neering? I understand what the finance department is. What's financial engineering in your estimation?

MS. DELEO. May I address the first part of your question?
Mr. STEARNS. Sure, absolutely, yes.

MS. DELEO. I think what we normally would have seen in a corporation is three areas, a strong internal accounting group, a strong internal audit staff and external auditors. What we found at Freddie was weaknesses in all of those areas, so when that existed you're going to have a situation where you're going to have misapplications of GAAP.

Mr. STEARNS. Okay, is financial engineering a department, generally, that's okay? It sounds like a financial engineering department is one to exploit and-find and exploit anomalies in GAAP. MS. DELEO. Well, that particular department was, I guess that name is a misnomer, but had you had a strong accounting

Mr. STEARNS. You wouldn't need a financial engineer.

MS. DELEO. And they would have prevented or turned down anything that that group was working on that would have misapplied GAAP.

Mr. STEARNS. Fannie Mae is also under your jurisdiction, Mr. Falcon.

Mr. FALCON. Yes.

Mr. STEARNS. And are you saying here today that there's no problems in the GAAP accounting compliance in that corporation too today?

Mr. FALCON. I'm not prepared to say that at this moment. We do not, as I said, secondarily, review accounting statements for compliance for GAAP and so we are about to undertake an extensive review of Fannie Mae to determine and make sure that there aren't any problems at Fannie Mae.

Mr. STEARNS. My time has expired.

Ms. SCHAKOWSKY. Thank you, Mr. Chairman. I appreciate your good questions, too. I was going to start really the same way. This is a scathing statement that you made. Some of the language is pretty harsh in here, rightfully so, I think, but obfuscate particular policies, disdain for appropriate disclosure standards, misled investors, low regard for disclosure, obsession with steady stable growth and earnings at the expense of proper accounting policies and strong accounting controls, weak or nonexistent accounting policies and on and on.

It really led me to think really the same question. Since, as I understand OFHEO, you employ "a full range of supervisory and enforcement tools including examination, capital standards and prompt corrective action procedures." Is it simply just the lack of expertise or is it that in the past you have not been looking for the thing, since safety and soundness wasn't a concern that you weren't looking at all for the things that we have subsequently have been discovered?

Mr. FALCON. This accounting misconduct is not something that we would you have to review their financial transactions and how they applied GAAP to those transactions to be able to protect against this type of conduct. And this conduct by its very nature isn't obvious or made plain to the public, investors or regulators. You have to go in and try to find this type of misconduct. And with

that and an accounting review by our agency on a regular basis, we can't do that which is why we're changing this part of our oversight program over these two enterprises. We will begin with use of our Office of Compliance as well as an Office of Chief Accounting to begin to spot check and review the implementing of the accounting standards.

Ms. SCHAKOWSKY. Now if they were forced to register with the SEC, the SEC would do that kind of work, is that correct? And let me just ask, and do you support legislation that would require, since they've been so lackadaisical and to date have not registered with the SEC.

Mr. FALCON. I think it became very clear to us, Congresswoman, in the course of this investigation that a system of voluntary disclosure standards is not adequate and so I do support the repeal of the company's 1933 and 1934 exemptions.

Ms. SCHAKOWSKY. Freddie Mac has been fined $125 million. I want to ask you, and I don't know the answer to this, is this sufficient? I think what Americans are feeling right now is that some of these scandals go largely unpunished that while there is a little burst of energy at first and isn't this terrible and a lot of finger pointing and wagging that in the end it's maybe a slap on the wrist and that's about it.

We have a particular responsibility here. It's one thing to talk about Enron or some private, totally private company and isn't this awful and there should be more consequences, but still we, because it's a GSE, have particular responsibility. Is this sufficient so far in the way of a fine?

Mr. FALCON. You mentioned the adjectives that were in the report and the testimony about the type of conduct they discovered. I'm not pleased about that kind of conduct at all, any more than

you are.

As you pointed out, these are government-sponsored enterprises. They live off of a public trust to fulfill their mission.

Ms. SCHAKOWSKY. Exactly.

Mr. FALCON. And if that public trust is violated, then our housing finance system is at risk which is why we are taking as strong an action as possible. I think the fine of $125 million was a very substantial fine, one of the largest ever imposed by a safety and soundness regulator for misconduct. Top management has been replaced. You'll see over the course of the next year a turnover on the board and we are implementing a very strong remedial plan for the company. This week, we'll decide whether or not the company shouldn't hold additional capital pending its compliance with the remediation plan.

Ms. SCHAKOWSKY. I thank you and thank you, Mr. Chairman.

Mr. STEARNS. I thank my colleague. I would just say to her question that I think Freddie Mac had $900 billion income and probably had a profit of $10 billion, so $125 million is a very, very small fee of fine and the gentleman from Arizona.

Mr. SHADEGG. Thank you, Mr. Chairman. I appreciate the questioning of my colleagues. I think you've done an excellent job of bringing out the points. I guess I'm intrigued by Ms. DeLeo, a comment you just made, that I think is almost pervasive here and if I'm misreading what you intended, correct me.

You said that it was the result of an inability to apply the standards and I jotted down the words very quickly. I guess I think that's a mischaracterization, because I don't think it was an inability. I think it was a chosen intent not to apply the standards. I don't think it was because they couldn't apply the appropriate standards. I think they read the standards carefully. I think they understood what the standards required. I think they figured out how to deceive, how to get around the standards through deception to achieve the end they wanted and that's the course they pursued, which means the fundamental issue for me is not are the standards appropriate and we already concede there are some problems with the standards, but rather, at least as I perceive it, it's not a question of whether the standards are appropriate. Indeed, they may be flawed to some degree.

There may be technical loopholes that shouldn't be there, but it seems to me the issue really is what's the culture? If the culture is you're going to set down a series of standards for us, and we're going to look carefully at the letter of those standards and we're going to manipulate them whatever way we can to report what we'd like to report and still comply with the letter of the law; if they claim they can do that, but we'll be able to get away with doing what we wanted to do, then I don't think the biggest problem is fixing the standards, I think the biggest problem is changing the culture. And your word "inability to apply the standards" troubles

me.

Am I misperceiving? Do we see this issue differently?

Ms. DELEO. It's where the inability is used. My comment was in reference to the expertise in the accounting area. Freddie did not have the proper expertise to be able to interpret and apply those standards. That allowed individuals outside accounting to be able to manipulate and work around that.

I do agree with your comment.

Mr. FALCON. The point is, Congressman, that the lack of a strong internal audit function, internal accounting office in the company, allowed those outside that office to work around the accounting rules without there being someone internal to police their conduct and additionally with the external auditor, not objecting to this conduct, in fact, Arthur Andersen was involved in day to day accounting decisions in the company, so in essence, they were auditing their own work. The lack of this expertise internal to the company allowed those in the financial transactions area to just disregard accounting standards.

Mr. SHADEGG. I agree very strongly with the comments of the Ranking Member with regard to the fact that this is unlike the Enron scandal or other public or other private entity scandals. This one is at our doorstep and I am deeply concerned that absent some draconian steps, we're not going to be able to regain the credibility of the public. And I guess you have already said that you think the exemption from the 1933 and 1934 acts should be repealed? What other steps do you think are necessary to regain credibility?

Mr. FALCON. I think we've recommended some very good corporate governance reforms for the companies in our report, Congressman. We will soon promulgate the corporate governance rule which will implement these.

We found that there was a conflict between one individual serving as both the Chairman of the Board and CEO of the company. The role of the Board is to oversee the management of the company and when you have a strong Chairman of the Board, what we found with Freddie Mac is that that is not a best practice and it allows that individual to sort of weaken the Board's oversight function.

We are also going to require that the Board become more active and meet more frequently. This company is still meeting just four times a year and a company as sophisticated as this I think needs a more active Board. So we are moving to implement more corporate governance reforms.

Mr. SHADEGG. Some believe that if there had not been a change in the auditor, there wouldn't have been a restatement and none of this would have been caught and Freddie Mac would still be engaged in what it was doing. Do you share that view?

Mr. FALCON. That may be. Absent, our lack of resources and expertise in this accounting area and our lack of a mission in looking at how they applied GAAP in their financial statements, that could be which is why we have to move in that direction, begin to take on that responsibility.

Mr. SHADEGG. So to those who say your criticism of the entity isn't very credible because you guys didn't catch this, your response is we didn't have the duty and we didn't have the resources?

Mr. FALCON. Right. I'm reluctant to say something which sounds like it wasn't our job, but in essence, the safety and soundness of a company requires the cooperation of not just the regulator. Management of the company has to run the company soundly. The Board of Directors has to fulfill its obligations and the external auditor has to do its job properly. The role of the regulator is to try to oversee that all of those functions are done right. Without the resources and expertise related to the accounting area, we could not properly oversee the work of the external auditor.

I don't think we're looking to implement a system where we secondarily certify the financial statements. More importantly, we need to make sure that when new accounting standards are brought on line, like this one involving FAS 133, that we have the capacity to make sure that the implementation of this accounting standard is done properly and that on an on-going basis the company is not using transactions to do anything like shifting earnings.

Mr. SHADEGG. I'm compelled to conclude by just noting, I think it's Paul Harvey who sometimes self-government without self-discipline won't work. It looks to me like the situation here and the situation with the Enron problems is people who are entrusted with responsibility, there simply isn't a big enough army of overseers to watch them all. If their basic motivation is deceit, then it's going to be tough.

Mr. FALCON. Right.

Mr. SHADEGG. We're going to have problems with them and it's really unfortunate because vastly expanding the regulatory structure just means you need smarter people to get around it and I'm not certain that's a very good answer. We need a culture of people

who say I'm not looking at the letter of the law. I'm looking at my obligation to the people for whom the law was intended to protect. Mr. Chairman, I yield back the balance of my time.

Mr. STEARNS. I thank the gentleman. The gentleman from Ohio. Mr. STRICKLAND. No questions.

Mr. STEARNS. No questions. The gentlelady from California.

MS. SOLIS. Actually, just more of a comment. I too am overwhelmed to hear all these statements being made and I would just ask the reforms that you are proposing, do you really believe that that's going to require a change in behavior?

Mr. FALCON. I think part of the problem has generated from, as we said in the report, a tone at the top. And aside from all of the additional corporate governance requirements and statutory changes that we're requesting to strengthen oversight, we also fundamentally need to make sure that there is a new corporate culture that's brought about, where the tone at the top is one of strict integrity and compliance with rules and regulations. That's something that we are looking at very closely and tracking very closely and so far, we're encouraged by the new tone we're seeing by the new CEO and Chairman that was brought into the company and the activities that the company has taken by way of remedial reforms.

So we have to make sure that there's a new corporate culture. Along the lines of what Mr. Shadegg said, everyone has to fulfill their own responsibilities.

Ms. SOLIS. I would just add that obviously these institutions, Fannie Mae and Freddie Mac, play an essential role in communities like mine where we are in a phase where we're not able to secure enough capital to provide sufficient housing for low income and middle income families and the integrity of these programs, obviously, are very reflective of what we as Members of Congress support. We have different activities, in fact, with some of these organizations in our Districts, so that doesn't sit well for us when we have to go home and our constituents are reading about all this mismanagement and somewhat collusion-I hate to use that word, but that's what it sounds like to me from reading your testimony, that there's collusion on the part of the accounting firms with these organizations.

We're not satisfied with that and I know there's legislation being proposed and we're certainly going to be monitoring that and hopefully, we're going to see that there is more transparency made available to the public.

Mr. FALCON. I fully support that, Congresswoman.

Mr. STEARNS. I thank my colleague. I was just going to ask a couple of questions before you leave, Mr. Falcon and if anyone else would like to ask a few additional follow-up questions.

You issued a fine of $125 million and I think you also were trying to get some of their stock options or some of their compensation back. How successful have you been on that?

Mr. FALCON. We're taking an action that's pending right now that I can't discuss too much because it's the subject of litigation. We are moving to require that the former Chairman of the Board and CEO, as well as the Chief Financial Officer of the company, be terminated for cause which could result in their losing approxi