I would like to begin my testimony by briefly describing the missions and activities of each of the GSEs, and the risks they pose to taxpayers. Then I will describe the current GSE regulatory structure. 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), which then use the proceeds to make additional mortgages available to home buyers. 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 a maximum of $729,750. Although Fannie Mae and Freddie Mac hold some mortgages in their portfolios that they purchased, most mortgages are placed in mortgage pools to support mortgage-backed securities (MBS). MBS issued by Fannie Mae or Freddie Mac 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 principal and interest on MBS that they issue. The 12 FHLBanks that constitute the FHLBank System traditionally made loans—also known as advances—to their members (typically banks or thrifts) to facilitate housing finance and community and 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 have the authority to securitize mortgages. The activities of the housing GSEs generally have been credited with enhancing the development of the U.S. housing finance market. For example, when Fannie Mae and the FHLBank System were created during the 1930s, the housing finance market was fragmented and characterized by regional shortages of mortgage credit. It is widely accepted that the activities of the housing GSEs helped develop a unified and liquid mortgage finance market in this country. While the housing GSEs have generated public benefits, their large size and activities pose potentially significant risks to taxpayers. As a result of their activities, the GSEs’ outstanding debt and off-balance sheet financial obligations total more than $6 trillion. 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 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 the Farm Credit System (another GSE) when they experienced difficulties due to sharply rising interest rates and declining agricultural land values, respectively. More recently, the housing GSEs have experienced a variety of operational and financial challenges, some of which are described below: Starting in 2003, first Freddie Mac and then Fannie Mae were found to have engaged in misapplication of relevant accounting standards and earnings manipulation. The GSEs also misstated their incomes by billions of dollars. Consequently, OFHEO required Fannie Mae and Freddie Mac to develop capital restoration plans and both GSEs are still operating under regulatory agreements, which require improvements in their operations. According to FHFB, some FHLBanks did not embrace and implement corporate governance and risk management tools necessary for their complex and evolving operations, which resulted in operational and financial challenges. In 2004, FHFB entered into supervisory written agreements with the FHLBanks in Chicago and Seattle, which required a variety of operational improvements. FHFB terminated the written agreement with the Seattle bank in January 2007. FHFB also entered into a related agreement with the Chicago bank in October 2007. Fannie Mae reported that rising mortgage defaults and falling home prices contributed to a $3.6 billion loss for the company in the last quarter of 2007. The GSE predicted that housing prices will continue to fall and that its financial performance will deteriorate further. Similarly, Freddie Mac reported a loss of about $2.5 billion for the same period, of which approximately $2.3 billion is attributed to losses on derivative trades. 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 in turn might become unable to meet their financial obligations. To the extent that this risk, called systemic risk, is associated with the housing GSEs, it is based primarily on 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 an event were to occur, widespread defaults could occur in derivatives markets. The current regulatory structure for the housing GSEs is divided among OFHEO, HUD, and FHFB, as described below: OFHEO is an independent office within HUD and is responsible for regulating Fannie Mae and Freddie Mac’s safety and soundness. OFHEO oversees the two GSEs through its authority to examine their operations, determine capital adequacy, adopt rules, and take enforcement actions. Although OFHEO’s financial plans and forecasts are included in the President’s budget and are subject to the appropriations process, the agency is not funded with tax dollars. Rather, Fannie Mae and Freddie Mac pay annual assessments to cover OFHEO’s costs. HUD is responsible for ensuring that Fannie Mae and Freddie Mac are accomplishing their housing missions. HUD is to accomplish this responsibility through its authority to set housing goals and review and approve new programs, and through its general regulatory authority. HUD is funded through appropriations. FHFB is responsible for regulating the FHLBank System’s safety and soundness as well as its mission activities. The agency has a five-member board, with the President of the United States appointing four members— each of whom serves a 7-year term—subject to Senate approval. The fifth member is the Secretary of HUD. The President also appoints FHFB’s chair. Like OFHEO, FHFB carries out its oversight authorities through examinations, establishing capital standards, rule making, and taking enforcement actions. FHFB is funded through assessments of the 12 Federal Home Loan Banks and is not subject to the appropriations process. We continue to believe that the current fragmented regulatory structure for the housing GSEs is inadequate to monitor these large and complex financial institutions and their mission activities. Establishing a single housing GSE regulator that is equipped with adequate authorities and governed by a board would better ensure that the GSEs operate in a safe and sound manner and fulfill their housing missions. The current fragmented structure of federal housing GSE regulation does not provide for a comprehensive and effective approach to safety and soundness regulation. Although the housing GSEs operate differently, they share common characteristics as large and complex financial institutions. For example, the GSEs rely on sophisticated strategies and activities, such as the use of derivatives, to manage the interest rate and other risks that are inherent in their operations. In recent years, the GSEs, as discussed earlier, have not always demonstrated the capacity to effectively manage the risks that they face. Moreover, OFHEO, and FHFB to a lesser degree, lack key authorities to fulfill their safety and soundness responsibilities, as described below: Unlike bank regulators and FHFB, (1) OFHEO’s authority to issue cease and desist orders does not specifically list an unsafe and unsound practice as grounds for issuance and (2) OFHEO’s powers do not include the same direct removal and prohibition authorities applicable to officers and directors. Bank regulators have prompt corrective action authorities that are arguably more robust and proactive than those of OFHEO and FHFB. These authorities require that bank regulators take specific supervisory actions when bank capital levels fall to specific levels or provide the regulators with the option of taking other actions when other specified unsafe and unsound actions occur. Although OFHEO has statutory authority to take certain actions when Fannie Mae or Freddie Mac capital falls to predetermined levels, the authorities are not as proactive or broad as those of the bank regulators. OFHEO also has established regulations requiring specified supervisory actions when unsafe conditions are identified that are not related to capital adequacy, but OFHEO’s statute does not specifically mention these authorities. FHFB’s statute does not establish a prompt corrective action scheme that requires specified actions when unsafe conditions are identified. Although FHFB officials believe they have all the authority necessary to carry out their safety and soundness responsibilities, the agency has significant discretion in resolving troubled FHLBanks. Consequently, there is limited assurance that FHFB would act decisively to correct identified problems. Unlike bank regulators—-which can place insolvent banks into receivership—and FHFB, which can take actions to liquidate an FHLBank, OFHEO is limited to placing Fannie Mae or Freddie Mac into a conservatorship.