I would like to begin by summarizing the roles and responsibilities of the GSEs, describing their potential risks to taxpayers and the financial markets, and offering certain principles on governance and oversight to help ensure that the GSEs’ activities are safe, sound, and consistent with their public missions. Over the past century, Congress established GSEs to address concerns that private financial institutions were not adequately meeting the credit needs of homebuyers and agricultural interests (see table 1). The GSEs are government-sponsored, privately owned and operated corporations whose public missions are to enhance the availability of mortgage and agricultural credit across the United States. It is also generally understood that the housing GSEs’ public missions include the obligation to meet the needs of targeted groups of borrowers. The GSEs generally carry out their missions by (1) borrowing funds in the capital markets and purchasing assets from financial institutions or making loans to the institutions or (2) securitizing assets and providing a credit guarantee to security holders. These activities may provide mortgage or real estate credit to homebuyers, businesses, or farmers at rates or conditions more favorable than those that would be available in the absence of these GSEs. It is important to note that the GSEs’ debt and security offerings are not explicitly guaranteed or insured by the U.S. government. Let me now briefly discuss the missions and activities of each of the GSEs: Fannie Mae and Freddie Mac’s mission is to enhance the availability of mortgage credit across the nation during both good and bad economic times by purchasing mortgages from lenders (banks, thrifts, and mortgage lenders) that use the proceeds to make additional mortgages available to homebuyers. Most mortgages purchased by Fannie Mae and Freddie Mac are conventional mortgages, which have no federal insurance or guarantee. The companies’ mortgage purchases are subject to a conforming loan limit that currently stands at $333,700 for a single-family home in most states. Although Fannie Mae and Freddie Mac hold some mortgages in their portfolios that they purchased, most mortgages are placed in mortgage pools to support MBS. Fannie Mae and Freddie Mac issued MBS are either sold to investors (off-balance sheet obligations) or held in their retained portfolios (on-balance sheet obligations). Fannie Mae and Freddie Mac guarantee the timely payment of interest and principal on MBS that they issue. The 12 FHLBanks traditionally made loans—also known as advances— to their members (typically banks or thrifts) to facilitate housing finance and community economic development. FHLBank members are required to collateralize advances with high quality assets such as single-family mortgages. More recently, the FHLBanks initiated programs to purchase mortgages directly from their members and hold them in their retained portfolios. This process is similar to Fannie Mae and Freddie Mac’s traditional business activities, although the FHLBanks do not currently have the authority to securitize mortgages. FCS, of which Farmer Mac is an independent institution, is a nationwide network of borrower-owned financial institutions and specialized service organizations. FCS consists of six Farm Credit Banks and one Agricultural Credit Bank, which provide funding and affiliated services to locally owned Farm Credit associations and numerous cooperatives nationwide. Among other activities, FCS provides credit and related services to farmers, ranchers, producers, and rural homeowners. Farmer Mac’s mission is to provide for a secondary marketing arrangement for agricultural real estate and rural housing loans subject to its underwriting standards. Farmer Mac purchases mortgages directly from lenders for cash and purchases bonds from agricultural lenders. Farmer Mac securitizes mortgages and issues AMBS and, like Fannie Mae and Freddie Mac, guarantees the timely payment of interest and principal on these securities. Farmer Mac holds most of the AMBS that it issues in its retained portfolio. As a result of their activities, the GSEs’ outstanding debt and off-balance sheet financial obligations are large. The GSEs’ financial obligations were $4.4 trillion as of September 30, 2003. By comparison, the U.S. Treasury had $6.8 trillion in total obligations for the same date. The GSEs face the risk of losses primarily from credit risk, interest rate risk, and operational risks. Although the federal government explicitly does not guarantee the obligations of the GSEs, it is generally assumed on Wall Street that assistance would be provided in a financial emergency. In fact, during the 1980s the federal government provided financial assistance to both Fannie Mae and FCS when they experienced difficulties due to sharply rising interest rates and declining agricultural land values, respectively. The potential exists that Congress and the Executive Branch would determine that such assistance was again necessary in the event that one or more of the GSEs experienced severe financial difficulties. Because the markets perceive that there is an implied federal guarantee on the GSEs’ obligations, the GSEs are able to borrow at interest rates below that of private corporations, which—as I discussed earlier—allows them to extend credit to financial institutions at favorable rates. The GSEs also pose potential risks to the stability of the U.S. financial system. In particular, if Fannie Mae, Freddie Mac, or the FHLBank System were unable to meet their financial obligations, other financial market participants depending on payments from these GSEs, may in turn become unable to meet their financial obligations. This risk, called systemic risk, is often associated with the housing GSEs because of the sheer size of their financial obligations. For example, as discussed in OFHEO’s 2003 report on systemic risk, if either Fannie Mae or Freddie Mac were to become insolvent, financial institutions holding the enterprise’s MBS could be put into a situation where they could no longer rely on those securities as a ready source of liquidity. Depending on the response of the federal government, the financial health of the banking segment of the financial services industry could decline rapidly, possibly leading to a decline in economic activity. As another example, derivatives counterparties holding contracts with a financially troubled GSE could realize large losses if the GSE were no longer able to meet its obligations. If such a hypothetical event were to occur, widespread defaults could occur in derivatives markets. To prevent the need for the federal government ever to have to provide financial support to a GSE and to minimize the risks of financial instability, it is critical to ensure that proper corporate governance, reasonable transparency, and effective oversight systems are in place. There are several lines of defense to ensure that GSEs’ activities are conducted in a safe and sound manner including management, boards of directors, auditors, and regulators. As we have seen in recent private sector instances such as Enron and Worldcom, these critical lines of defense can and do fail. Consequently, the private sector, Congress, and regulators have initiated actions—such as the passage and implementation of the Sarbanes-Oxley Act—to ensure that the risk of such failures of governance and oversight are minimized. In my view, it is all the more important that strong safeguards are established for the GSEs because such institutions are not subject to the same degree of market discipline as other privately run businesses. As a result of the perception of an implied guarantee of GSE obligations, customers and creditors may be less willing to monitor the companies’ risk-taking, which could encourage managers to take on excessive risks. Not only should GSEs be sensitive to good governance but it is all the more important they lead by example in connection with accountability, integrity, and public trust. In particular, GSEs should strive to have a truly independent board, compensation arrangements consistent with their public mission and private shareholder obligations, and appropriate transparency of their financial activities. Under model governance theory, the board of directors works in the best interest of the shareholders and the CEO works for the board. Board members should be independent and be able to provide strategic advice to management in order to help maximize shareholder value. The board should also help manage risk to shareholders and have a clear responsibility to hold management accountable for results both currently and over time. I note that in the context of the GSEs, boards could also have a responsibility to ensure that the GSEs’ activities fulfill their public missions. In some cases, there can be a tension between maximizing shareholder value and fulfilling public missions. GSE boards and executives must have the requisite commitment and talent to respond to this challenge. To adhere to model governance theory, it is also important for the board to ensure that overall executive compensation is aligned with achievements related to the company’s long-term strategic objectives and less on short-term accomplishments such as quarterly or annual earnings. Further, it is not just the total amount of compensation but the form and structure of executive compensation arrangements that is important as well. Finally, transparency through timely and reliable financial and performance information and reasonable disclosures is necessary to enable capital markets and investors to understand related values and risks associated with the GSEs. Market discipline works best when firms fully and publicly disclose their financial obligations and activities. A regulatory system of GSE oversight must have the necessary strength, independence, and capability to protect against the significant risks and potential costs to taxpayers posed by the GSEs. We have consistently supported and continue to believe in the need for the creation of a single regulator to oversee both safety and soundness and mission of the housing GSEs, which, as I will describe later, are currently divided among OFHEO, HUD, and FHFB. A single regulator could be more independent and objective than separate regulatory bodies and could be more prominent than either one alone. Although the housing GSEs operate differently, the risks they manage and their missions are similar. We believe that valuable synergies could be achieved and expertise in evaluating GSE risk management could be shared more easily within one agency.