HUD should continue to speak for housing, new GSE program oversight, and the GSES' critical mission supporting homeownership.

Over the past decade the housing sector and American homeowners have benefited significantly from the strength of the Nation's housing finance system. At the core of our housing finance system are the secondary mortgage market and the Government sponsored mission of Fannie Mae and Freddie Mac. The National Association of REALTORS® supports a credible and vigorous GSE regulator. A strong regulator reinforces President Bush's and Congress commitment to housing and homeownership, promotes confidence in Fannie Mae, Freddie Mac, and the real estate and housing finance industries, and protects U.S. citizens against systemic risk. Although realtors support a strong regulator, we insist that regulatory reform does not imply and should not result in any weakening of the current housing finance system. Congress deemed the Government Sponsored Enterprise model as an appropriate vehicle to advance housing and housing policy as recently as 1992. Fannie Mae and Freddie Mac were chartered as private corporations with publicly traded stock with the mission to bring new mortgage products to the market, and to use innovation and technology to continue simplifying the mortgage process. In exchange for the Federal charter to facilitate the residential secondary mortgage market, certain advantages were provided to Fannie Mae and Freddie Mac. Since enactment of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Title XIII of Public Law 102–550), Congress, homeowners, the housing finance system, and the Nation's economy have all benefited tremendously. The unprecedented expansion of homeownership rates is undeniable testament to the efficiency and liquidity of the secondary mortgage market and the housing sector.

Administration Regulatory Recommendations

In recent testimony to the Senate Banking Committee, Treasury Secretary John Snow and HUD Secretary Mel Martinez outlined the powers, duties, and authorities a new GSE safety and soundness regulator should have in a new agency within the Treasury Department and the relationship that HUD would have going forward. The proposed new supervisory agency would focus on safety and soundness, together with program and product approval, in consultation with HUD. Secretary Snow urged consideration of an agency that would be independent of the Congressional appropriations process, and that Treasury would have, at a minimum, clearance of new regulations and Congressional testimony.

Secretary Martinez supported the Administration view that authority over new program approval be transferred from HUD to the new regulator in his testimony. Secretary Martinez advocated HUD retaining authority over the GSE affordable housing goals, and called for expanded authority to enforce the housing goals, impose civil penalties for failure to meet the housing goals, explicitly provide that the GSE's act to increase homeownership, and expand authority to set housing goals and sub goals.

NAR would like to comment on key elements of the Administration's plan that are most relevant for the real estate industry.

Independent Regulator

REALTORS® would agree that Fannie Mae and Freddie Mac should have an independent regulator for safety and soundness. We would recommend that the new regulatory agency in the Treasury Department should have necessary and sufficient firewalls to ensure its political and operating independence similar to those that currently exist for the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) regulatory models.

GSE Capital

In outlining the authority for the new regulator regarding GSE capital, Secretary Snow highlighted in his testimony a need for stability in capital standards. "Capital," he said, “is the fundamental element of the financial condition of an enterprise, and the capital standards should not become the subject of frequent change.” REALTORS® agree with Secretary Snow on this general point regarding capital. These capital standards should be allowed to remain in place for a period of time sufficient to evaluate their effectiveness.

GSE Mission, Program and Product Review

The Administration proposal to place GSE regulatory oversight and new program approval under the Treasury Department is a major change in regulatory oversight of the housing GSE's. REALTORS® expressed opposition to moving GSE housing mission oversight from HUD when the Administration's plan was first released. Our concern is that housing policy has not been the purview or expertise of the Treasury

Department; this has been the purview of HUD. The housing and real estate industries naturally look to HUD to address the housing mission, programs and products, and affordable housing goals that are central to the GSEs' existence. In the new GSE regulatory regime we strongly believe that HUD should maintain its primacy in these areas.

Secretary Martinez proposed that HUD continue to consult with the Treasury Department on new activities requested by the GSE's. REALTORS® recognize that new programs and products could have an impact on safety and soundness considerations. But REALTORS® believe that new program approval should remain at HUD with the same approval standards in current law. There is “substantial expertise," as stated by Secretary Martinez in his testimony on September 10 before the House Financial Services Committee regarding mortgage and housing markets programs. While REALTORS® have considerable respect for the financial expertise at Treasury, HUD expertise as our Nation's primary housing agency should not be relegated to a consultative role on matters of new programs approval or lines of business.

Secretary Snow and Secretary Martinez outlined the Administration's principles in subtle terms. Consequently, REALTORS® are guarded about the direction of draft legislation that we understand will be the starting point for GSE regulatory reform. Significant revisions in the GSEs' role in the housing finance system could introduce uncertainties and unintended consequences that will have ill effects for the GSE's and the housing sector.

Federal Home Loan Banks

Secretary Snow's recent testimony to this Committee reiterated a call to create a credible, single regulator for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. REALTORS® do not have position on regulating the Federal Home Loan Banks.

Targeted, Not Sweeping Reform

REALTORS® firmly believe that targeted reform for the GSE regulatory system strengthens our housing finance system. We support a narrow bill that institutes safety and soundness regulatory reforms, and does no harm to the GSE housing mission, charter, or status. Given the fragility of the economy with mixed, weak signals about recovery, REALTORS® want to impress on lawmakers that safety and soundness concerns should not undermine the housing mission, programs and product innovations, or charter status of Fannie Mae and Freddie Mac. Targeted reform for the GSE regulatory system strengthens our housing finance system. REALTORS® expect that Congress will act judiciously to assure a critical role for HUD in GSE mission, program development and review. Congress should assure that under new regulatory oversight Fannie Mae and Freddie Mac would thrive and continue their critical roles in supporting American homeownership. In short order, these companies should have the best opportunities to help our citizens achieve homeownership.

Conclusion

We applaud the Committee's efforts to build a more robust GSE regulatory structure. The National Association of REALTORS® believes that an overarching principle guiding any consideration of regulatory reform proposals should assure that reform not become a reason or justification for rewriting the GSEs' housing mission or weakening the housing finance system.

Congressional intent and the Nation's homeowners have been well-served since 1992 when the GSEs' charter, mission, and status were reaffirmed. What is needed is a strong, rigorous safety and soundness regulator, while HUD retains mission and new program oversight.

The National Association of REALTORS® looks forward to reviewing the proposed legislation to reinvigorate GSE regulation. REALTORS® want to work with Congress to continue addressing housing and homeownership issues and supporting the mission and charter objectives of the housing GSE's.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ARMANDO FALCON, JR.

Q.1. In your written statement, you proposed that any new regulator be given "full discretion in setting capital standards." For the record, what is the value of having both a minimum capital standard and a risk-based capital standard? That is, what purpose does each standard serve?

A.1. Capital standards are designed to ensure that regulated institutions can survive periods of significant misfortune involving sizeable financial losses. In theory, a single standard that encompassed all relevant considerations would suffice to determine capital adequacy. In practice, that would be very difficult, and Congress has wisely required OFHEO and all depository institution regulators to implement both a leverage-based standard and a more finely tuned risk-based standard.

Evaluation of capital adequacy entails a broad range of considerations including not only an institution's current book of business; but also the current and prospective risk environment, its business strategies and potential changes in those strategies, the strength of its customer and supplier relationships, the strength of its internal controls, potential fragility if the markets in which it buys and sells, the structure of those markets and potential changes in the way those markets function, the vulnerability of the institution's reputation, the systemic importance of the institution, and many other factors.

Issues of practicality constrain the determinants of capital requirements to a small subset of these factors. Thus, for example, OFHEO's risk-based standard focuses on each Enterprise's, current book of business and two possible future risk environments. It requires sufficient capital to cover losses or current positions in extended, specific adverse' circumstances. This is a highly detailed rule that examines this aspect of capital adequacy in depth. It is important that the Enterprises be able to meet this requirement, but does not necessarily imply that capital is adequate. A high degree of protection against interest rate and credit risk can reduce the risk-based requirement to very low or zero levels, without addressing other risks.

The minimum capital (leverage-based) standard is a fail-safe mechanism that ensures a substantial amount of capital regardless of measured interest rate and credit risks. Incorporating all other risks into the risk-based standard would be problematic. They generally do not fit well into the scenario format because the range of possibilities is essentially infinite. Also, the magnitudes of other risks generally are not easily quantifiable, but rather are more a matter of judgment.

A separate standard that encompasses these judgments makes sense. While it would be possible to add the two requirements to make a single rule that would produce an overall requirement that would be considerably more volatile than the current combination, and might usually be higher than necessary. So far, the judgment exercised by Congress in setting the ratios used to determine the minimum capital requirements has worked satisfactorily. However, institutions and their business environments change over time. An expert safety and soundness regulator is best able to judge, if and

when changes, to a leverage-based ratio should be made. Accordingly, Congress should give the regulator of Fannie Mae and Freddie Mac the same authority it has given depository institution regulators to adjust all capital requirements if necessary.

Q.2. The Administration has suggested that the new regulatory agency should have more than the powers associated with conservatorship. Should one of the GSE's under your watch encounter serious financial difficulties, do you believe that the existing authority of your agency would be sufficient to manage the crisis? A.2. OFHEO has strong conservatorship authority that it may bring to bear should an Enterprise under its jurisdiction encounter problems that merit appointment of a conservator. This authority, while sufficient to manage a crisis, does not provide all the tools a safety and soundness regulator should have. OFHEO has supported legislative clarification of its authority to support its interpretation of the law. Additionally, OFHEO has called for legislative action to provide receivership authority that is available to other Federal financial regulators. It should be noted that existing statutory law permits the charters of the Enterprises only to be revoked by Congress, thus receivership would enhance the ability to oversee the Enterprises, and assure the markets of a full range of remedies available to the safety and soundness regulator while preserving Congressional control over charter termination.

Q.3. OFHEO and the Finance Board clearly do not have the complete arsenal of Prompt Corrective Action tools that the OCC and other bank regulators have. In fact, the Finance Board has no statutory Prompt Corrective Action authority. Do you believe that a new regulator must have the same Prompt Corrective Action tools as the bank regulators?

A.3. Yes, and OFHEO has an array of Prompt Corrective Action tools. Modeled on bank regulations, the Prompt Corrective Action regulations are broad and tied to capital levels. However, OFHEO has proposed legislative enhancements that would conform OFHEO's statutory authorities even more closely to the bank regulators; that is, express authority to act on safety and soundness matters.

It also should be noted that OFHEO has added to its Prompt Corrective Action rules a section on prompt supervisory response. This section provides an orderly procedure for OFHEO to act in cases where capital may not be impaired and provides both a description of key situations as well as an order for OFHEO actions. Thus, OFHEO has a regulatory structure that provides for action before capital levels are reached that trigger Prompt Corrective Actions.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED

FROM ARMANDO FALCON, JR.

Q.1. In your testimony, you suggested that the current minimum capital standard of 2.5 percent is sufficient to ensure the safety and soundness of the GSE's. However, you argued the new proposed safety and soundness regulator should have absolute discretion to change both the risk-based and minimum capital requirements, since, as you characterized it, the minimum capital standards acts

as a "fail-safe mechanism" to capture risks that allegedly cannot be addressed in the risk-based role.

Please explain in detail why the risk-based capital rule cannot address these alleged risks to the safety and soundness to the GSE's. If these risks cannot be quantified, on what basis would the regulator change the minimum capital requirements in order to act as a "fail-safe mechanism?" How would this basis for changing the minimum capital standard be different from the basis for determining the risk-based capital rule? Do you believe that it would harm the ability of Fannie and Freddie's regulator to perform its oversight functions if Congress placed restrictions on its ability to adjust the minimum capital standards? Why or why not?

A.1. Capital standards are designed to ensure that regulated institutions can survive periods of significant misfortune involving sizeable financial losses. In theory, a single standard that encompassed all relevant considerations would suffice to determine capital adequacy. In practice, that would be very difficult and Congress has wisely required OFHEO and all depository institution regulators to implement both a leverage-based standard and a more finely riskbased standard.

Evaluation of capital adequacy entails a broad range of considerations including not only an institution's current book of business; but also the current and prospective risk environment, its business strategies and potential changes in those strategies, the strength of its customer and supplier relationships, the strength of its internal controls, potential fragility if the markets in which it buys and sells, the structure of those markets and potential changes in the way those markets function, the vulnerability of the institution's reputation, the systemic importance of the institution, and many other factors.

Issues of practicality constrain the determinants of capital requirements to a small subset of these factors. Thus, for example, OFHEO's risk-based standard focuses on each Enterprise's current book of business and two possible future risk environments. It requires sufficient capital to cover losses or current positions in extended, specific adverse circumstances. This is a highly detailed rule that examines this aspect of capital adequacy in depth. It is important that the Enterprises be able to meet this requirement, but does not necessarily imply that capital is adequate. A high degree of protection against interest rate and credit risk can reduce the risk-based requirement to very low or zero levels without addressing other risks.

The minimum capital (leverage-based) standard is a fail-safe mechanism that ensures a substantial amount of capital regardless of measured interest rate and credit risks. Incorporating all other risks into the risk-based standard would be problematic. They generally do not fit well into the scenario format because the range of possibilities is essentially infinite. Also, the magnitudes of other risks generally are not easily quantifiable, but rather are more a matter of judgment.

A separate standard that encompasses these judgments makes sense. While it would be possible to add the two requirements to make a single rule that would produce an overall requirement that would be considerably more volatile than the current combination,