent financial strength, and 
that we would disclose this rating to the public.
    On February 27, 2001, S&P assigned a AA- ``risk to the government'' 
rating to Fannie Mae. Only five commercial bank holding companies, and 
no thrifts, have a rating this high on their senior debt. This rating, 
according to S&P, ``refers to the inherent default risk of a Federally 
related entity operating under its authorizing legislation, but without 
assuming an infusion of cash from the Government.'' S&P incorporates 
into the rating such criteria as an evaluation of Fannie Mae's business 
fundamentals, including the company's competitive position, evaluation 
of management and its strategies, and examination of relevant financial 
measures.
    At Fannie Mae's request, S&P's ``risk to the government'' rating 
will be maintained on a continuous, ``surveillance'' basis. This goes 
beyond the annual rating that Fannie Mae committed to obtain last 
October. Under a surveillance rating, S&P will continuously monitor our 
financial position and change the rating--with an accompanying press 
release --if our risk posture changes.
    In summarizing its analysis of Fannie Mae's credit strength, S&P 
wrote:

          Fannie Mae has demonstrated consistently good operating 
        performance over a sustained period of time, testifying to its 
        ability to manage the risks inherent in holding a portfolio of 
        mortgage loans and the strength of its franchise as one of two 
        government sponsored mortgage guaranty agencies. It has 
        successfully weathered changing conditions in the demand for 
        mortgage guaranties, several regional housing market declines, 
        and changing interest rate environments. Asset quality is very 
        strong, and the risk profile of its portfolio of mortgages 
        remains very low. Capitalization has been stable, and is 
        expected to remain so given the regulated nature of the 
        company.\9\
---------------------------------------------------------------------------
    \9\ Standard and Poor's, News, Fannie Mae's Risk to the Government 
Assigned ``AA-'' Rating, February 27, 2001.

    With this ``risk to the government'' rating, Fannie Mae now has 
outstanding a full range of ratings, including those on senior debt, 
subordinated debt, and preferred stock. This suite of ratings gives 
investors a clear, comprehensive, and ongoing assessment of Fannie 
Mae's credit position. And combined with the daily updates to the 
prices of our subordinated debt, Fannie Mae now has more signals than 
any other company of how market professionals view the company's risk 
posture.
    Liquidity. The third initiative from the October package was an 
enhancement of Fannie Mae's liquidity management. When we looked at the 
recommendations from the Basel Committee, we noted an emphasis on 
liquidity management. In its February 2000 paper recommending enhanced 
liquidity management for banks, the Basel Committee noted that:

          Liquidity, or the ability to fund increases in assets and 
        meet obligations as they come due, is crucial to the ongoing 
        viability of any banking organization. . . . Sound liquidity 
        management can reduce the probability of serious problems. 
        Indeed, the importance of liquidity transcends the individual 
        bank, since a liquidity shortfall at a single institution can 
        have system-wide repercussions.\10\
---------------------------------------------------------------------------
    \10\ Basel Committee on Banking Supervision, Sound Practices for 
Managing Liquidity in Banking Organizations, Consultative Paper No. 69 
(February 2000) at 7.

    Based on the discussions of safety and soundness that we had with 
the House Subcommittee and other policymakers last year, Fannie Mae 
wanted to ensure that we met the very highest standards of liquidity 
---------------------------------------------------------------------------
management. As a result, we committed to:

 Maintain 3 months worth of liquidity, as recommended by the 
    Basel Committee, based on the assumption that the company has no 
    access to the public new-issue debt markets during this period.

 Maintain at least 5 percent of our on-balance-sheet assets in 
    a liquid, marketable portfolio of nonmortgage securities.

 Comply with the 14 principles of sound liquidity management 
    set forth by the Basel Committee in February 2000.\11\
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    \11\ Basel notes that ``[t]he relevant time-frame for active 
liquidity management is generally quite short. . . . Banks which are 
reliant on short-term funding will concentrate primarily on managing 
their liquidity in the very short term (say the period out to 5 days). 
. . . Other banks (for example, those that are less dependent on the 
short-term money markets) might actively manage their net funding 
requirements over a slightly longer period, perhaps 1 to 3 months 
ahead.''

    In mid-March 2001, Fannie Mae announced that we had met this 
commitment. We have a contingency plan in place to ensure that we could 
meet our funding needs for 3 months without access to the agency debt 
markets. We are maintaining more than 5 percent of our on-balance-sheet 
assets in high-quality, liquid, nonmortgage securities. In fact, Fannie 
Mae's ratio of liquid assets to total assets was 6.3 percent as of 
March 31, 2001, and we are disclosing this ratio to the public on a 
quarterly basis. And last, our liquidity plan meets the 14 principles 
for sound liquidity management set forth by the Basel Committee and 
satisfies our safety and soundness regulator. We have briefed OFHEO on 
our liquidity plan, and OFHEO has confirmed that the plan would ensure 
that Fannie Mae could function for 3 months without access to the new 
issue debt markets.
    These commitments are in addition to a rigorous liquidity program 
already in place at Fannie Mae. We begin with a close cash-flow match 
between our assets and liabilities. In addition, we manage our liquid 
assets under strict investment guidelines approved by our Board of 
Directors. Under these limits, liquid assets have an explicit goal of 
zero credit losses. Fannie Mae's typical liquid assets are money market 
paper and AAA-rated securities. Understandably, the margins on these 
high quality, liquid investments are much lower than those Fannie Mae 
earns on our mortgage portfolio, but that is the opportunity cost the 
company pays to maintain a safe cushion of liquidity.
    By virtue of the company's sound liquidity practices and our 
commitment to maintain more than 3 months worth of liquid assets, 
Fannie Mae is positioned not only to withstand swings in the markets, 
but also to provide liquidity to the market when other financial firms 
withdraw. Thus, for example, during the market turbulence in the second 
half of 1998, when other investors withdrew from the market, Fannie Mae 
stepped up our mortgage purchases--largely by drawing down liquid 
assets--which maintained the stability of the mortgage market and kept 
mortgage rates at historic lows for homebuyers.
    New Risk Disclosures. Our subordinated debt issuance and annual 
ratings can serve as excellent signals to policymakers and investors, 
but the company has added additional transparency that puts it at the 
leading edge of risk disclosures. The fourth and fifth of our October 
initiatives were our new monthly interest rate risk sensitivity 
disclosures and new quarterly credit risk disclosures.
Interest Rate Risk Disclosures
    We committed to disclose on a monthly basis the impact on Fannie 
Mae's financial condition of a plus or minus 50 basis point 
instantaneous change in interest rates and an instantaneous 25 basis 
point shift in the slope of the yield curve in both directions. On 
March 26, 2001, we made our first monthly interest rate risk disclosure 
under this commitment to investors and the public. Going beyond the 
commitment we made in October, Fannie Mae released the two primary 
measures of interest rate risk that the company uses in managing our 
interest rate business: Portfolio net interest income at risk and 
effective asset/liability duration gap.
    Fannie Mae's net interest income at risk measure discloses the 
sensitivity of Fannie Mae's projected net interest income to an 
immediate 50 basis point increase or decrease in interest rates and a 
25 basis point increase or decrease in the slope of yield curve. Net 
interest income at risk compares projected net interest income under 
the more adverse of the interest rate and yield curve scenarios with 
projected net interest income without the interest rate shocks. We are 
disclosing our net interest income at risk over both a 1- and 4-year 
period. For the 4-year disclosure, the net interest income at risk 
calculation reflects the percentage difference in cumulative net 
interest income over the period.
    As of March 31, 2001, the company's net interest income at risk 
from a 50 basis point change in interest rates was 3.8 percent over the 
next 1 year, and 3.2 percent over the next 4 years. The company's net 
interest income at risk from a 25 basis point change in the slope of 
the yield curve was 3.1 percent over the next 1 year, and 4.7 percent 
over the next 4 years.
    These changes in interest rates and in the slope of the yield curve 
encompass about 95 percent of the actual changes that are likely to 
occur over the one-month reporting period. Fannie Mae generally expects 
our net income at risk measures to range between 1 and 5 percent.
    In addition, we are supplementing our net interest income at risk 
disclosure with monthly disclosure of the company's effective asset/
liability duration gap. Effective duration is a measure of the 
sensitivity of a security's value to changes in interest rates, and is 
commonly used in fixed-income portfolio management. Fannie Mae has 
successfully used effective duration gap as an internal risk management 
tool for a number of years, and we report on duration management to our 
Board of Directors. We also reported this information as of year-end in 
our Annual Report to the shareholders.
    As of March 31, 2001, the effective duration gap of our mortgage 
portfolio was a positive 1 month. A positive duration gap indicates 
that the effective duration of the portfolio's assets exceeds the 
effective duration of its liabilities by that amount, while a positive 
duration gap indicates the opposite. Fannie Mae has a target range for 
our effective duration gap of plus or minus 6 months. When the duration 
gap moves outside this range--which it can do if interest rates move 
quickly or by large amounts--we rebalance our assets and liabilities to 
bring the duration gap within the target band.
    Fannie Mae's interest rate risk disclosures follow the 
recommendations of the New Basel Accord and the report of the Working 
Group on Public Disclosure, headed by Walter V. Shipley. Both recommend 
that risk disclosures be consistent with internal risk management 
practices. Net interest income at risk and duration gap are the primary 
portfolio risk measures at Fannie Mae. Basel further proposes that 
disclosures incorporate expected future activity, and that 
sophisticated disclosures use multiple simulations of interest rates. 
Fannie Mae's net interest income at risk measure is based on projected 
future activity over the next one and 4 years, and both net interest 
income at risk and duration gap are calculated using at least 300 
interest rate paths.

Credit Risk Disclosures
    We also committed in October to disclose on a quarterly basis the 
sensitivity of expected credit losses from a 5 percent drop in property 
values. On March 26, 2001, Fannie Mae released our first quarterly 
credit risk disclosure under this commitment.
    To calculate our credit risk sensitivity, Fannie Mae uses internal 
credit models, as recommended by Basel, to project the present value of 
future credit losses. We then calculate the present value of losses 
assuming an immediate 5 percent decline in the value of all properties 
securing mortgages owned or guaranteed by Fannie Mae. Following this 
decline, home prices are assumed to increase at the same long-run rate 
embedded in the company's credit pricing models. Projected default 
incidence and loss severity are consistent with the assumed changes in 
home prices. The sensitivity of future credit losses is the dollar 
difference between credit losses in the baseline scenario and credit 
losses assuming the immediate 5 percentage point home price decline.
    As of December 31, 2000, the company's net sensitivity of future 
credit losses, taking into account the effect of credit enhancements, 
was $295 million. This figure reflects a gross credit loss sensitivity 
of $1,065 million without the effect of credit enhancements, and is net 
of projected credit risk sharing proceeds from mortgage insurance 
companies, lenders, and others of $770 million.
    Fannie Mae's current low level of sensitivity to credit losses 
reflects the quality of our existing book of business, the impact of 
our loss mitigation techniques, and the effectiveness of our credit 
enhancement and risk-sharing strategies. While slightly less than 40 
percent of Fannie Mae's single-family portfolio as of December 31, 
2000, was covered by credit enhancements, we project that our credit 
enhancement counterparties would absorb $770 million, or 72 percent, of 
the increase in credit losses that would result from a 5 percent home 
price shock.
    We expect our credit risk sensitivity to vary over time based on a 
number of factors, including the composition of the company's credit 
portfolio, recent home price changes, the level of interest rates, and 
the amount of mortgage insurance and other credit enhancements that 
reduce Fannie Mae's losses.
    Interim Implementation of the Risk-Based Capital Rule. The final 
component of the October 2000 voluntary initiatives is our commitment 
to implement on an interim basis the risk-based capital stress test 
included in the 1992 Act and disclose to the public whether we passed 
or failed the test. We will run this interim implementation only until 
the final risk-based capital standard is adopted by OFHEO.
    The stress test spelled out in the 1992 Act requires Fannie Mae to 
hold sufficient capital to withstand an unprecedentedly severe economic 
and financial shock that extends for 10 years, without defaulting on 
our obligations. The test includes severe adverse interest-rate 
movements and nationwide depression-level conditions in residential 
real estate lasting throughout the decade-long period. The required 
level of current capital is an amount sufficient for Fannie Mae to 
remain solvent in every quarter throughout the 10-year span of adverse 
economic conditions plus, for good measure, an additional 30 percent to 
account for operations risk.
    The possibility of these two credit and interest-rate scenarios 
happening simultaneously is extremely small, and very few companies 
could survive for 10 years the type of environment assumed in Fannie 
Mae's stress test. Indeed, a study commissioned by Fannie Mae found 
that the thrift industry would have to boost its capital base by 60 to 
90 percent to be able to survive the type of scenario envisioned by 
Fannie Mae's stress test.\12\
---------------------------------------------------------------------------
    \12\ Dave Dufresne, Risk-Based Capital and the Thrift Industry: 
Implications of Risk-Based Capital Stress Test Requirements 7 (IPS-
Sendero, February 1999).
---------------------------------------------------------------------------
    Fannie Mae has run our own internal version of the risk-based 
capital stress test since 1993, and has built capital and managed our 
business to remain in compliance with that test. For purposes of the 
voluntary disclosure, Fannie Mae constructed an interim implementation 
of the risk-based capital test using the OFHEO's Notice of Public 
Rulemaking 2 (NPR2) as a basis, modified to reflect subsequent changes 
implemented or suggested both by OFHEO and the company.
    OFHEO's NPR2 was published in the Federal Register in April 1999, 
and is extensively documented. Since April 1999, OFHEO has made 
corrections to NPR2, and the corrections are noted on the OFHEO web 
site. In constructing our interim stress test, Fannie Mae incorporated 
OFHEO's NPR2 changes along with the changes we recommended in our March 
10, 2000, comment letter to OFHEO and other refinements enumerated on 
our web site (www.fanniemae.com). Fannie Mae will disclose whether we 
have passed or failed our interim risk-based capital test as of the end 
of each quarter, and also give an indication of the amount by which our 
total capital exceeds or falls short of the calculated risk-based 
requirement.
    In March 2001, we announced that we had sufficient capital to pass 
our interim version of the OFHEO risk-based capital test as of December 
31, 2000, and that our capital cushion on that date was between 10 and 
30 percent of total capital. We were able to pass the interim risk-
based capital test because of the substantial amount of hedging and 
loss-sharing arrangements in which we engage. Typically between 45 and 
50 percent of Fannie Mae's liabilities consist of callable debt or 
other option-based instruments. Our reliance on mortgage insurance and 
credit risk sharing arrangements reduce credit risk exposure and allow 
the company to withstand the stresses in the risk-based capital test.
    Fannie Mae's interest rate risk and credit risk disclosures 
complement the results of our quarterly stress test. In summarizing the 
value of the package of disclosures to which Fannie Mae and Freddie Mac 
committed themselves, Moody's stated:

          These financial disclosure commitments by Fannie Mae and 
        Freddie Mac set new standards not only for them, but also for 
        the global financial market.
          The provision by Fannie Mae and Freddie Mac of periodic, 
        detailed risk information to the broad market will permit 
        better independent reviews and monitoring of their risk 
        profiles and should substantially reduce the uncertainty about 
        their actual financial health, as well as dampen any systemic 
        risks they present.
          The regular disclosure of their interest and credit risk 
        exposure, combined with stress testing of their capital base, 
        should significantly increase market comfort with their risk 
        management disciplines and capital adequacy. The stress test, 
        in particular, will show whether the two GSE's have sufficient 
        capital to withstand very harsh market developments over a long 
        period.\13\
---------------------------------------------------------------------------
    \13\ Moody's Investor Service, Op. Cit. at 4.
---------------------------------------------------------------------------
Conclusion
    A generation ago, the housing industry was more cyclical than it is 
today, and when the economy slowed, housing slowed as well. Today, the 
housing sector--which makes up about 8 percent of annual gross domestic 
product--is more stable than other sectors of the economy. Indeed, 
while the manufacturing sector is in a downturn, overall job growth has 
slowed sharply and orders for high-tech equipment have dropped 
significantly, housing activity has remained robust. Total home sales 
in the first quarter of 2001 were at a record level--with new sales in 
March at an all-time high and existing sales at their second highest 
level ever.
    The strength of the housing industry translates into greater 
financial stability for American families. Strong home price 
appreciation in recent years has increased the average net worth of 
homeowners, and these gains in housing wealth have helped offset 
declines in equity wealth.\14\ With the declining trend in mortgage 
rates--from 8.62 percent last May to the current rate of slightly over 
7 percent--many homeowners have refinanced, allowing them to reduce 
their monthly mortgage payments. The extra cash from refinancing has 
enabled households to increase their spending, which has helped cushion 
the slowing economy. We estimate conservatively that consumer spending 
may increase by $40 billion this year as a result of refinancing 
activity.
---------------------------------------------------------------------------
    \14\ According to the House Price Index from the Office of Federal 
Housing Enterprise Oversight, the year-over-year average increases in 
home prices in 1998, 1999, and 2000 were 5.5 percent, 5.8 percent, and 
7.7 percent, respectively.
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    The financing that Fannie Mae provides through all types of 
economic circumstances is one reason that housing is so stable. Despite 
stagnating home prices in California in the first half of the 1990's 
and in New England in early 1990's, Fannie Mae delivered a steady 
supply of financing to lenders across the country and consistent 
earnings to our investors. Our strong financial performance over time 
is a key factor in drawing investors from around the world to invest 
their capital in U.S. housing finance.
    This financial strength means that we are ready to meet the housing 
finance challenges ahead. The homeownership rate in America today 
stands at a record 67.5 percent, but the gap between whites and 
minorities is huge. Seventy-four percent of white Americans own their 
homes, but that figure is less than 50 percent for minorities. We have 
the best housing finance system in the world. Now we must make it work 
for more American families.
    In this context, I would like to propose a straightforward test for 
examining policy proposals that affect the housing finance system:

 Do they reduce costs for consumers?
 Do they improve the safety and soundness of the housing 
    finance system?
 Do they expand opportunities for homeownership?
 Do they allow innovation in the market without cumbersome 
    regulatory requirements?

    I proposed a test similar to this in 1996, when I testified before 
the Banking Committee, and they remain relevant, particularly in view 
of the challenges we continue to face in expanding homeownership 
opportunities for all Americans.
    Thanks to Congress' wisdom in understanding the power of private 
enterprise to meet this critical public purpose --and in crafting a 
compact with private investors--no single company in America is 
focusing more capital and commitment to closing the homeownership gap 
than Fannie Mae. We are in the American Dream business, and our mission 
is to ``tear down barriers, lower costs and increase the opportunities 
for homeownership and affordable rental housing for all Americans.'' In 
partnership with mortgage lenders, elected leaders, housing leaders, 
community groups, and many others, Fannie Mae will bring more 
homeownership to more people and places than ever.
    Thank you for inviting me to testify before you today. I look 
forward to working with the Subcommittee on these important issues.

                PREPARED STATEMENT OF LELAND C. BRENDSEL

           Chairman and Chief Executive Officer, Freddie Mac

                              May 8, 2001

    Good morning, Chairman Allard, Senator Reed, and Members of the 
Subcommittee. It is a pleasure to be here. I am Leland C. Brendsel, 
Chairman and Chief Executive Officer of the Federal Home Loan Mortgage 
Corporation, known as Freddie Mac.

Executive Summary
    Freddie Mac plays a vital role in financing homeownership and 
rental housing for the Nation's families. Mortgage funds are available 
whenever and wherever they are needed. Mortgage rates are lower, saving 
homeowners thousands of dollars in interest payments. Thirty-year 
fixed-rate mortgages are plentiful, protecting families from unexpected 
interest-rate increases. In addition, the availability of low down 
payment loans has helped open the door of homeownership to more low- 
and moderate-income families.
    Freddie Mac's ability to continue to provide these benefits rests 
on our financial strength. As a result of our superior risk management 
capabilities, strong capital position and state-of-the-art information 
disclosure, Freddie Mac is unquestionably a safe and sound financial 
institution. Freddie Mac is fiercely committed to maintaining the 
confidence of Congress, investors and the public in our financial 
strength because that is what we need to meet our mission.
    Last October, Freddie Mac made six commitments that keep us at the 
vanguard of world financial practices. These commitments are 
significant. They outpace the financial management practices of other 
institutions; they meet or exceed recommendations of international 
experts in financial risk and capital management; and they set a new 
standard for global financial institutions. We made these commitments 
voluntarily. There can be no doubt that Freddie Mac will be able to 
serve our vital mission in a safe and sound manner for generations to 
come.

Freddie Mac Brings Tremendous Benefits To Consumers
    Freddie Mac is a shareholder-owned corporation chartered by 
Congress in 1970 to create a stable flow of funds to mortgage lenders 
in support of homeownership and rental housing. We bring tremendous 
benefits to America's families.
    Constant Availability. There is never a shortage of mortgage money. 
Freddie Mac's high-quality, liquid mortgage and debt securities attract 
global investors to finance America's housing. A diversified investor 
base makes the housing finance system highly resilient and stable. When 
other markets face disruption--as they did during the global financial 
turmoil in the fall of 1998--there is no disruption whatsoever in the 
mortgage market we serve.
    Low Cost. By linking local communities with global investors, 
Freddie Mac enables homebuyers to compete for funds in the capital 
markets alongside the largest corporations. As a result, families save 
thousands of dollars in mortgage interest. In a recent report, former 
Office of Management and Budget Director Dr. Jim Miller and fellow 
economist Dr. James Pearce totaled the savings to America's families to 
between $8 billion and $23 billion each year.\1\
---------------------------------------------------------------------------
    \1\ Pearce, James E. and Miller III, James C., ``Freddie Mac and 
Fannie Mae: Their Funding Advantage and Benefits to Consumers,'' at 29 
(2001). Available at http://www.fhlmc.com/vitalrole/docs/cbo-final-
pearcemiller.pdf. The Freddie Mac commissioned report estimates the 
funding advantage between $2.3 billion to $7.0 billion. Drs. Pearce and 
Miller concluded: ``Thus, even using the lowest estimate of consumer 
benefits and the highest estimate of the funding advantage in our range 
of estimates, the value of consumer interest-cost savings resulting 
from Freddie Mac and Fannie Mae's activities significantly exceeds the 
highest estimate of their funding advantage.''
---------------------------------------------------------------------------
    Perhaps the best evidence of how we save consumers money is in the 
weekly real estate section of major newspapers. For example, in its 
Saturday Real Estate section, The Washington Post provides two sets of 
mortgage interest rates: Those for conforming mortgages, which are 
eligible for Freddie Mac purchase (currently up to $275,000 for a 
single-family home), and those for higher-balance jumbo loans. 
Invariably, rates on conforming mortgages are lower than those on jumbo 
loans by as much as 50 basis points. Furthermore, Freddie Mac's 
activities lower mortgage interest rates on all conforming loans, not 
simply the ones we purchase. Whether a conforming loan is held in 
portfolio by a bank or a credit union, mortgage rates are lower for all 
conforming market borrowers.
    Uniformity. Freddie Mac purchases mortgages in every community in 
the country. As a result, a borrower in Denver pays the same for a 
mortgage as a borrower in Providence. This stands in sharp contrast to 
1970 when mortgage interest rates differed by as much as one and a half 
percentage points across the country.
    Product Choice. America's families choose from a broad array of 
mortgage products, including the 30-year fixed-rate mortgage with a low 
down payment. In many other countries, this type of mortgage is simply 
not available.
    Innovation. From the development of the mortgage securities market 
in the 1970's to the development of automated underwriting in the 
1990's, Freddie Mac has been at the forefront of innovation in the 
mortgage market. Borrowers are the direct beneficiaries of Freddie 
Mac's innovation.
    In 1995, Freddie Mac introduced automated underwriting to the 
market with our Loan Prospector  automated underwriting 
service. Loan Prospector  has revolutionized the mortgage 
origination process, reducing the time and expense of getting a loan. 
Automated underwriting also brings greater objectivity and fairness to 
lending decisions. Every piece of information is evaluated the same way 
for every borrower, every time, with an accuracy no human underwriter 
can match. This high degree of accuracy has led to the development of 
new products that would have been deemed too risky a few years ago. The 
Joint Center for Housing Studies at Harvard University concludes that 
these products enable ``more income-constrained and cash-strapped 
borrowers at the margin to qualify for mortgage loans.'' \2\
---------------------------------------------------------------------------
    \2\ Joint Center for Housing Studies of Harvard University, State 
of the Nation's Housing 1999, p. 4.
---------------------------------------------------------------------------
    High Standards. By bringing competition, standardization, and 
accountability to the mortgage market, Freddie Mac promotes responsible 
lending. We have taken a leadership role in combating predatory lending 
practices.
    Economic Stability. Freddie Mac's activities also play a vital role 
in stabilizing our Nation's economy. When the economy weakens, we 
deliver lower interest rates to the mortgage market. This, in turn, 
boosts housing activity, which is often just the spark the economy 
needs. According to Barron's:

          If the Fed has staved off a recession, some of the credit 
        should go to Freddie Mac and Fannie Mae. By helping to transmit 
        the benefits of the central bank's rate cuts to the mortgage 
        market, these agencies have done their part in cushioning the 
        impact of the Nasdaq knockdown on the American consumer.\3\
---------------------------------------------------------------------------
    \3\ Ablan, Jennifer, ``Despite Treasury Selloff, More Fed Easing 
Ahead?'' Barron's Online (January 15, 2001).

    Lower mortgage rates also enable existing homeowners to refinance 
their mortgages, putting real money back into their pockets. The easing 
of mortgage interest costs and the strength of the housing market are 
among the bright spots on today's economic horizon.
    Homeownership. The stability, efficiency, and innovation that 
Freddie Mac brings to the mortgage market turn homeownership dreams 
into reality. Since our inception, Freddie Mac has purchased more than 
$2 trillion in residential mortgages, financing homes for more than 27 
million families. In so doing, we have contributed to an all-time high 
homeownership rate. Today, more than two-thirds of America's families 
are homeowners, building wealth and brighter prospects for their 
future.
    Freddie Mac brings tremendous benefits to the Nation. They far 
outweigh any benefits we derive from our Congressional charter. 
America's homebuyers can depend on Freddie Mac because we are safe, 
sound, and strong.

Superior Risk Management
    Freddie Mac has a 30-year record of successfully managing our 
business in a rigorous and disciplined way. The tools we have developed 
to manage both credit and interest-rate risk are second to none, and 
our exposure to these risks remains at very low levels.
    Credit Risk Management: Freddie Mac operates in only one business--
residential mortgages. This business has low credit risk, which is the 
risk that borrowers will default on their loans. Because of the value 
attached to homeownership, families pay their monthly mortgage payment 
first and faithfully. More than $500 billion in home equity stands 
between Freddie Mac and the risk of default on the mortgages we own. We 
are further protected through the use of third-party credit 
enhancements on a large share of our mortgage purchases. These 
enhancements include recourse arrangements with our lenders and 
mortgage insurance on low down payment loans. Finally, by funding 
mortgages nationwide, geographic diversity mitigates the risk of local 
economic downturns.
    These extensive loss protections support mortgages that are 
underwritten and managed using state-of-the-art statistical tools. Loan 
Prospector  is used by thousands of lenders to originate 
mortgages that Freddie Mac purchases; in fact, Loan Prospector 
 recently processed its 10 millionth loan. Automated 
underwriting's sophisticated evaluation of risks allows us to purchase 
mortgages with low down payments in a safe and sound manner. Freddie 
Mac further mitigates credit losses by actively seeking alternatives to 
foreclosure. Our loss mitigation techniques reduce credit costs and in 
many cases enable struggling borrowers to keep their homes.
    Our credit risk management techniques have produced extraordinarily 
low credit losses. Freddie Mac's mortgage delinquency rates are 
consistently and significantly lower than the overall conventional 
market, and much lower than those of the Federal Housing 
Administration. Our loan charge-offs are significantly lower than those 
of banks and thrifts. We maintain loan loss reserves that are seven 
times our credit losses, and hold capital against credit losses 
sufficient to withstand severe losses.
    Interest-Rate Risk Management: Freddie Mac also is a leader in 
managing interest-rate risk. Interest-rate risk is the risk that 
changes in the level of interest rates could adversely affect the value 
of a portfolio and could lead to mismatches in the expected cash flows 
between assets and liabilities. Freddie Mac's interest-rate risk 
exposure results primarily from the uncertainty as to when borrowers 
will pay off their mortgages. When mortgage interest rates decline, 
borrowers tend to prepay their mortgages by refinancing into lower-cost 
loans. This creates financing challenges for mortgage investors who 
must find alternative investment instruments in a lower yield 
environment.
    Freddie Mac manages this risk on the mortgages we buy using 
extremely disciplined standards. We fund our mortgage investments with 
an appropriate mix of bullet debt, callable debt, and effective 
callable debt. We closely monitor the sensitivity of our portfolio to 
changes in the interest-rate environment and rebalance our portfolio as 
needed. We regularly reassess the accuracy of our prepayment models.
Strong Capital Management And Supervisory Oversight
    Not only is Freddie Mac highly skilled at managing risk, we are 
extremely well-capitalized for the risks we take. We manage our 
business to hold enough capital to withstand 10 years of economic 
stress resembling the Great Depression. In addition to our own rigorous 
capital management, the Federal Housing Enterprises Financial Safety 
and Soundness Act of 1992 (the GSE Act) subjects us to both a minimum 
capital requirement and a stringent risk-based capital standard. The 
minimum capital requirement applies to both on-balance-sheet and off-
balance-sheet assets, unlike bank capital standards. The risk-based 
capital standard is the industry's toughest, requiring us to withstand 
10 years of extremely severe stress.
    Our safety and soundness regulator, the Office of Federal Housing 
Enterprise Oversight (OFHEO), currently assesses our financial strength 
using the minimum capital standard.\4\ Each quarter since OFHEO began 
assessing Freddie Mac's capital in 1993, our regulator has determined 
that Freddie Mac is adequately capitalized, which is the highest 
rating. OFHEO is required to communicate examination results, as well 
as its determination of our capital strength in an annual report to 
Congress.
---------------------------------------------------------------------------
    \4\ The GSE Act established a minimum capital requirement as the 
sum of 2.5 percent of on-balance-sheet assets and 0.45 percent of 
outstanding mortgage-backed securities and other off-balance-sheet 
obligations. 12 U.S.C. Sec. 4612.
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    The risk-based stress test required by the GSE Act is innovative, 
stringent, dynamic, and more responsive to risk than any ratio-based 
capital regulation.\5\ It requires Freddie Mac to maintain sufficient 
capital to withstand a 10-year period of extreme swings in both credit 
and interest-rate risks.
---------------------------------------------------------------------------
    \5\ 12 U.S.C. Sec. 4611.
---------------------------------------------------------------------------
    The credit risk portion of the stress test is based on the 
assumption that defaults and losses on mortgages occur throughout the 
United States at a rate and severity equal to the highest default rates 
experienced in a regional downturn.\6\ In implementing this extremely 
severe scenario, OFHEO intends to subject Freddie Mac's entire mortgage 
portfolio to the actual default experience of the collapse of real 
estate in the oil-belt States in the 1980's. The default rates on 
mortgages with low down payments during this period were approximately 
25 percent; loss rates were approximately 60 percent.
---------------------------------------------------------------------------
    \6\ 12 U.S.C. Sec. 4611(a)(1).
---------------------------------------------------------------------------
    The interest-rate risk portion of the test mandates a stress test 
in which yields on 10-year Treasury bonds fall or rise by as much as 
600 basis points.\7\
---------------------------------------------------------------------------
    \7\ 12 U.S.C. Sec. 4611(a)(2).
---------------------------------------------------------------------------
    Further, the GSE Act requires a 30 percent add-on to required 
stress test capital to account for management and operations risk.\8\
---------------------------------------------------------------------------
    \8\ 12 U.S.C. Sec. 4611(c)(2).
---------------------------------------------------------------------------
    A pioneer in the use of risk-based stress tests, Freddie Mac 
believes that a well-implemented regulation would meet four key 
criteria:

 The test must be consistent with the GSE Act. For example, the 
    Act calls for the projected stressful conditions to reasonably 
    reflect economic reality and past experience. This means that every 
    assumption from interest rates to prepayment rates to house-price 
    appreciation must be derived from historical data.

 The test must tie capital to the actual risks we face. 
    Assigning too little capital or too much both have negative 
    consequences. Too little capital could jeopardize our ability to 
    withstand an extreme downturn in the economy. On the other hand, 
    requiring too much capital would impose unnecessary costs on the 
    Nation's families. Mortgage rates would rise, and mortgage products 
    attractive to lower income borrowers might become unavailable.

 The test must be operationally workable. For Freddie Mac to 
    purchase mortgages on a daily basis, we must be able to calculate 
    the amount of capital that will be required and incorporate it into 
    our business processes. The test must produce reliable and accurate 
    results.

 The test must foster innovation. Freddie Mac is relentless in 
    our search to wring out every inefficiency and barrier to 
    homeownership. New instruments for managing risk and financing 
    housing are constantly being developed in the markets. The test 
    must encourage Freddie Mac to quickly respond to new opportunities 
    while remaining safe and sound.

    Freddie Mac is working with OFHEO toward final risk-based capital 
regulations that will be a model for the industry.
    OFHEO currently carries out a detailed and comprehensive 
examination program, which includes continuous on-site examinations and 
quarterly capital determinations. OFHEO's highly regarded examination 
staff focuses all day, every day on two companies in one line of 
business. By comparison, examiners of large banks must inspect 
activities ranging from annuities to foreign currencies to commercial 
loans to credit cards taking place at hundreds of subsidiaries here and 
around the world. Despite the monoline nature of Freddie Mac's 
business, there are roughly the same number of examiners reviewing 
Freddie Mac as there are reviewing a large bank's dozens of business 
lines.

Comprehensive Disclosure That Promotes Market Discipline
    We disclose more information to the public about the risks we face 
and our effectiveness at managing them than almost any other financial 
institution. The annual report and quarterly information statement 
supplements of Freddie Mac provide comprehensive information related to 
credit risk. They include extensive discussion, analysis, and 
quantification of types of credit risk exposures, such as the ``at-
risk'' share of delinquent loans, loan-to-value ratios, and geographic 
concentrations.
    Freddie Mac's interest-rate risk disclosures are similarly 
comprehensive. Our quantitative methodologies measure the change in 
portfolio market value that would be caused by immediate upward or 
downward shifts in interest rates.\9\ Freddie Mac provides these 
disclosures on a regular basis, exceeding the annual disclosure 
requirements required of financial institutions by the Securities and 
Exchange Commission (SEC).
---------------------------------------------------------------------------
    \9\ Freddie Mac's quantitative disclosures employ sensitivity 
analysis, one of three methods of quantitative disclosure prescribed by 
the Securities and Exchange Commission. SEC's rules require SEC 
registrants to provide quantitative disclosure about market risk 
sensitive instruments, and permit them to use: (1) a tabular 
presentation of fair value information and of contractual terms; (2) a 
sensitivity analysis; or, (3) a value-at-risk methodology.
---------------------------------------------------------------------------
    Last year, Freddie Mac requested that PriceWaterhouseCoopers (PWC) 
compare our public risk disclosures to those of selected financial 
institutions generally recognized to be providing best-in-class risk 
management disclosures.\10\ PWC found that our risk management 
disclosures ``are among the best of the risk management disclosures 
provided by the recognized best-in-class group included in this 
study.'' \11\
---------------------------------------------------------------------------
    \10\ PriceWaterhouseCoopers, ``Freddie Mac: Risk Disclosure 
Benchmarking Study'' (May 15, 2000).
    \11\ Id. p. 4.
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    Greater transparency through information disclosure exposes an 
institution to the rigorous discipline of financial markets. If 
investors perceive that a company's financial condition has 
deteriorated, they will require higher yields on their investments to 
assume the higher risk.
    Market discipline is not a replacement for strong capital and 
vigilant oversight, but is a necessary and desirable complement. 
Recently, Federal Reserve Chairman Alan Greenspan called market 
discipline the ``first line of regulatory defense.'' \12\ In a speech 
to the American Bankers Association, he stated that:
---------------------------------------------------------------------------
    \12\ Remarks by Federal Reserve Chairman Alan Greenspan in his 
address ``Banking Supervision,'' before the American Bankers 
Association, Washington, DC (September 18, 2000).

          We are moving toward a system in which . . . public 
        disclosure and market discipline are going to play increasing 
        roles, especially at our large institutions, as a necessity to 
        avoid expansion of invasive and burdensome supervision and 
        regulation. Bank regulators are perforce being pressed to 
        depend increasingly on greater and more sophisticated private 
        market discipline, the still most effective form of 
        regulation.\13\
---------------------------------------------------------------------------
    \13\ Ibid.

    OFHEO also has endorsed market discipline as an important component 
of a comprehensive regulatory framework. In its most recent annual 
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report to Congress, OFHEO stated:

          If creditors have accurate and timely information on the 
        financial risks of Fannie Mae and Freddie Mac and believe that 
        they are exposed to material risk of loss if the Enterprises 
        get into financial trouble they will take steps to ensure that 
        the Enterprises strike an appropriate balance between risk and 
        return.\14\
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    \14\ Office of Federal Housing Enterprises Oversight, 2000 Report 
to Congress, at 33, (June 15, 2000).
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Six Commitments Set A New Standard In Financial Management
    Freddie Mac is a leader in risk and capital management and 
information disclosure. Last October, Freddie Mac made six commitments 
that keep us at the vanguard of evolving worldwide practices. In 
developing these commitments, we sought out the best practices among 
financial institutions. We looked at the recommendations of global 
financial regulators, including the Basel Committee on Banking 
Supervision. In its first revision to the 10-year-old Basel Accord, the 
Committee embraced a ``Three Pillars'' framework for financial 
regulation.\15\ The pillars, are Capital, Supervisory Oversight and 
Market Discipline. Viewed against these three pillars, Freddie Mac 
already is among the ``best-in-class'' for risk and capital management 
and disclosure practices.
---------------------------------------------------------------------------
    \15\ A New Capital Adequacy Framework, Consultative Paper on 
Capital Adequacy No. 50, Basel Committee on Banking Supervision (June 
1999); The New Basel Capital Accord, Consultative Document, Basel 
Committee on Banking Supervision (January 2001).
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                     Freddie Mac's Six Commitments

    1. Publicly disclose our independent rating.

    2. Maintain a high degree of liquidity.

    3. Issue subordinated debt on a semiannual basis.

    4. Implement a risk-based capital stress test on an interim basis.

    5. Publicly disclose a forward-looking measure of credit risk every 
quarter.

    6. Publicly disclose interest-rate risk every month.

    Since we announced our six-point plan, other regulatory experts 
have voiced support for similar principles and best practices:

 In December 2000, the Federal Reserve Board and the Department 
    of Treasury released a joint report to Congress entitled ``The 
    Feasibility and Desirability of Mandatory Subordinated Debt.'' \16\ 
    The report concludes that the use of subordinated debt may 
    contribute to market discipline.
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    \16\ The Feasibility and Desirability of Mandatory Subordinated 
Debt, Report to Congress by the Board of Governors of the Federal 
Reserve System and the Department of the Treasury, December 2000.

 In January 2001, the Working Group on Public Disclosure, also 
    known as the Shipley Commission, issued a report to the Federal 
    Reserve, SEC, and Office of the Comptroller of the Currency 
    (OCC).\17\ The report recommends improved and more frequent 
    disclosure of credit and interest-rate risk.
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    \17\ Letter of the Working Group on Public Disclosure (January 11, 
2001).

 In March, the Federal Reserve Board and the OCC released 
    supervisory guidance urging large banks to adopt the Shipley 
    Commission recommendations.\18\
---------------------------------------------------------------------------
    \18\ Board of Governors of the Federal Reserve System, Supervisory 
Staff Report SR 01- 6 (March 23, 2001). See Appendix A.

    These reports and recommendations provide strong affirmation that 
Freddie Mac's six commitments are aligned with the best and most up-to-
date thinking on financial risk management.
    Freddie Mac asked William Seidman, the former Chairman of the FDIC, 
for his assessment of our commitments. He concluded:

          Your package of disclosures and standards puts [Freddie Mac] 
        in a position of providing more and better public information 
        than any other financial institution, both regulated and 
        nonregulated, of which I am aware.\19\
---------------------------------------------------------------------------
    \19\ Memorandum of L. William Seidman to Freddie Mac (December 13, 
2000).

    Our six commitments set the pace for other institutions to adopt 
similar practices and to enhance their public disclosures. In fact, 
Moody's Investors Service said that the commitments ``set new standards 
not only for themselves [Freddie Mac and Fannie Mae], but for the 
global financial market.'' \20\ They added:
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    \20\ New Freddie Mac & Fannie Mae `Open Book' Policy: A Positive 
Credit Development, Moody's Investors Service (October 2000).

          The leadership shown by Freddie Mac and Fannie Mae could 
        prove difficult for other firms to ignore, and could usher in a 
        wave of enhanced financial risk disclosure. This may prove to 
        be one of the most important ramifications of the GSE's 
        initiatives.\21\
---------------------------------------------------------------------------
    \21\ Ibid.

    Freddie Mac met all six commitments in just 6 months. I will 
briefly describe each commitment and how it sets a new standard in 
financial practices and disclosure.

Commitment 1: Public Disclosure of Independent Rating
    What we accomplished. On February 27, 2001, we released our ``AA-'' 
risk-to-the-government rating from Standard & Poor's (S&P). We 
originally pledged to obtain a rating once a year. Now Freddie Mac is 
going beyond that. We have asked S&P for a continuous ``surveillance'' 
rating. This means that the S&P will be obligated to notify the public 
if there is ever a change in our financial position that affects the 
rating.
    Why it is important. Independent ratings are crucial to our 
financial system. Every day, millions of securities change hands on the 
basis of rating agency opinions of financial quality. Freddie Mac's 
commitment to seek an annual independent rating provides a readily 
discernible measure of capital strength that promotes market 
discipline. Ratings provide an independent early warning signal to the 
public, Congress and investors regarding our financial condition.
    In the preamble of the joint agency proposed rulemaking on risk-
based capital standards for recourse and direct credit substitute 
transactions,\22\ the Federal bank and thrift regulatory agencies 
stated:
---------------------------------------------------------------------------
    \22\ 65 Fed. Reg., at 12320, 12321 (March 8, 2000).

          In the opinion of the agencies, ratings have the advantages 
        of being relatively objective, widely used and relied upon by 
        investors and other participants in the financial markets. 
        Ratings provide a flexible, efficient, market-oriented way to 
        measure credit risk.\23\
---------------------------------------------------------------------------
    \23\ 65 Fed. Reg., at 12321.

    How we measure up. A risk-to-the-government rating of AA- places 
Freddie Mac in the top tier of financial institutions. To put this in 
perspective, of the 10 largest bank holding companies, only two have 
earned a rating this high on their senior debt--and none has a higher 
rating.
Commitment 2: Liquidity Management and Contingency Planning
    What we accomplished. On March 8, 2001, we announced that we met 
our liquidity commitment. Freddie Mac holds enough liquid, high-quality 
assets so that we can meet all of our financial obligations, even in 
the event of a market disruption so severe that we are unable to issue 
debt for 3 months. With this commitment, we also are meeting the Basel 
Committee's 14 principles of sound liquidity management for large 
banks.\24\
---------------------------------------------------------------------------
    \24\ ``Sound Practices for Managing Liquidity in Banking 
Organizations,'' Consultative Paper No. 69, Basel Committee on Banking 
Supervision (February 2000).
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    Why it is important. Liquidity is the lifeblood of any financial 
institution and of any financial market. We take it for granted until 
it is gone. Freddie Mac's liquidity commitment, together with public 
disclosure, will provide strong assurances to investors about Freddie 
Mac's financial strength. Regardless of disruptions in the capital 
markets that may make it impossible to borrow, Freddie Mac has the 
means to meet our financial obligations for at least 3 months.

                         Summary of Principles
              Basel Sound Practices for Managing Liquidity

     1. Strategy for day-to-day management of liquidity.
     2. Approval of liquidity strategy by bank's Board of Directors.
     3. Effective management structure for implementing liquidity 
strategy.
     4. Adequate information systems to measure and monitor liquidity 
risk.
     5. Process for measuring and monitoring net funding requirements.
     6. Use of scenario analysis to analyze liquidity needs.
     7. Frequent review of underlying assumptions.
     8. Periodic review of relationships with liability holders.
     9. Contingency plans for handling liquidity crisis.
    10. Control system for managing currency risk.
    11. Limits on possible cash flow mismatches arising from currency 
risk.
    12. Effective internal control systems, including independent 
review.
    13. Mechanism to ensure adequate public disclosure.
    14. Supervisory oversight.

    How we measure up. Freddie Mac's ability to withstand 3 months 
without access to debt markets and still meet our financial commitments 
is an extraordinary indication of our financial strength and liquidity. 
It is unlikely that many other financial institutions can meet this 
standard. In its 1999 liquidity paper, the Basel Committee suggested 
that large institutions be prepared to weather a liquidity crisis of 
between 1 and 3 months.\25\ We chose the more stringent 3 months.
---------------------------------------------------------------------------
    \25\ Basel Liquidity Paper, at 7, par. 28.
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    Our liquidity commitment also exceeds current market practices and 
represents a new best practice for financial institutions. For example, 
the Federal Housing Finance Board recently adopted a minimum liquidity 
requirement for the Federal Home Loan Banks.\26\ The rule requires the 
FHLB's to withstand only 5 days without access to the debt markets.
---------------------------------------------------------------------------
    \26\ FHLB Final Rule, 66 Fed. Reg. at 8261-321 (January 30, 2001).
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Commitment 3: Periodic Issuance of Subordinated Debt
    What we accomplished. On March 21, 2001, we met our subordinated 
debt commitment with the issuance of $2 billion of 10-year subordinated 
debt securities, known as Freddie SUBSSM. This will create a 
supplement to our already strong capital position. The amount of 
subordinated debt we issue, when combined with our core capital, will 
equal at least 4 percent of on-balance-sheet assets. We expect that 
within 3 years, there will be an additional $8 billion to $10 billion 
of investor funds standing in front of our senior debt holders.
    Why it is important. Subordinated debt is a tool for market 
discipline. Subordinated debt is paid to the holders only after all 
other debt instruments are paid. Interest payments on Freddie Mac SUBS 
will be suspended and allowed to accumulate for up to 5 years if 
Freddie Mac's core capital deteriorates materially. As a result, the 
yield at which our subordinated debt trades will provide a market-based 
indication of our financial strength.
    Chairman Greenspan has likened the use of subordinated debt to a 
``canary in the mine,'' alerting investors and the public of potential 
financial weakness well before any regulatory or other governmental 
intervention would be needed.\27\ Similarly, the December 2000 joint 
report by the Federal Reserve and the Treasury concluded that issuing 
subordinated debt contributes to market discipline. While the report 
stopped short of recommending mandatory issuance by banks, Freddie Mac 
stepped up to the challenge of frequent, large issues.
---------------------------------------------------------------------------
    \27\ Testimony of Federal Reserve Board Chairman Alan Greenspan in 
his renomination hearing before the Senate Banking Committee (January 
26, 2000).
---------------------------------------------------------------------------
    How we measure up. Freddie Mac's subordinated debt commitment 
exceeds practices of other financial institutions. According to the 
joint report and a 1999 Federal Reserve study, typically only the 
largest banks and bank holding companies issue subordinated debt, and 
most banks' subordinated debt is not publicly traded.\28\ Moreover, no 
bank has voluntarily committed to issue publicly traded subordinated 
debt on a regular basis to enhance its transparency and market 
discipline.
---------------------------------------------------------------------------
    \28\ ``Using Subordinated Debt as an Instrument of Market 
Discipline,'' Federal Reserve Study Group on Subordinated Debt and 
Debentures, Staff Study 172 (December 1999).
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Commitment 4: Interim Implementation of Risk-Based Capital Stress Test
    What we accomplished. We met this commitment on March 26, 2001, 
when we announced that we passed the risk-based capital stress test 
envisioned in GSE Act. Our interim disclosure will not substitute for 
OFHEO's regulatory process. We are working with OFHEO toward final 
risk-based capital regulations that will be a model for the industry.
    Why it is important. Adequate capital is critical to an 
institution's ability to weather adverse circumstances. Freddie Mac's 
commitment to implement the risk-based stress test and disclose the 
outcome ensures that we are adequately capitalized for the risks we 
take.
    How we measure up. Freddie Mac's statutory risk-based capital 
stress test is the toughest test in the financial industry and is 
entirely consistent with the 2001 New Basel Capital Accord. A 1999 
study conducted by the economic consulting firm IPS-Sendero concluded 
that the thrift industry would run out of capital after 5 years of this 
stress test and would need to triple its capital to survive.\29\
---------------------------------------------------------------------------
    \29\ Thrift Industry Analysis: Implications of Risk-Based Capital 
Stress Test Requirements IPS-Sendero (August 19, 1999).
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Commitment 5: New Quarterly Credit Risk Disclosures
    What we accomplished. We met this commitment on March 26, 2001, 
when we disclosed the impact on Freddie Mac of a 5 percent decline in 
house prices everywhere around the country. Since we began keeping 
track of house-price changes in 1975, there has not been a nationwide 
decline of this magnitude. Our new disclosure demonstrates the 
outstanding credit quality of Freddie Mac's portfolio.
    Why it is important. Freddie Mac's commitment to disclose quarterly 
our exposure to credit risk represents a new best practice for 
financial institutions. Most credit risk disclosure is backward 
looking, focusing on charge-offs and loans that are already delinquent 
and in default. This type of information is useful, and Freddie Mac 
will continue to report it. The addition of our new credit-risk 
disclosure, which predicts exposure to a worsening economy, provides 
forward-looking insights into our business.
    How we measure up. By subjecting ourselves to this test, Freddie 
Mac has set a new standard in the measurement and reporting of mortgage 
credit risk. The Basel Committee issued a paper in July 1999 regarding 
best practices for credit risk disclosure \30\ stating the Committee's 
expectation that banks disclose sufficient, timely, and detailed 
information to allow market participants to perform meaningful 
evaluations of the bank's credit risk profile.\31\ Our commitment is 
consistent with the Basel approach.
---------------------------------------------------------------------------
    \30\ ``Best Practices for Credit Risk Disclosure,'' Basel Committee 
on Banking Supervision, Basel, July 1999 (``Basel Credit Paper'').
    \31\ These best practice recommendations are consistent with the 
recommendations concerning hedge fund disclosures in ``Hedge Funds, 
Leverage and the Lessons of Long-Term Capital Management'' a report of 
the President's Working Group on Financial Markets (April 1999). The 
President's Working Group (comprised of representatives from the 
Department of Treasury, Federal Reserve Board, Securities and Exchange 
Commission, and Commodities Futures Exchange Commission) concluded that 
the current scope and timeliness of information about hedge funds was 
limited and recommended that ``more frequent and meaningful information 
on hedge funds should be made public.''
---------------------------------------------------------------------------
Commitment 6: New Monthly Interest-Rate Risk Disclosures
    What we accomplished. On April 18, 2001, we began the monthly 
disclosure of interest-rate risk. We disclosed the impact on Freddie 
Mac of an abrupt change in our funding costs--both a 50 basis-point 
shift in interest rates and a 25 basis-point shift in the slope of the 
Treasury yield curve. The disclosure demonstrates Freddie Mac's 
disciplined and skilled risk management, as our interest-rate risk 
exposure remained at very low levels in a volatile environment.
    Why it is important. In modern financial markets, interest-rate and 
other market risks can expand and contract at great speed. To 
understand the impact of rapidly changing interest-rate environments 
and manage their investment positions, investors need current 
information about their risk exposure.
    How we measure up. Freddie Mac's commitment to monthly disclosure 
of interest-rate risk significantly raises the bar; no banking 
institution reports interest-rate risk as frequently. Our commitment 
also exceeds the recommendation of the Shipley Commission. In its 
January report to the Federal Reserve, the SEC, and the OCC, the 
Commission recommended quarterly disclosure of interest-rate risk. In 
supervisory guidance released on March 23, 2001, the Federal Reserve 
and the OCC urged large banking organizations to adopt Shipley 
recommendations to improve both their quantitative and qualitative 
disclosures.\32\ Institutions also were encouraged to seek new avenues, 
such as company web sites, for disseminating financial information more 
frequently than regular annual or quarterly disclosures.\33\ Freddie 
Mac is using our web site at freddiemac.com to give the public and our 
investors financial information about our six commitments.
---------------------------------------------------------------------------
    \32\ Board of Governors of the Federal Reserve System, Supervisory 
Staff Report SR 01- 6 (March 23, 2001).
    \33\ Federal Reserve Advisory Letter (March 23, 2001).
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    Taken together, our six commitments represent a watershed in 
financial practices and disclosure.
The Commitments Support Our Vital Mission
    Freddie Mac is safe, sound, and strong. We are committed to the 
highest standards in financial management and disclosure, because we 
are committed to opening doors to housing for more of America's 
families.
    Because of the high level of support provided by Freddie Mac and 
the secondary market, America enjoys the world's best housing finance 
system. By attracting global capital to finance homeownership in 
America, we reduce mortgage costs, saving families billions of dollars. 
The extraordinary liquidity we bring to the Nation's mortgage markets 
also helps stabilize our Nation's economy.
    To meet our mission, Freddie Mac is relentlessly wringing out every 
unnecessary cost and barrier to homeownership; we are pushing the 
limits of technology; and we are searching the globe to find the lowest 
costs funds for housing. As a result of our activities, more families 
than ever before can afford to buy a home. In addition, they compete on 
an equal footing with the largest corporations for low-cost funds in 
the world's capital markets.
    America is projected to grow by 30 million people over the next 10 
years. The country is expected to form 1 million new households yearly. 
All told, America's families will need an additional $6 trillion to 
finance their homes over the next decade. Freddie Mac will open doors 
of opportunity for the homebuyer of the future, who is more likely to 
be a low-income, minority or immigrant family, eager to realize the 
American Dream.
    Recently, HUD Secretary Martinez captured the essence of why 
housing holds a special place in the Nation. He said:

          We believe that if you help a man or a woman buy a home, you 
        are helping to make a better citizen. Homeownership is vital in 
        creating strong communities. It helps average Americans build 
        equity and increase their household wealth.\34\
---------------------------------------------------------------------------
    \34\ Remarks by HUD Secretary Mel Martinez to the National 
Association of Counties' Legislative Conference (March 5, 2001).

    Freddie Mac's strength and vitality ensure that we are able to meet 
the housing finance needs of the future. Our superior risk management 
capabilities, strong capital position and state-of-the-art information 
disclosure make Freddie Mac unquestionably a safe and sound financial 
institution. The six commitments demonstrate our determination to stay 
that way, so that we can finance housing for generations to come.
    Thank you for the opportunity to appear today. Freddie Mac is a 
great Congressional success story. I look forward to working closely 
with Chairman Allard, Senator Reed, and the Members of this 
Subcommittee to ensure that Congress is confident that Freddie Mac is 
meeting our very important mission in a safe and sound manner. Together 
we will secure the future of our housing finance system and, with it, 
the dreams of millions of families.

```