Congress created GSEs to help make credit available to certain sectors of the economy, such as housing and agriculture, in which the private market was perceived as not effectively meeting credit needs. GSEs receive benefits from their federal charters that help them fulfill their missions. Freddie Mac and Fannie Mae (the housing enterprises) have federal charters granting each of them explicit benefits, which include (1) exemption from registering their securities with the Securities and Exchange Commission (SEC), (2) exemption from state and local corporate income taxes, and (3) use of the Federal Reserve as a transfer agent. Farmer Mac is subject to SEC registration requirements, but it uses the Federal Reserve as a transfer agent, and Farmer Mac officials told us that it is exempt from state income taxes in most states. The most important benefit that all three enterprises receive is an implicit one stemming from investors’ perception that the federal government would not allow the enterprises to default on their obligations. Due to this perception, investors do not demand yields on investments in enterprise debt and mortgage-backed securities that are as high as those on comparable financial instruments issued by corporations without government sponsorship. One result of government sponsorship, therefore, is a reduction in debt costs compared with debt costs in similar corporations without government sponsorship. Freddie Mac and Fannie Mae were chartered by Congress to enhance the availability of residential mortgage credit across the nation. The housing enterprises accomplish this mission by purchasing residential mortgages from lenders. The housing enterprises retain some of the mortgages they purchase in their own portfolios, but a majority of the mortgages are pooled into mortgage-backed securities (MBS) that are sold to investors in the secondary residential mortgage market. As of December 1996, Freddie Mac had about $463 billion in MBS obligations and $156 billion in debt obligations outstanding. The corresponding figures for Fannie Mae were about $548 billion and $331 billion, respectively. Therefore, combined MBS and debt obligations of these housing enterprises totaled about $1.5 trillion. Farmer Mac was chartered by Congress to enhance the availability of agricultural mortgage credit across the nation. Farmer Mac is making efforts to establish a secondary mortgage market for agricultural mortgages along the lines the housing enterprises have established for residential mortgages. Farmer Mac issues, and guarantees payment on, agricultural mortgage-backed securities (AMBS). One type of AMBS, called Farmer Mac I securities, is backed by agricultural mortgages not containing federally provided primary mortgage insurance. The other type of AMBS, called Farmer Mac II securities, is backed by agricultural mortgages containing primary mortgage insurance provided by the Department of Agriculture. Farmer Mac is a small financial institution in comparison to the housing enterprises. As of December 31, 1996, Farmer Mac had about $642 million in AMBS (of which about $226 million were owned by others, and about $416 million were held by Farmer Mac) and about $546 million in debt obligations outstanding. Therefore, combined AMBS owned by others and debt obligations of Farmer Mac totaled about $772 million. The housing enterprises pass along, at least in part, the benefits they receive from government sponsorship, such as lower debt costs, to residential borrowers. In a previous study, we estimated that interest rates on single-family, fixed-rate, conforming mortgages were probably 15 to 35 basis points lower than they would have been without government sponsorship of the enterprises. Limiting the activities of the housing enterprises primarily to funding conforming residential mortgages helps create a mechanism for the benefits they receive, such as lower debt costs, to be passed through to borrowers. Such limitations are consistent with the special purpose charters imposed by Congress. Congress gave the Department of Housing and Urban Development (HUD) general regulatory authority over the housing enterprises so that HUD can ensure that the missions of these enterprises as stated in their respective charter acts are being fulfilled. HUD also has regulatory authority to approve new mortgage programs proposed by the housing enterprises. In consideration of the potential risks to taxpayers from an enterprise default on its financial obligations, Congress created safety and soundness regulators for the enterprises. HUD’s Office of Federal Housing Enterprise Oversight (OFHEO) is the safety and soundness regulator of the housing enterprises. The Farm Credit Administration (FCA), through its Office of Secondary Market Oversight (OSMO), has regulatory responsibility with respect to Farmer Mac, including specific authority over safety and soundness matters. We reviewed the enterprises’ charters and relevant statutes to examine the enterprises’ legal authority for making nonmortgage investments and regulatory oversight of that activity. We obtained and analyzed publicly available and proprietary information on the enterprises’ investment policies, practices, and justification of those policies and practices to examine the relationship between nonmortgage investment policies and practices and missions. We reviewed literature on the role of the housing enterprises in the residential mortgage market to examine the extent to which the enterprises have undertaken nonmortgage investments for arbitrage profits. We also interviewed officials at the enterprises, HUD, OFHEO, and FCA; and we received written responses to questions submitted to the Department of the Treasury. We obtained and analyzed information the enterprises considered to be proprietary that included information packages prepared for board members of the enterprises; detailed information on nonmortgage investments, their yields, and maturity; yield and other characteristics of enterprise debt issued to fund the nonmortgage investments; and compensation policies for senior officers and board members. We do not report specific details of the enterprises’ investment policies and practices or compensation policies because of the proprietary nature of such enterprise information. Our interviews with officials at OFHEO and FCA on their regulatory oversight of nonmortgage investments included discussion of proprietary information relied upon by the regulators in making their safety and soundness determinations regarding nonmortgage investments. We did not verify their findings leading to the safety and soundness determinations. Generally, the financial practices that the housing enterprises used to limit the interest rate and credit risks of their nonmortgage investments were fairly straightforward. From the data we collected at the housing enterprises and interviews with housing enterprise and OFHEO officials, we obtained a general understanding of OFHEO’s determinations. In contrast, the financial practices that Farmer Mac used to limit the interest rate risk of its nonagricultural-mortgage investments were not as straightforward and were not fully captured by the specific data we collected from Farmer Mac. Therefore, we were not able to obtain as complete an understanding of FCA’s determinations. We obtained written comments on a draft of this report from each of the three enterprises, HUD, OFHEO, FCA, and Treasury. Their comments are discussed near the end of this report and are reprinted in appendixes III through IX. We conducted our work in Washington, D.C., from April 1997 through October 1997 in accordance with generally accepted government auditing standards. The charters of all three enterprises provide them with broad investment powers. OFHEO has clear authority to regulate investments by the housing enterprises if such investments pose a safety and soundness concern. HUD has general regulatory authority over the housing enterprises and is charged with making such rules and regulations as shall be necessary and proper to ensure that the purposes of the respective charter acts are accomplished. In addition to general regulatory authority, HUD also has authority to approve new mortgage programs that could contain nonmortgage investment components. FCA, through OSMO, has safety and soundness and general regulatory authority with respect to Farmer Mac. “to enter into and perform contracts, leases . . . or other transactions, on such terms as it may deem appropriate . . . to lease, purchase, or acquire any property, real personal or mixed . . . and to sell, for cash or credit, lease, or otherwise dispose of the same, at such time and in such manner as and to the extent that it may deem necessary or appropriate, . . . and to do all things as are necessary or incidental to the proper management of its affairs and the proper conduct of its business.” The Farmer Mac charter act empowers it to, among other things, “ . . . purchase or sell any securities or obligations . . . necessary and convenient to the business of the Corporation.” One general rule of law is that a corporation’s powers can be no broader than the purposes for which the corporation is organized. This rule is particularly relevant where, as in the case of the enterprises, the corporation is organized for special, as opposed to general, purposes. Thus, even though the enterprises have broad investment powers, the exercise of those powers should not be unrelated to the accomplishment of the special purposes for which the enterprises were created. Under general corporate law, this relationship has been described as the logical relation of the activity to the corporate purpose expressed in the charter. OFHEO, as safety and soundness regulator, is charged with ensuring that the housing enterprises are adequately capitalized and operate safely and in accordance with the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the 1992 Act). OFHEO has regulatory and enforcement authority, without the review or approval of HUD, with respect to matters generally related to enterprise safety and soundness and to a few specific matters, including certain capital distributions and executive compensation at the enterprises. Therefore, OFHEO has authority to supervise an enterprise investment that affects the enterprise’s safety and soundness without consultation with HUD. Actions taken by OFHEO with respect to other matters not specified in the 1992 Act as exclusive to OFHEO are subject to the review and approval of the Secretary of HUD. FCA, through OSMO, has regulatory responsibility for Farmer Mac. Among other things, OSMO is responsible for ensuring that Farmer Mac holds adequate capital for the activities it performs and operates in a safe and sound manner. OSMO is also responsible for supervising the safety and soundness of Farmer Mac’s program and investment activities. OFHEO has concluded that each housing enterprise’s nonmortgage investment policies and practices have not constituted a safety and soundness concern.