Responding to the massive and expensive failure of federally insured savings and loans in the mid-1980s, Congress and the administration examined government-sponsored enterprises to ensure that they were operating in a manner that protected the taxpayers’ interest and minimized the risk that these entities would fail. Prior GAO reports noted that the enterprises’ ties to the government had weakened private market discipline to the point that creditors believed the government would likely assist an enterprise through financial difficulties, even though the government has no legal obligation to do so. This expectation is not without foundation; in 1987, Congress approved $4 billion to help the ailing Farm Credit System. According to a report from the Senate Committee on Banking, Housing, and Urban Affairs, this perception is based on the structure and privileges of the enterprises and the special treatment of their securities. The enterprises were created by statute, are exempt from state and local income taxes, and each has a line of credit with the Treasury of $2.25 billion. Their securities are issued and paid through the facilities of the Federal Reserve Banks and are eligible for purchase by the Federal Reserve, for unlimited investment by Federal Reserve member banks and federally insured thrifts and as collateral for public deposits of the U.S. government and most state and local governments. As a result, the enterprises’ debt trades at yields only marginally above those on Treasury debt of comparable maturity. This implicit credit enhancement allows the enterprises to operate with relatively little capital. The enterprises’ federally established charters set out specific purposes that they are to address. They are to provide stability in the secondary market of residential mortgages, respond appropriately to the private capital market, and provide ongoing assistance to the secondary market for residential mortgages. They are also to promote access to mortgage credit throughout the nation by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for residential mortgage financing. For these reasons, the government has an interest in seeing that these enterprises are managed and operated in a prudent and financially sound manner. Both enterprises have been highly profitable for several years,but Congress recognized that both may not always remain as profitable and well managed as they are today. Consequently, Congress reformed the enterprises’ regulatory structure and established capital requirements by passing the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. According to the Senate report accompanying the bill, the capital provisions are designed to ensure that the enterprises are financially sound. The primary emphasis of these provisions is on a risk-based capital standard that reflects risks the enterprises assume. The new regulatory structure was designed to address concerns over HUD’s inadequate regulation and supervision of the enterprises. The act established OFHEO as an independent entity within HUD. The act reserved for the Secretary of HUD certain authorities relating to HUD’s responsibility to oversee the enterprises’ efforts to meet housing goals.But the act also clarified that the duty to ensure that Fannie Mae and Freddie Mac are adequately capitalized and operate in a safe and sound manner, consistent with the achievement of their public purposes, belongs to OFHEO. Consequently, the act specifically delegated other responsibilities and authorities to the Director of OFHEO. OFHEO was intended to operate separately from HUD and be staffed with experts in financial management or financial institution oversight. OFHEO is under the management of a presidentially appointed and Senate-confirmed Director. The act provided the Director with numerous exclusive authorities (i.e., without the review and approval of the Secretary of HUD), such as powers to examine the operations of the enterprises, determine capital levels, assign the enterprises capital classifications, and take certain enforcement actions. The act also gave the Director exclusive authority to manage OFHEO, including establishing and implementing annual budgets and hiring personnel. Thus, the Director leads and directs OFHEO’s activities by setting internal and external policy, managing overall operations, and serving as the chief spokesperson for the organization. As of February 1995, OFHEO’s six components reported to the Director and Deputy Director. Figure 1 illustrates OFHEO’s organizational structure. Three line functions are directly responsible for carrying out OFHEO’s mission: The Office of Examination and Oversight (OEO) is responsible for designing and conducting annual on-site examinations of Fannie Mae and Freddie Mac, as required by law, and performing additional examinations as determined by the Director. Research, Analysis and Capital Standards (RACS) is responsible for developing and implementing financial “stress tests,” which use interest rate and credit risk scenarios prescribed in the act to determine the enterprises’ risk-based capital requirements. This unit is responsible for conducting research and financial analysis on issues related to the enterprises’ activities, such as simulating Treasury yields and associated interest rate indices. The General Counsel has responsibility for preparing the regulations required by the act and advising the Director on legal issues, including financial institution regulatory issues, applicable securities and corporate law principles, and administrative and general legal matters. Three staff functions support OFHEO’s mission: Finance and Administration is responsible for ensuring that OFHEO has the infrastructure to function independently. This unit is to provide human resources management, budget formulation and execution, financial and strategic planning, contracting and purchasing, office automation, travel, records and document security, and related administrative support services. Finance and Administration is also responsible for developing annual budgets and serving as the liaison with the Office of Management and Budget. The Office of Chief Economist is responsible for providing and coordinating economic and policy advice to the Director on all issues related to the regulation and supervision of the enterprises. This office is also to direct and conduct research to assess the impact of issues and trends in the housing and mortgage markets on OFHEO’s regulatory responsibilities. The Office of Congressional and Public Affairs is responsible for handling public and press inquiries, briefing Members of Congress and staff on matters relating to OFHEO, monitoring legislative development, and bringing congressional concerns to the attention of the Director. OFHEO’s staffing has grown slowly but steadily since the Director, its first employee, was sworn in on June 1, 1993. At the end of fiscal year 1993, five other employees were on board. According to testimony from the Director in October 1993, recruiting specialized staff was slowed somewhat by OFHEO’s need to first do such fundamental things as obtain hiring authority, develop procedures, and obtain office space. By September 1994, however, OFHEO had 37 staff on board. And in February 1995, OFHEO’s staff had grown to 53. OFHEO’s budget projects filling 69 positions in fiscal year 1996. Table 1 compares the distribution of positions among OFHEO’s different units at the end of fiscal year 1994 with that projected for fiscal year 1996. Relative to other federal financial regulatory agencies, OFHEO is a small organization. In testimony before the House Banking Committee in October 1993, OFHEO’s Director spoke about the unique challenge facing OFHEO in regulating two entities as large, complex, and sophisticated as Fannie Mae and Freddie Mac. She compared OFHEO’s regulatory task with that of other federal financial regulatory agencies. For example, OFHEO’s fiscal year 1994 budget funded 45 positions to oversee the enterprises (1 employee for every $23.1 billion in regulated assets). As a point of comparison, 2,500 Office of Thrift Supervision (OTS) employees oversaw institutions with $800 billion in assets (1 employee per $0.3 billion in assets). To address that challenge, OFHEO’s philosophy was to create a lean and flat organization that would attract and retain a highly qualified, diverse staff with sophisticated financial, legal, and supervisory expertise. Most OFHEO expenses cover personnel and contractor services. For fiscal year 1996, OFHEO estimates that it will spend $7.9 million (53.3 percent of its $14.9 million total) on personnel services (i.e., expenses related to personnel compensation and benefits, but exclusive of contractors). According to OFHEO, it bases salaries and benefits on market rates for the required technical expertise comparably with those of other federal banking regulatory agencies. The second largest category of expenses (“Other services”) generally covers OFHEO’s contractor services. In fiscal year 1996, OFHEO expects to spend $4.4 million (29.7 percent) on specialized technical services associated with developing and maintaining its research capability and computer models, examination services, and specialized legal services. All other expenses constitute a smaller, but growing, proportion of OFHEO’s total obligations. These expenses cover such fundamental but crucial items as computer acquisition, travel, and rent, which fluctuate with changing numbers of staff and contractors on location. Table 2 shows actual and estimated OFHEO obligations for fiscal years 1994 through 1996. Although OFHEO’s financial plans and forecasts are to be included in the budget of the United States and in HUD’s congressional justifications, it is not funded with tax dollars through the congressional appropriations process. Rather, the act requires the enterprises to pay annual assessments to cover OFHEO’s costs. OFHEO’s fiscal year 1996 budget estimated that it would obligate nearly $0.6 million less than was estimated for operations in fiscal year 1995. That estimate reflects a diminished reliance on other contractor services, especially in support areas, partially offset by increases in rent associated with the need for additional space and in personnel expenditures associated with four additional OFHEO positions. Because OFHEO continues to develop its major management systems, we limited the scope of our work for this report to the planning and initial implementation of those systems. As of February 1995, none of OFHEO’s major management systems had been completely implemented. Consequently, we did not evaluate their ultimate implementation or effectiveness. To develop our information, we interviewed OFHEO’s senior management and HUD officials and reviewed OFHEO management systems documentation, focusing on the policies and procedures relating to OFHEO’s human resource management and accounting and financial control systems.