Mr. Chairman and Members of the Committee: We are pleased to be here today to discuss the operations of the Office of Federal Housing Enterprise Oversight (OFHEO) and the status of OFHEO’s efforts to fulfill its mission of helping to ensure the safety and soundness of the two largest housing government-sponsored enterprises: Fannie Mae and Freddie Mac (the enterprises). Congress has a long-standing concern that the safety and soundness of the enterprises be maintained so that they can continue to fulfill their public purposes while taxpayers are protected from unnecessary financial risks. Consequently, Congress passed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the act), which established OFHEO as an independent regulator within the Department of Housing and Urban Development (HUD). Under the act, OFHEO is authorized to help ensure the enterprises’ safety and soundness by setting capital standards, conducting examinations, and taking enforcement actions if unsafe and unsound financial or management practices are identified. As mandated in the Department of Veterans Affairs/HUD Appropriations Act of 1997, we recently issued a report on OFHEO’s implementation of its safety and soundness responsibilities since it began operations in June 1993. We concluded that OFHEO has not yet fully implemented its statutory responsibilities and faces considerable future challenges in doing so. In particular, OFHEO currently does not expect to establish final risk-based capital standards for the enterprises until 1999, even though this process was to have been completed under the act by December 1, 1994. Further, OFHEO has not fully implemented a comprehensive and timely safety and soundness enterprise examination program. Although Fannie Mae and Freddie Mac have been consistently profitable in recent years, we believe it is essential, given the enterprises’ outstanding financial commitments of about $1.5 trillion at year-end 1996, that OFHEO implement its safety and soundness responsibilities as quickly as feasible so that any potential long-term financial risks to taxpayers are lowered. The federal government’s creation and continued sponsorship of Fannie Mae and Freddie Mac have created the perception in the financial markets that the government may choose to provide financial assistance to them in a financial emergency, even though there is no statutory requirement to do so. Recognizing the potential financial risks the enterprises’ activities pose to taxpayers, Congress created OFHEO in 1992 as an independent safety and soundness regulator with wide authority to help ensure that the enterprises’ long-term financial security is maintained. Congress established and chartered the enterprises as government-sponsored, privately owned and operated corporations to enhance the availability of mortgage credit across the nation during both good and bad economic times. It is widely accepted that the enterprises’ activities have generated benefits to home-buyers, such as lower mortgage interest rates. Moreover, the enterprises have reduced regional disparities in mortgage interest rates and spurred the development of new technologies to facilitate the home financing process. However, the potential also exists that the federal government would choose to rescue the enterprises in a financial emergency. OFHEO officials have stated that, despite the enterprises’ consistent profitability in recent years, past financial performance does not guarantee future success. For example, during the 1990s, Fannie Mae and Freddie Mac have rapidly increased the size of their debt-financed mortgage asset portfolios. According to OFHEO, large holdings of debt-financed mortgage assets potentially expose Fannie Mae and Freddie Mac to increased losses resulting from fluctuations in interest rates. For fiscal year 1998, OFHEO has requested a budget of about $16 million to carry out its safety and soundness responsibilities and to perform administrative support functions. As of October 27, 1997, OFHEO had a total staff of 96 individuals consisting of full-time and temporary staff, contract employees, and detailees from bank regulatory agencies. As required by the act, OFHEO is to carry out its oversight function in part by establishing minimum capital standards. Minimum capital is computed on the basis of capital ratios specified in the act that are applied to certain on-balance-sheet and off-balance-sheet obligations. OFHEO has classified Fannie Mae and Freddie Mac as “adequately capitalized” under the minimum standard in each quarter beginning with the quarter that ended on June 30, 1993. The act also mandated that OFHEO develop a stress test to serve as the basis for more sophisticated risk-based capital standards. The purpose of a stress test is to lower taxpayer risks by simulating, in a computer model, situations where the enterprises are exposed to adverse credit and interest rate scenarios and requiring them to hold sufficient capital to withstand these scenarios for a 10-year period, plus an additional 30 percent of that amount to cover management and operations risk. Under the act, the stress test and risk-based capital standards derived from the test were to have been completed by December 1, 1994. However, as of April 1997, OFHEO’s acting director said the organization expected to issue a proposed rule implementing the stress test and risk-based capital standards by September 1998, with the final rule to be issued in 1999. The act also gave OFHEO broad authority and responsibility to examine the enterprises and requires annual on-site examinations. At such examinations, OFHEO staff with the assistance of contractors and bank regulatory detailees are to assess the financial condition of the enterprises and recommend improvements as necessary. OFHEO also has the authority to (1) take enforcement actions, such as cease and desist orders, against the enterprises to stop unsafe practices and (2) place an enterprise into a conservatorship when certain circumstances exist and the enterprise is unable to meet its financial obligations or it is critically undercapitalized. In OFHEO’s planning process and its published documents, the organization has consistently underestimated the time necessary to complete major components of the stress test and risk-based capital standards. For example, in 1995 OFHEO estimated that the final rule would be issued in May 1997, but OFHEO now expects that the process will not be completed until 1999. We identified several reasons why OFHEO did not comply with the statutory deadline and found that OFHEO faces continuing challenges in meeting its current estimate. Thus, we believe that strong congressional oversight of the development process is necessary to help ensure that OFHEO’s plan to complete the risk-based capital standards is accomplished as quickly as feasible. closely related to enterprise risks by developing its own sophisticated stress test and associated financial modeling capability. We note that OFHEO’s approach has, ultimately, involved a substantial development period and commitment of resources. OFHEO encountered delays in obtaining accurate financial data from the enterprises. Beginning in 1994, OFHEO officials requested that the enterprises provide large amounts of historical and current financial data so it could do the work necessary to develop the stress test. According to OFHEO officials, the enterprises did not always provide all of the necessary data, or they provided data that may have been inaccurate. These problems persisted into 1996 and impeded development of the stress test, according to OFHEO officials. In response, Fannie Mae officials said that OFHEO’s data requests were burdensome and would have been less extensive if OFHEO had used a simpler approach to develop the stress test. The Fannie Mae officials said that a more simplified approach would have resulted in appropriate risk-based capital standards and could have been completed faster than OFHEO is currently taking to develop its stress test. Freddie Mac officials said they have tried to assist OFHEO in developing the stress test and that inaccurate data submissions have not been responsible for the delays. OFHEO experienced significantly greater technical and managerial challenges and associated delays than initially anticipated in developing an integrated financial model. This model—which is referred to as the Financial Simulation Model is to serve as the foundation of the stress test—is designed to simulate the behavior of the enterprises’ assets, liabilities, and off-balance-sheet obligations under adverse credit and interest rate scenarios. According to an OFHEO official, OFHEO had largely completed the model by April 1997, although some final testing and software documentation work remained. final rules while protecting proprietary enterprise data from unauthorized disclosure. Given OFHEO’s history of consistently underestimating the time necessary to complete the stress test and risk-based capital standards, we believe congressional oversight appears necessary to ensure that OFHEO completes the process as soon as possible. Accordingly, we recommended that OFHEO report periodically to Congress on the organization’s progress towards compliance with the plan. We further recommended that OFHEO inform Congress of any problems that may arise in completing the process by 1999, as well as corrective actions that the organization planned to address such problems. In the absence of a stress test and risk-based capital standards, OFHEO’s primary means of helping to ensure the safety and soundness of the enterprises is its examination program. However, OFHEO has not fully implemented the detailed examination schedule and plan that it established in 1994, which limits the organization’s ability to monitor the enterprises’ financial condition. We believe that limited resources allocated to the examination office as well as staff attrition contributed to OFHEO’s inability to fully implement the 1994 plan. Beginning in 1998, OFHEO plans to restructure its examination program so that it assesses all enterprise core risks annually. OFHEO established an examination plan in September 1994 that provided for a 2-year cycle for the assessment of six “core” risks, such as interest rate and credit, facing the enterprises. Although OFHEO identified six core risks, the plan stipulated that examiners were to cover these risks in five examinations—four examinations would each cover one core risk while another examination would cover two risks. OFHEO’s examination plan was similar in substance but not in timing to risk-focused examination plans that the Office of the Comptroller of the Currency and the Federal Reserve System have established to monitor the activities of large commercial banks.