compelled them to side with the shareholders against the taxpayers.22 In any event, government appointments to GSES' boards of directors have served more as political plums than as vehicles for upholding the public interest. Ending such appointments—so that GŜE shareholders would elect all GSE directors-would remove the conflict of interest. By strengthening shareholders' control over each GSE, ending such appointments could also help shareholders hold management more accountable and thus promote better corporate governance. COMPLYING WITH SECURITIES LAWS The GSES' statutory exemption from the registration and reporting requirements of the Federal securities laws is an anachronism and deserves to be repealed. The exemption sends the wrong signal: That GSE's are so "special," so close to the Government, that investors in their securities have no need for the protections afforded by those requirements. OPPORTUNITIES FOR IMMEDIATE ADMINISTRATIVE ACTION Regulators can and should act now to improve the regulation of Fannie and Freddie. First, to help avoid unhealthy concentrations of credit risk among FDIC-insured banks, the Federal banking agencies should prescribe guidelines for banks' credit exposure to individual GSE's and to GSE's generally.23 Second, the Securities and Exchange Commission should prohibit mutual funds whose portfolios consist largely of GSE securities from mislabeling themselves as "Government" or "U.S. Government" funds.24 Third, the Federal Reserve Board should proceed with its proposal to curtail socalled "daylight overdrafts" by GSE's. Fourth, HUD should tighten its scrutiny of the GSES' mission, using its authority to review activity-expansion, prescribe affordable-housing goals, and interpret rel evant statutes. Conclusion The GSE's argue as though the present is always the wrong time to enact any reform that they do not want, such as reform that benefits taxpayers or homebuyers rather than the GSES' managers and shareholders. In the GSEs' view, either (1) there is no acute problem warranting reform, or (2) reform now would crimp housing markets and risk destabilizing the financial system. But now is the right time to act to correct the deficiencies in GSE regulation before a crisis hits or another scandal breaks. Introduction PREPARED STATEMENT OF JAMES R. RAYBURN The 215,000 members of the National Association of Home Builders (NAHB) appreciate the opportunity to present their views to the Senate Committee on Banking, Housing, and Urban Affairs on the regulatory framework for Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLBank) System, including safe 22 The three members of the old Federal Home Loan Bank Board-appointed by the President and confirmed by the Senate-served ex officio as Freddie's board of directors. Freddie's preferred share price had more than doubled in response to a proposal to allow anyone to own Freddie shares. (By severing Freddie's historic link to the thrift industry, the proposal would free Freddie to increase its profits by amassing a large portfolio of mortgage-backed securities.) Senate Banking Committee Chairman William Proxmire developed a plan to grant the relief desired upon payment of a fee to reduce the taxpayers' bill for the thrift clean-up. But Freddie's management convinced Freddie's directors that their fiduciary duties compelled them to oppose the Proxmire plan. 23 Regulators could, for example, prescribe rules or guidelines under Section 305(b)(1)(A)(ii) of FDICIA, which requires risk-based capital standards to "take adequate account of... concentration of credit risk." Regulators could also issue more specific examination standards. 24 The SEC prohibits a mutual fund from having "name suggesting that the Fund . . . [is] guaranteed I by the United States Government." 17 CFR §270.35d-1. But many mutual funds that invest predominantly in GSE securities nonetheless call themselves "U.S. Government Securities Funds." To take what is probably an extreme example, the Pacific Capital U.S. Government Securities Cash Assets Trust had 98.8 percent of its assets in GSE securities as of September 30, 2003; it evidently held no U.S. Government securities at all. See http:// www.aquilafunds.com/ourcompany/moneyfunds.htm (semi-annual report), at 9. ty and soundness oversight, new program approval, and the establishment and enforcement of affordable housing goals. These housing-related Government sponsored Enterprises (GSE's) are critical components of the Nation's housing finance system and are largely responsible for the efficiency and resiliency of that system, as reflected in the tremendous advances recorded in the availability and affordability of mortgage products for homebuyers and providers of rental housing. The success and value of our housing finance system has been clearly evident in recent years, as the housing sector sustained economic performance while other areas of the economy faltered. Considering the complexity of the housing finance marketplace and the risks at stake, the task of restructuring the regulatory framework of the housing-related GSE's is a daunting one. However, NAHB believes that two governing principles should guide the debate. First, the regulatory framework for the GSE's must be credible and effective to ensure these organizations fulfill their mission in a safe and sound manner. Second, the public/private partnership of the housing finance system is sacrosanct; any other changes to the current system should not disrupt the efficient operation of the mortgage markets and the impediments to the development of effective programs to address the Nation's housing needs. With these concepts as a foundation, NAHB offers the following recommendations. NAHB maintains its previously asserted position that the Department of Housing and Urban Development (HUD) is the appropriate agency to regulate the mission of Fannie Mae and Freddie Mac, including approving new programs and establishing and enforcing affordable housing goals. However, if Congress chooses to explore the option of creating an independent regulator with oversight for all the housing-related GSE's, we implore Congress to ensure that the regulator has a thorough understanding of and extensive involvement in housing-related issues. We do not believe that the Department of the Treasury, which is well-suited as a safety and soundness regulator, has sufficient expertise and involvement in housing issues to serve as a housing-related GSE program regulator. Background HOUSING AND THE ECONOMY The housing market has been an engine of growth in recent years, sustaining the economy during a difficult stretch. That performance continued in 2003, with new home sales reaching a record performance of more than a million closings. Singlefamily home construction has been robust and totaled 1.5 million units in 2003. Multifamily activity has been more subdued, but still posted a respectable showing, pushing total housing starts above the lofty 1.8 million units threshold. While low interest rates and favorable demographics have spurred demand, these results would not have been possible without the support of the finance system for housing. The bedrock of that system is a liquid and vibrant secondary market that is the product of the activities of Fannie Mae, Freddie Mac, and the FHLBank System. These enterprises have not only contributed to the affordability of housing credit, but also have taken the lead in expanding the menu of affordable housing programs and products. GSE'S AND HOUSING FINANCE The housing-related GSE's are American success stories. As mentioned above, they have brought enormous benefits to homebuyers, renters, and the housing finance system. These include: Reduction of mortgage interest rates-The impact of the housing-related GSE's on mortgage borrowing costs is well documented. Homebuyers with conforming loans-mortgages eligible for purchase by Fannie Mae and Freddie Mac, those up to $333,700 for one-unit properties-pay mortgage rates that are approximately 25 to 50 basis points lower than rates paid by other conventional mortgage borrowers. The FHLBanks have done their share by passing through their advantageous borrowing rates for use in member loan programs. Further rate reductions are provided through the subsidies of the FHLBank System's Affordable Housing Program (AHP) and the Community Investment Program (CIP). Reliable and stable flow of mortgage credit-The linkage that the GSE's provide to the national and international capital markets sustains the flow of capital to housing, even under changing economic conditions. While the economy has undergone major shocks over the past decade, homebuyers have experienced no interruption in the availability of mortgage credit. Elimination of regional disparities in interest rates-The GSE's provide a nationwide market for mortgage funds, a key factor in the elimination of regional disparities in the availability and cost of mortgage credit, which oc curred regularly before the housing-related GSE's came on the scene. Today, interest rates in mortgage markets around the country vary by no more than 10 basis points. Cushion against local economic downturns-When regional economies begin to slow, some participants in the mortgage industry have restricted credit or abandoned markets in search of opportunities elsewhere. This is not the practice of the GSE's. They maintain a presence in all markets under all economic conditions, cushioning the impact of local or regional declines in economic activity. Market standardization and innovation-The GSE's have brought innovation to the mortgage markets to address a broad range of borrower and investor preferences. For example, Fannie Mae and Freddie Mac have established reduced downpayment programs to help cash-strapped first-time homebuyers. Recently developed mortgage products to assist borrowers with tarnished credit histories further exemplify the extent to which Fannie Mae and Freddie Mac employ novel approaches to respond to consumer credit needs. The FHLBanks also stand out in this area by virtue of the programs that are stimulated and supported by the AHP and the CIP. Expansion of homeownership and rental housing opportunities—The housing GSE's have made very significant strides in expanding homeownership opportunities and increasing the supply of affordable rental housing in underserved areas. The housing goals enacted by the 1992 GSE Act have successfully encouraged both Fannie Mae and Freddie Mac to significantly increase their service to the market sectors targeted by the housing goals. The supply of affordable housing is further augmented by the 12 FHLBanks; each contributes at least 10 percent of its annual net earnings to its statutorily prescribed Affordable Housing Program to subsidize the cost of housing for very low-income and low- or moderate-income households. CONTEXT FOR GSE OVERSIGHT EVALUATION NAHB believes that debate and discussion on the future of GSE regulation should begin by reflecting on how and why these entities came to exist. The genesis of all three housing-related GSE's can be traced to Congress' recognition of the strong public policy benefits of housing and homeownership opportunities. Fannie Mae, Freddie Mac, and the FHLBank System were chartered to provide liquidity and stability for the Nation's housing finance system. The decision by Congress to confer the sponsorship of the U.S. Government on these entities was not a superficial one. Undoubtedly, Congress realized that no private corporation would assume the risks or expend the resources to undertake an objective of this magnitude. Moreover, it would be unlikely that any particular entity would have the credibility to attract the appropriate blend of borrowers and investors. Rather, Congress was keenly aware that in order for an enterprise to overcome such obstacles it would need the imprimatur of the U.S. Government. It is this well-forged public/private alliance that makes this Nation's housing finance system the model, if not the envy, of the world. As mentioned above, housing is a significant financial element in today's economy, not just in a macroeconomic sense, but also in terms of every homeowner's portfolio. The remarkable growth of Fannie Mae, Freddie Mac, and the FHLBank System has been raised by others as a point of discussion and concern. NAHB suggests that the performance of these entities should be evaluated within the context of the growth of the housing finance sector and its impact on consumers, investors, and the economy at large. From this perspective their growth can be viewed in a positive light. NAHB believes it would be a tremendous mistake to turn discussion on GSE regulation into a referendum of our highly successful housing finance system. Attempts to alter the Government's sponsorship of Fannie Mae, Freddie Mac, or the FHLBanks arguably contradicts Congress' intent, and most definitely would destroy the foundation upon which the system rests. The key to the GSEs' success is their steadfast focus on their mission. They are in one business, housing finance-a relatively low-risk endeavor. This narrow focus should be recognized in the discussion of any future regulatory framework. The GSE's are not banks operating in far-flung and highly risky product lines and markets and should not be regulated as such. Even the staunchest advocates of GSE regulatory reform would agree that there is no imminent crisis in the GSE system. Therefore, NAHB urges a careful and thoughtful approach on GSE regulation. NAHB is certain that such a course will produce tremendous rewards to those with most at stake in the process-America's homeowners and renters. Guiding Principles for GSE Oversight Since the GSE regulatory reform debate began in earnest last year, there has been no shortage of recommendations on a wide range of elements that many policymakers believe would enhance the stature of the regulatory system for Fannie Mae, Freddie Mac, and the FHLBank System. NAHB notes that most of the recommendations focus primarily on enhancing the power of the regulator to impose restrictions on the GSE's. Such proposals often make no reference to the responsibility of the regulator to ensure that the GSE's fulfill their Congressionally mandated purpose. Furthermore, others have recommended simply transferring the oversight from one agency to another without establishing a logical nexus between the expertise of the regulator and the mission of the entities to be regulated. NAHB urges this Committee to take a more rational approach by first establishing a foundation of core principles on which to build a solid regulatory framework. As direct participants in the production of housing and related activities, NAHB offers the committee the following set of core principles: 1. The GSE status of these institutions must be maintained. Efforts to privatize, withdraw any of the Federal privileges and legal exemptions, or otherwise diminish the ability of the GSE's to provide housing financing at the lowest possible cost should be opposed. 2. The GSE's should fulfill their public mission by conducting activities authorized by their charters in a safe and sound manner and by promoting access to mortgage credit to address the needs of affordable housing throughout the Nation. 3. The regulatory framework of the GSE's should be strong and credible, possess adequate authority and resources and reflect the differences inherent in the charters and operating structures of the GSE's. Further, the regulatory framework should foster competition among the GSE's to develop and implement innovative, low-cost funding and other programs to meet the nation's housing credit needs. 4. The mission oversight of Fannie Mae and Freddie Mac (including approval of new programs and enforcement of affordable housing goals) should be conducted by the Department of Housing and Urban Development or another entity with a thorough understanding of and extensive involvement in housing-related issues. 5. The safety and soundness oversight of Fannie Mae and Freddie Mac should be conducted by an independent regulatory agency through rigorous examinations, enforcement of regulations (including capital standards) and transparency, without unnecessarily impairing the ability of these GSE's to accomplish their mission. 6. The recently implemented risk-based capital standards for Fannie Mae and Freddie Mac should be allowed to remain in place for a period of time sufficient to evaluate the effectiveness of the new standards. 7. The regulation of the mission and safety and soundness of the Federal Home Loan Bank System should reflect the uniqueness of the System's mission, cooperative operating structure, charter type, and other characteristics. This is best accomplished by having a regulator dedicated solely to FHLBank System oversight or by having a separate FHLBank System oversight division if a single agency regulates all of the housing GSE's. Current GSE Regulatory Framework FANNIE MAE AND FREDDIE MAC The 1992 GSE Act established a dual regulatory oversight structure for Fannie Mae and Freddie Mac. HUD is the programmatic (or mission) regulator and the Office of Federal Housing Enterprise Oversight (OFHEO) is the safety and soundness regulator. The 1992 GSE Act requires Fannie Mae and Freddie Mac to obtain prior approval by HUD of any new mortgage programs. The Act defines new programs as any programs that are significantly different from programs previously approved or engaged in prior to 1992. HUD is required to review new programs to ensure that they are consistent with the GSEs' charters and are in the public interest. In addition, Fannie Mae and Freddie Mac are required by law to meet annual housing goals established by HUD. Finally, the 1992 GSE Act established OFHEO as an independent office within HUD to oversee the safety and soundness of Fannie Mae and Freddie Mac. OFHEO's primary responsibilities are to establish and enforce capital standards for Fannie Mae and Freddie Mac and to conduct annual on-site examinations of the firms to ensure that they are operating in a safe and sound manner. Fannie Mae and Freddie Mac are required to meet two capital standards, a minimum leverage ratio and a risk-based capital (RBC) standard. FEDERAL HOME LOAN BANK SYSTEM The FHLBank System was created by Congress in 1932 by the Federal Home Loan Bank Act. The Federal Housing Finance Board (Finance Board) is the FHLBank System's regulator. An independent agency, the Finance Board regulates both mission and financial safety and soundness. The FHLBanks are required to comply with both a leverage and a RBC capital requirement. The FHLBanks are also required by law to contribute a percentage of their net earnings each year to fund affordable housing programs. Administration's Proposal The Bush Administration proposes to create a new Federal agency within the Department of the Treasury (Treasury) to regulate and supervise the financial activities of Fannie Mae, Freddie Mac, and the FHLBank System. The new agency would have general regulatory, supervisory, and enforcement powers for GSE oversight, including the authority to establish, enforce, and revise capital standards. Oversight of Fannie Mae's and Freddie Mac's existing activities and approval of new activities would be shifted from HUD to the new Treasury agency. HUD would be left with minimal regulatory authority, limited to oversight of the annual affordable housing goals and a consultative role in program oversight. The Administration's proposal makes no specific recommendations for how the new regulatory agency would accommodate the inherent differences between Fannie Mae, Freddie Mac, and the FHLBank System. The Secretary of the Treasury would enforce policy accountability through review of the new agency's regulations, budget, and policy statements to the Congress. Importantly, the Administration does not recommend any changes in the GSES' agency status. NAHB POSITION ON KEY ELEMENTS Several elements of the Administration's proposal are antithetical to the core principles of GSE oversight. At the very least, the Administration's proposal would raise the costs of housing and stifle innovation. At worst, the proposal has the potential to undermine the entire housing finance system. Much of the debate surrounding the GSE regulatory restructuring has focused on the treatment of Fannie Mae and Freddie Mac. Indeed, most of the key elements of the Administration's proposal relate exclusively to these two GSE's. Other reform proposals have proposed including the Federal Home Loan Banks under the new GSE regulatory framework, either within the Treasury safety and soundness regulator or through the establishment of an independent regulator for all the housing GSE's. NAHB's comments and recommendations on key elements of these various proposals are discussed below. PROPOSED FANNIE MAE AND FREDDIE MAC REGULATORY FRAMEWORK Location of Program Oversight Under the Administration's proposal, Treasury would assume not only safety and soundness duties but also most mission-related oversight duties. For example, HUD's current authority to approve new programs would be transferred to Treasury under the premise that new program approval is a safety and soundness issue rather than a mission-oversight issue. HUD would have a consulting role. NAHB maintains that the program approval activities that are currently conducted by HUD should not be transferred to the Treasury Department. HUD is the preeminent regulatory authority on housing-related issues. Treasury has virtually no experience or expertise in evaluating the effectiveness and appropriateness of housing policies, especially those pertaining to housing for working families. Treasury presently has oversight for two important housing tax programs, low-income housing tax credits and mortgage revenue bonds. Operation of these programs is left to the States and HUD to set program specifics. Outside of these tax programs, Treasury has little experience or expertise in evaluating the effectiveness and appropriateness of housing policies. The ability of Fannie Mae and Freddie Mac to spur innovative solutions and to develop new products that increase homeownership and rental housing opportunities will be jeopardized if the mission of these corporations is regulated by Treasury. This stifling of innovation would reduce the capacity of Fannie Mae and Freddie Mac to provide the liquidity and stability needed to keep mortgage credit available at the lowest possible cost to homeowners and rental housing providers. NAHB believes that Fannie Mae's and Freddie Mac's ability to spur innovative solutions and to develop new products that increase homeownership will continue |