tect against liquidity risk? You said you believe they are pretty well-managed.

Chairman GREENSPAN. I would say generally they have quite adequate liquidity.

Chairman SHELBY. Mr. Chairman, we have had one hearing on Basel II here, and there has been some skepticism, as you know, from some of your regulator contemporaries expressed on some of the models that Basel II's framework would come about.

You note in your testimony, "In order to manage risk with little capital requires a conceptually sophisticated hedging framework" and that these are your words "in essence, the current system depends on the risk managers at Fannie and Freddie to do everything just right.”

If this is the case for Freddie and Fannie, who tout their risk management practices, shouldn't we have similar concerns with the reliance that Basel II would similarly place on such models, because they would change the whole capital structure as we know it, at least from up here?

Chairman GREENSPAN. Yes. Fannie and Freddie are special cases which are quite different from the institutions that Basel II is directed at.

In other words, this is a special case of highly leveraged, low credit risk, high interest rate institutions. I do not want to say they are unique, but they are close to that. The type of risk-based capital procedures that are involved in Basel II are far less complex types of issues than arise here, and also, it is a different type of risk management.

Chairman SHELBY. Okay. Mr. Chairman, one last question. You assert in your testimony that "Fannie and Freddie's purchases of their own or each other's securities or their debt do not appear needed to supply mortgage market liquidity or to enhance capital markets in the United States." Those are your words.

You suggest-and these are your words again-"deep and liquid markets that are provided by MBS's held by private investors." What effect if any would we see on liquidity in the mortgage market where the GSE is prevented from holding these securities in their own portfolio?

Chairman GREENSPAN. I do not think there should be a prohibition. I just think the size is what the issue is all about. In other words, to the extent that you need to hold securities for various different operations which facilitate the securitization operations of the GSE's, that is perfectly sensible.

Chairman SHELBY. Is that generally temporary, though?

Chairman GREENSPAN. Well, the issue is not the temporary; it is a question that is a very small part of the portfolio they hold. Chairman SHELBY. Senator Sarbanes.

Senator SARBANES. Thank you, Mr. Chairman.

Let me just follow up on the question that the Chairman just put, because I think it is interesting. Some have argued that the GSE's provide important stability in the mortgage markets during periods of economic instability, and they cite, for example, the Asian debt crisis in 1998 or the business and bank recession of 1990-1992, and argue that the mortgage rates would have increased dramatically at that time-as in fact they did in the jumbo

mortgage market and in other credit markets-but that the GSEs' ability to continue buying mortgages and mortgage-backed securities made a difference so that they helped play an important stabilizing role.

What is your response to that?

Chairman GREENSPAN. First of all, the reason that there were fairly significant purchases at that time is that during that crisis you had a flight to quality which pushed long-term Treasury rates down, and because the presumption was that the GSE debt was comparable to Treasury, its rates went down, and as a consequence of that, the margins opened up, and it became quite profitable to go in and purchase mortgages and mortgage-backed securities. So that the issue was not an endeavor to do something for the markets per se; it was a very sensible business decision.

Senator SARBANES. But did that endeavor contribute to stability? Chairman GREENSPAN. I think it did in part, yes; I said I think it did in part.

Senator SARBANES. Okay. Now, I was struck by your response to Senator Stabenow earlier on the effect of GSE's on mortgage rates in which you said, well, if it is 7 basis points, citing the Passmore study, and then you said, well, maybe it is 10 or maybe it is 12, and that was the range of your example. But are you familiar with the CBO study in 2001 that said the effect of GSE's on mortgage rates was 25 basis points?

Chairman GREENSPAN. I am, Senator.

Senator SARBANES. And are you familiar with the CBO study in 1996 that said the effect of GSE's on mortgage rates was 35 basis points?

Chairman GREENSPAN. I am, Senator.

Senator SARBANES. I am interested why your range of example seemed to fall so significantly short of these other studies excepting, at least in part, the argument that we have all these different studies, and we do not really know, which I think was the thrust of your argument, but then the range you gave really fell well short of these CBO studies.

Chairman GREENSPAN. Well, I think you have to remember that as these studies progress, we are learning things, and each analyst has the ability to learn from previous estimates. The early estimates, as best I can judge, were much simpler in structure and in evaluation than those that have occurred more recently.

Remember that Wayne Passmore and his colleagues who worked on this study were fully familiar with those previous studies and clearly, they had the choice of saying, well, they are right, or we can improve on them; and in the process, as best I can judge looking at the different techniques that are employed, the most recent study by Passmore and his colleagues is by far the most sophisticated and the one most likely to be accurate.

Senator SARBANES. There is considerable controversy over that.
Chairman GREENSPAN. Oh, indeed, there is.
Senator SARBANES. Yes.

Chairman GREENSPAN. And I might say that the one thing that I am quite pleased about, Senator, is that we are finally coming to grips with this issue, and I hope that a good deal of resources, private and otherwise, are applied in this direction. And as we said

when we released the draft of the Passmore study, we hope that people will criticize it.

Senator SARBANES. Am I right in thinking that the rates offered by mortgage lenders are such that the rates on conforming mortgages are 25 to 30 basis points less than the jumbo loan rate?

Chairman GREENSPAN. Let me say this issue that has been raised about-you can look in the newspaper, and you can find all these rates, and differ the jumbos look significantly different from the conforming-what Passmore and his colleagues did was basically to look at the actual transactions that occurred. Remember that these things that you read in the newspaper are list prices, and list prices have never, in any market, been a good reflection of what transactions were. And while there are questions about the quality of the transactions data-there is an issue there of whether or not there are sub-prime loans in those data

Senator SARBANES. That is right.

Chairman GREENSPAN. —but there is no question that you do not use posted prices or offers or listed prices when you have transaction prices, which is essentially the market, and it is the market which determines what the spread is between jumbos and conforming mortgages.

Senator SARBANES. What do you think that spread is?

Chairman GREENSPAN. I think the numbers that came out of the Passmore studies look—since I did not do the actual numbers— they look to me like they did a fairly sophisticated job.

Senator SARBANES. What are those numbers?

Chairman GREENSPAN. What is the actual number used in that? [Conferring.] Dr. Passmore says it is 16 to 19 basis points. Senator SARBANES. That is Dr. Passmore there?

Chairman GREENSPAN. That is Dr. Passmore.
[Laughter.]

And if you have questions for him, by all means go ahead.
Senator SARBANES. He actually exists.

[Laughter.]

He is not just a pseudonym in the Federal Reserve System. Chairman SHELBY. He is real. Senator Sarbanes, he is real and breathing. We just saw him in action.

Senator SARBANES. I see that, I see that. Okay.

Chairman GREENSPAN. Sorry I outed you, my friend. [Laughter.]

Senator SARBANES. Chairman Greenspan, Comptroller General Walker testified to this Committee that the Federal Housing Finance Board, FHFB, had just 10 examiners in July 2002 to examine the 12 Home Loan Banks-10 examiners—and the Board is planning to expand that to only 30 examiners by the end of this year.

Now, most observers feel that the Federal Home Loan Banks are engaging in riskier activities than they used to be. This point of concern was raised by former Assistant Secretary of the Treasury Sheila Baer at a hearing held here last year.

I understand, actually, that the OCC has as many as 20 or more examiners resident in each of the large national banks. What is your view of the capacity of the Federal Housing Finance Board to meet its supervisory responsibilities?

Chairman GREENSPAN. The number seems quite low in the context of what the banking regulators' general relationship is between examiners and examined institutions. I do not know what the actual numbers are, but our number is very substantially greater, and I assume the Comptroller's is as well, than the numbers you cite.

Senator SARBANES. You said earlier that you thought the Federal Home Loan Banks should be brought under the umbrella of this supervisor of the GSE's, but I think it might be helpful to us if you gave us some of your rationale and reasons for thinking that.

Chairman GREENSPAN. The reason basically is first that they too have a subsidy very similar to that of Fannie and Freddie. Indeed, the GSE subsidies are generally fairly consistent with one another. Then, of course, the major asset that is involved in the Federal Home Loan Bank System is mortgages. So both the assets and the liabilities are quite similar and have the same economic effects. And as a consequence, it would strike me that many of the principles that would be involved in supervising and regulating Fannie and Freddie would also be applicable, with some changes, to the Federal Home Loan Bank System.

Senator SARBANES. Well, the Chairman had to leave, and I am going to wrap it up. It is a great temptation, obviously, at this point, but I am going to forego that temptation and thank you, Chairman Greenspan, for coming before the Committee. We appreciate, as always, your testimony.

The hearing stands adjourned.

[Whereupon, at 12:13 p.m., the hearing was adjourned.]

[Prepared statements and response to written questions supplied for the record follow:]

PREPARED STATEMENT OF SENATOR MICHAEL B. ENZI

As we are coming to the close of hearings on the regulatory oversight of the housing Government Sponsored Enterprises, we should take a step back to where we began. At that time, the focus of the hearings were on the accounting errors of Freddie Mac and whether the Office of Federal Housing Enterprise Oversight was sufficient in catching those errors in a timely and effective manner. Today, it is clear that the issues as well as our national housing agenda have become much broader than that.

Not only are we discussing a new regulator for Freddie Mac and Fannie Mae but there has also been much discussion of whether to include the Federal Home Loan Banks into the system.

Back in August, I sent a letter with a few of my colleagues to Treasury Secretary Snow that a new regulator for Fannie Mae and Freddie Mac should be established and that the new regulatory entity have sufficient resources and tools to oversee the complex financial instruments used by those two entities. In addition, I stated that the regulator must be independently financed. Today, I still believe that those issues are valid and necessary.

Our housing market is still one of the most important driving sectors of our economy. That is due in large part to the Federal Reserve Board's ability to maintain I low interest rates and from homebuyers being able to tap into the equity of their homes built upon the tremendous growth of the housing market. The housing industry bears little resemblance to what it looked like 15 years ago. However, from a rural State perspective, there are still improvements that can be made.

As we debate the new regulatory structure of the Government Sponsored Enterprises, I believe that it is essential that we maintain the individual characteristics of Fannie Mae and Freddie Mac and the Federal Home Loan Banks. Wyoming, as a rural State, has benefitted from the unique nature of both systems. We must be cautious not to make any legislative changes that may limit the distinctions or cause those distinctions to disappear in the future. In addition, if the new regulator is to be entrusted with complete oversight of the Enterprises, the regulator must be structured as not to impede rural or Native American housing needs or the Enterprises ability to solve those difficult housing problems. I look forward to working with you, Mr. Chairman, and my colleagues as we will be considering legislation in the near future.

Another vital component of the housing market is the need for reform of the real estate settlement process. The settlement process has helped us achieve the growth in the housing market. The Department of Housing and Urban Development has pending a regulatory proposal to amend the regulations implementing the Real Estate Settlement Procedures Act. This proposal has been very controversial both from a small and a large business perspective.

Recently, I had the opportunity to meet with Acting Secretary Jackson. I told him that reform of the settlement process is essential, however, I strongly believe that it would be in the best interest of everyone involved that the rule be reproposed. This will allow everyone a fair opportunity to comment on whatever changes the Department intends to make. In addition, it will give the Department a chance to fix its flawed small business economic analysis. It is important this rule proposal be done properly otherwise it could significantly affect our strong housing market.

Turning for a moment to topic unrelated to the housing industry, Chairman Greenspan, you recently stated before this Committee on the skills of our workforce, "what will ultimately determine the standard of living of this country is the skill of the people." You went on to state, "[w]e need a level of skills of our working population which is continuously becoming more conceptual to match the types of goods and services that consumers want."

The Workforce Investment Act Amendments is designed to accomplish the goal that you describe-preparing the 21st century workforce for 21st century jobs. The well-being of our workers, their families, and our country depends on meeting this goal.

This legislation has passed both the House and the Senate. In light of your comments, I am urging the leadership of both parties to appoint conferees on this vital legislation for the growth of our economy and for the jobs of our people.

Thank you Mr. Chairman for holding this important hearing. And thank you Chairman Greenspan for being with us today.