I would like to begin my testimony by briefly describing the development of the FHLBank System, significant statutory changes to the System, and its operations. Then, I will describe FHFB’s structure and activities. Congress passed the Federal Home Loan Bank Act (FHLBank Act) in 1932 and established the FHLBank System to facilitate the extension of mortgage credit and the housing finance market, which had been severely affected by the Great Depression. The FHLBank Act required all federally chartered thrifts to become members of the FHLBank located in their districts (see fig. 1) and invest capital in the FHLBanks. The System acted as a central credit facility that made advances to thrifts which, in turn, were expected to make additional mortgage credit available to homebuyers and thereby revive the housing finance market. The act also established safeguards to help ensure the financial soundness of the FHLBanks. In particular, thrifts had to pledge high-quality assets in excess of the value of their advances as collateral. In addition, the act created the Federal Home Loan Bank Board (Bank Board) to oversee the safety and soundness regulation of the FHLBanks as well as the thrift industry. However, between 1985 and 1989, the Bank Board delegated its oversight responsibility of the thrift industry to each of the FHLBanks. The business of the FHLBank System and its members essentially remained unchanged from the 1930s until the 1980s. The System is generally credited with serving as a relatively low-cost funding source for thrifts during that period and helping to overcome regional shortages in housing credit. However, due to regional downturns, sharply rising interest rates, and poor management, hundreds of FHLBank member thrifts failed during the 1980s, causing a contraction in FHLBank System business. As a result, Congress appropriated billions of dollars to cover the costs associated with ensuring the payment of insured thrift deposits. In addition, the regulatory structure for the thrift industry—where FHLBanks supervised thrifts on behalf of the Bank Board—involved significant conflicts of interest. These conflicts (such as FHLBanks regulating institutions to which they made advances) compromised the safety and soundness oversight of the thrift industry. In response to these issues, Congress enacted the FIRREA, which made substantial changes to the FHLBank System’s membership, regulation, and mission requirements as summarized below: FIRREA opened FHLBank system membership to commercial banks and credit unions that engaged in mortgage activities. These voluntary members were required to invest capital in their FHLBank but could normally withdraw such capital on 6-months notice. However, FIRREA still required thrifts to be members of their FHLBank and did not allow them to withdraw their capital contributions. FIRREA required the System to capitalize the Resolution Funding Corporation (REFCORP) to help pay for the deposit insurance fund losses resulting from thrift failures. Furthermore, the System had to pay up to $300 million per year of annual earnings to contribute towards interest payments on bonds issued by REFCORP to pay for thrift losses. FIRREA abolished the Bank Board and established FHFB to regulate the 12 FHLBanks. FIRREA also transferred the Bank Board’s previous supervisory and regulatory responsibilities for thrift institutions and their holding companies to the newly created Office of Thrift Supervision. FIRREA also directed each FHLBank to establish or maintain two low- and moderate-income housing programs—the Community Investment Program (CIP) and the Affordable Housing Program (AHP). As part of CIP, each FHLBank makes advances to finance the purchase or rehabilitation of housing for eligible households and finance other projects benefiting residents of low- and moderate-income neighborhoods. AHP requires each FHLBank to subsidize the financing of eligible low- and moderate-income housing and FIRREA sets priorities for use of these advances among eligible projects. Although FIRREA is credited with helping to restore the financial condition and supervision of the thrift industry during the 1990s, the capital structure of the FHLBank System and the financial obligations that the act imposed on the System and its members subsequently raised concerns. In particular, the fact that voluntary members, such as commercial banks, had the option of removing their capital from the System with 6-months notice appeared to increase financial risks to the System. Additionally, since the FHLBanks’ earnings had been weakened by the declining profitability of the thrift industry, the $300 million REFCORP obligation posed a challenge. Consequently, FHLBanks looked for new sources of revenue and increased investments in mortgage-backed securities that offered potentially higher returns, but exposed them to increased risks. After years of attempting to resolve these issues, Congress passed the Gramm-Leach-Bliley Act of 1999 (GLBA), which contained provisions that Eliminated the requirement that thrift institutions be members of the FHLBank System and made membership voluntary for all members. Additionally, GLBA established new capital requirements for FHLBank members that were intended to make the System’s capital more permanent. I will describe the capital provisions of GLBA in more detail later in my testimony; Revised the System’s REFCORP obligations, moving from a fixed annual payment of about $300 million to a specified percentage (20 percent) of the System’s annual earnings after AHP expenses. This change minimized the financial obligation on the System during periods of relatively low profitability but increased the total payment when profits increased; and Expanded the amounts and types of collateral that FHLBanks could accept for advances from small members known as community financial institutions (CFI). GLBA permitted CFIs to pledge small business and agricultural loans as collateral for FHLBank advances. Each of the 12 FHLBanks has a board of directors of at least 14 persons, with 8 elected by members and at least 6 appointed by FHFB. The FHFB appointed directors are commonly referred to as public interest directors. Additionally, each FHLBank board appoints a president who is responsible for overseeing the institution’s staff (see table 1). The president and staff are responsible for such activities as the FHLBank’s asset and liability management, AHP and other community development activities, and compliance with laws and regulations. The FHLBank System raises funds in the capital markets through its Office of Finance (OF), which has a board of directors consisting of three individuals who serve 3-year terms. FHFB appoints the OF chair and selects two FHLBank presidents to serve as the other OF board members. As I discussed earlier, the FHLBank System can issue debt, generally referred to as consolidated obligations, at a relatively low cost due to its GSE status, which may allow members to fund mortgages at lower rates. Consolidated obligations are the “joint and several” obligations of the FHLBanks. That is, if an FHLBank defaults on its repayment obligations, all the other FHLBanks may have to cover its obligations. Although the federal government does not explicitly guarantee that it would provide financial assistance to the FHLBank System in a financial emergency, investors perceive an implied guarantee because of the ties between the government and the System. For example, each FHLBank has a federal charter and consolidated obligations are exempt from federal, state, and local taxes. Moreover, the federal government did provide financial assistance to other GSEs, such as Fannie Mae and the Farm Credit System, when they experienced financial difficulties during the 1980s. In addition to providing advances to its members, the FHLBank System provides member institutions other benefits and services. For example, FHLBanks generally pay dividends to their member financial institutions. Other services FHLBanks may offer members include providing discounts on advances for large transactions, funding the AHP and CIP programs to help members finance affordable housing and community development activities, and offering mortgage purchase programs as discussed next. Although reportedly no FHLBank has ever suffered a credit loss on an advance, the business activities of the FHLBanks have become increasingly complex and potentially risky in recent years largely due to the implementation of the mortgage purchase programs. All of the FHLBanks are authorized to purchase mortgages from members through programs such as the Mortgage Partnership Finance (MPF) program and the Mortgage Purchase Program (MPP). Through these mortgage purchase programs, FHLBanks purchase conventional or government- guaranteed mortgages directly from their members. The FHLBanks hold the mortgages on their books and bear the interest-rate risks associated with them. To manage the interest-rate risks, FHLBanks must employ sophisticated risk-management techniques including the use of financial derivatives. Although such strategies are appropriate for risk management, they require specialized expertise, sophisticated information systems, and an understanding and application of sometimes complex accounting rules. As I discuss later, some FHLBanks recently have encountered financial problems in managing the interest rate risks associated with their mortgage portfolios. FHFB is responsible for regulating the FHLBank System’s safety and soundness as well as its mission achievement. The agency has a five- member board, with the President of the United States appointing four board members, subject to Senate approval. Each appointee serves a 7- year term. The fifth board member is the Secretary of the Department of Housing and Urban Development, or the secretary’s designee. The President also designates one of the four appointed board members as the chair, subject to Senate approval. FHFB is located in Washington, D.C. and has a staff of about 124 individuals, including 17 examiners in eight cities where FHLBanks are located. FHFB supervises the FHLBanks by conducting annual on-site examinations and off-site monitoring to ensure that the Banks satisfy capitalization requirements and maintain their ability to raise funds in the capital markets.