companies to distort their balance sheets and hide the true value of their derivatives.

I worry that a FASB attempt to clarify the rule will once again be overwhelmed by the same opposition and threaten to weaken the existing rule. I mention the history of FASB's derivative accounting rule to put today's hearing in its proper context.

Today we are going to explore Freddie Mac's accounting scandal. In January, Freddie Mac announced that it is restating its earnings from the past 3 years, and in June they dismissed their top three executives. The turmoil at Freddie Mac has put FASB's rule once again in the public spotlight. It has gotten the attention of Congress and the press because, as we all know, Freddie Mac is not just another company. Freddie Mac has a major impact on the housing market. This government-sponsored enterprise purchased $592 billion in mortgages in 2002, and helped finance homes for nearly 2.5 million low and moderate income families and families living in under-served areas.

It is in the best interest of our constituents to have a viable secondary housing market, and I am hopeful that Freddie Mac will emerge from this turmoil in a strong position. Their experience can help provide insight into how FASB derivative accounting standards are implemented in the marketplace.

Congress has responsibility to ensure that investors are protected, but I should note that at this point we do not know what happened at Freddie Mac, and we do not know its true impact on investors. In my estimation, this hearing is a bit premature. Freddie Mac has not yet restated its earnings. Freddie Mac's internal investigation has not been completed.

In June, Freddie Mac's Board of Directors hired the law firm of Baker Botts to conduct an internal investigation. I understand that their report is going to be released any day. Also, the FEC, the Office of Federal Housing Enterprise Oversight, and U.S. Attorney's Office are all investigating Freddie Mac's accounting and corporate governance as we speak. We will be in a better position to analyze Freddie Mac's accounting practices once the investigations have been completed. And so I hope that we will have another hearing once we gather more facts. I hope that as we continue to study FASB standards, we will take a closer look at how derivative accounting standards are used throughout our financial markets, not just at the GSEs, and I look forward to hearing the testimony of today's witnesses. Thank you.

Mr. STEARNS. Thank the gentlelady. The gentleman from Florida, Mr. Davis.

Mr. DAVIS. No statement, Mr. Chairman.

Mr. STEARNS. Then I think what we will do is we will go down and vote and recess the subcommittee, and I will be right back and we will start with our witnesses. The subcommittee is recessed. [Additional statements submitted for the record follow:]

PREPARED STATEMENT OF HON. BARBARA CUBIN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF WYOMING

Thank you, Mr. Chairman, for holding this hearing. It is an excellent opportunity to further familiarize ourselves with how derivatives are accounted for and will lay the foundation for future action taken on this matter.

I would also like to thank the distinguished panelists for coming before the subcommittee. Your insight today will serve to advance the discussion of accounting standards so the most appropriate and effective legislative solution may be reached. We are not here today to point fingers in search of a financial scandal. In the fallout of Sarbanes-Oxley we need to be sure we are seeking transparency and not embarking on a perpetual witch hunt.

Instead, the existing circumstances that led to the need for an investigation should be the focus of our discussion today. We must continue to analyze accounting standards and in particular FAS 133.

The factors in this debate are complex and numerous. The questions we must ask can be dizzying, and I suspect the answers will not differ. Is this particular rule doing more harm than good? By providing companies with complex flexibility_in their compliance with FAS 133, is the purpose of this rule negated altogether? The fair value rule is established in twenty pages, but the next several hundred pages outline the flexibility afforded to companies in complying with the rule.

I look forward to the testimony and dialogue that will take place in order to obtain a better understanding of FAS 133, how it is used, what it communicates and how it can better serve its purpose. In the end, companies should be required to maintain and disclose accurate records while simultaneously being afforded the flexibility to communicate their potential to both investors and consumers without undermining public faith in our system.

I thank the Chairman again and yield back the remainder of my time.

PREPARED STATEMENT OF HON. W.J. “BILLY” TAUZIN, CHAIRMAN, COMMITTEE ON ENERGY AND COMMERCE

Derivatives are important financial instruments that provide companies opportunities to manage risk of core business functions. Derivatives can also be used as speculative instruments, creating the potential for enormous windfalls or losses for the parties to the contracts. Whatever the use, I think we all can agree that investors deserve to know the value of derivative contracts into which companies enter. Derivatives are no small part of business today-the total value of outstanding derivatives is estimated at more than $141 trillion through the end of last year. This is precisely what makes this hearing so important.

Today we are going to look at issues of accounting for derivatives. Federal Accounting Standard (FAS) 133 states that all derivatives should be accounted for at fair value. But this general rule is accompanied by a 500-page exception, known as special hedging rules. The special hedging rules enable companies to avoid recognizing gains or losses on certain derivatives in their income statements.

When looking at the application of FAS 133 by Freddie Mac and Fannie Mae, the comparability and transparency problems created by the special hedging rules become apparent. Both Fannie and Freddie are in the same business, they have the same charter, and they manage interest rate risk through derivative contracts. And both Fannie and Freddie use FAS 133 and its special hedging rules. Yet each comes up with a very different result. Freddie Mac has revealed that it made an error in its application of FAS 133 by treating certain derivatives as hedges when they should have been marked-to-market and reported in earnings. And while Fannie Mae's application of the special hedging rules is GAAP compliant, use of FAS 133 allowed Fannie to defer billions of dollars of losses to future years.

Do these results serve investors well? I ask our experts here today, should such similarly situated entities have such vastly different accounting results? If the special hedging rules were eliminated and all derivatives contracts had to be markedto-market would comparability be enhanced?

I am certainly not coming down on the FASB here today-FAS 133 has much improved derivatives disclosure over the pre-1998 accounting models. I only suggest it does not go far enough. The examples of Fannie and Freddie force us to ask whether accounting standards for derivatives should be re-evaluated. As we address this question, I look forward to hearing from our distinguished panel. Thank you all for participating in this important hearing. I would also like to give a special thanks to Chairman Stearns. He has been a steadfast proponent of improving accounting standards and accounting disclosure. I thank him for his dedication to this issue. Mr. Chairman, I yield back my time.

PREPARED STATEMENT OF HON. HILDA L. SOLIS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF CALIFORNIA

Mr. Chairman, thank you very much for holding this important hearing so that we may hear testimony from today's witnesses on the state of FAS 133 and the role its complexity may have played in the recent Freddie Mac restatement.

At the outset, Mr. Chairman, I want to say that it's very important we exercise oversight of our nation's housing GSES.

However, we should not allow the reported accounting irregularities at Freddie Mac obscure the important role housing GSEs play in making affordable mortgage lending available to communities across the United States. Secondly, I do not want us to lose sight of the significant role housing has played in stabilizing our economy especially during this most recent economic downturn.

Housing GSEs were created to bring low cost capital to the housing market and it is a congressionally mandated obligation that, in my experience, they have done well.

Fannie Mae and Freddie Mac have harnessed their expertise in housing finance and greatly advanced access to low cost capital to millions of low and moderate-income Americans.

So I am eager to learn how these companies use derivatives to make lending more affordable to our constituents and how it is that FAS133 affects their mission.

I raise these matters because, at a time when we are all struggling for answers on how to get our nation's economy moving again, it is as important to focus not only on what needs to be fixed but also what functions well and should not be disturbed.

Mr. Chairman, we are here today to examine a singular aspect of the recent Freddie Mac restatement-and that is the role FAS133 played in that restatement. I hope that we maintain that focus and sidestep the temptation to add to today's headlines at the expense potential long-term damage to one of the most robust segments of the economy.

On the specific subject of derivatives, I want to quote a portion of Alan Greenspan's testimony before the Senate Banking Committee, "What we have found over the years in the market place is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn't be taking it to those who are willing to and are capable of doing so."

I think Mr. Greenspan's testimony is of particular relevance to us because it highlights that derivatives are used by any number of financial interests-not just GSEs and also clearly indicates that their use spreads risk rather than concentrating it.

In closing, I look forward to hearing from these witnesses and learning how this Subcommittee, in guiding FAS 133, can help advance the missions of these compa

nies.

PREPARED STATEMENT OF HON. ED TOWNS, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NEW YORK

Thank you, Mr. Chairman, for holding this second hearing on FASB issues this year. Your commitment to these issues is commendable. In particular, I am pleased the Subcommittee today has brought before us the issue of derivatives accounting standards. The complexity of these financial instruments seems to pale only when compared to the accounting for them. I, for one, look forward to the opportunity to discuss with the FASB witness and our other witnesses the fundamentals behind derivatives, and explore whether the way we ask companies to account for them is realistic and valuable to investors and other market players.

I am especially pleased that Freddie Mac is here today, given the company's recent prominence in the news on issues relating to accounting for derivatives and other hedges. It is timely that we hear from Freddie Mac regarding their use of these instruments and what pitfalls there may have been in accounting for derivatives. There may be lessons from this experience not only for Freddie Mac, but for other companies as well.

In that vein, while I have concerns about the accounting issues at Freddie Mac, I do want to be clear that I am not supportive of efforts to abolish Freddie Mac's charter. I support Freddie Mac's mission of improving affordable housing opportunities for the people of this country. Freddie Mac and Fannie Mae play a central role in the U.S. mortgage markets, which are the envy of the world. We must act carefully-even today-in assuring the capital markets that our examination is not a witch hunt, but a carefully measured analysis of derivatives accounting standards.

With that, I look forward to hearing from our witnesses. Again, thank you, Mr. Chairman.

PREPARED STATEMENT OF HON. GENE GREEN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS

Thank you, Chairman Stearns and Ranking Member Schakowsky, for holding this hearing on derivative accounting standards.

I applaud the subcommittee for its attention to this important issue.

I must note, however, that the timing of this hearing seems premature, if, as the Chairman has stated, we are here to examine the role that derivative accounting standards played in Freddie Mac's accounting problems.

The SEC, the DOJ, the Office of Federal Housing Enterprise Oversight and Freddie Mac's outside counsel are all conducting on-going investigations into Freddie's accounting practices.

Currently, all we know about accounting at Freddie Mac is what has appeared in the press and what Freddie Mac has told us: that company personnel made accounting errors in applying generally accepted accounting principles and that accounting policies were implemented to smooth earnings.

If we are here to draw policy conclusions from the accounting mistakes made at Freddie Mac, we should reserve judgment until the investigations are concluded and the results released. It is my hope that, at that time, the subcommittee will revisit this issue with respect to Freddie Mac.

In the meantime, I hope that the witnesses before us today can provide insight into the Financial Accounting Standards Board and, specifically, FAS 133.

My primary concern is that investors receive quality information about a company's financial situation, and I question whether the rule provides for an adequate level of transparency.

Furthermore, the complexity of this rule raises the question of whether it is applied in a consistent manner within and among companies. I am interested to hear from our witnesses if, in their opinion, the derivative accounting standards applied today open the door for confusion or misuse, and, ultimately, whether adherence to this standard paints the most accurate picture for investors concerning a company's financial health.

I thank the witnesses for appearing before us today and look forward to hearing their views on this issue.

Thank you, Mr. Chairman, and I yield back the balance of my time.

PREPARED STATEMENT OF HON. JOHN D. DINGELL, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MICHIGAN

I commend both Rep. Tauzin, the chairman of the full committee, and Rep. Stearns, the chairman of this subcommittee, for opening an inquiry in early June into the accounting problems at Freddie Mac, and for asking the Minority to participate in that inquiry. To that end, staff met with representatives of Freddie Mac on June 12, the Office of Federal Housing Enterprise Oversight (OFHEO) on June 16, the Financial Accounting Standards Board (FASB) on June 17, the Securities and Exchange Commission (SEC) on June 23 and on June 26, with representatives of the Baker & Botts law firm and FTI_Consulting forensic accountants who are conducting the special investigation for Freddie Mac's board of directors (the so-called "Doty report"). The OFHEŎ and SEC inquiries had just begun. The committee staff has been unable to interview the PricewaterhouseCoopers accountants involved in the restatement or to review any board or accounting documents, nor have we received the Doty report yet. I look forward to these steps being completed so that we can make educated decisions on these matters and on what, if anything, these events may tell us about the efficacy of FAS 133, the accounting standard for derivative and hedge accounting.

While I welcome hearings on these issues, I believe today's hearing is premature. I am not convinced that we have the right witnesses before us. For example, Mr. Wallison's written statement spends roughly two pages criticizing GAAP accounting and the effectiveness of regulation in general, but all the rest of his testimony criticizes the substantive benefits and risks of the two housing GSES and calls for (1) the privatization and breakup of Fannie Mae and Freddie Mac or (2) alternatively the constraining of their mortgage purchase and pooling activities, all matters outside the scope of our jurisdiction and the subject matter of this hearing.

FASB started studying accounting for derivatives and hedging in September 1991, and held 100 public meetings to discuss the complex issues in this project. FASB

and the SEC went forward respectively with proposed accounting and disclosure rules after several high-profile losses at companies and banks and municipalities caught investors, analysts, and regulators by surprise and pointed to the urgency and need for reforms. The main purpose of FAS 133 was simple: to get derivatives on the balance sheet at their fair value and present derivative gains as assets and derivative losses as liabilities.

The FASB and SEC met strong opposition from key_Senators and Representatives, as well as the chairman of the Federal Reserve Board and the Comptroller of the Currency. Legislation was introduced in the Senate to authorize the bank regulators to exempt banks from any final FASB standard. Legislation was introduced in the House to make FASB an SRO under the SEC and require explicit SEC approval of all standards issued by FASB, impose a strict cost benefit analysis and burden on competition finding on all FASB proposals, and provide for immediate federal-court challenges of final FASB standards. The American Bankers Association, ABA Securities Association, International Swaps and Derivatives Association, Securities Industry Association, The Bankers Roundtable, and The New York Clearing House Association wrote a strong letter to FASB and the SEC labeling their proposals "a radical and disruptive change" and warned them to reconsider their plans. The Administration's nominee to head OFHEO was the chief lobbyist in the effort to tip over FASB and its proposal. Twenty-two banking, securities, insurance, and corporate executives, joined by Freddie, Fannie, and the Federal Home Loan Bank of Chicago also came together in strong opposition to the proposed standard. Twenty-three Members of the House Banking Committee wrote to FASB, urging it to consider alternative models for improving disclosure. I believe I was one of the few Members of Congress to write FASB in strong support of their goals and urging them to act promptly on this matter. Attached to this statement are copies of the aforementioned comment letters. In order to get a clear picture of FAS 133 practice, we need to look at what all of the major users are doing, not just at the GSES.

Recent press reports, (“IASB to stand firm' following French attack,” Financial Times, July 12, 2003) note that French President Jacques Chirac has written to the European Commission president in strong opposition to the International Accounting Standards Board's derivatives accounting reforms and pressing for concessions for the European banks that oppose the effort. The push toward international convergence means we have to take a broader look at this and other accounting issues. This also highlights the push toward principles-based accounting but I, for one, am skeptical about placing more reliance on the judgments of company managers and accountants who have betrayed the trust and confidence of the American public.

Finally, I commend Fannie Mae for successfully registering its common stock with the SEC in March of this year and, since then, for complying with all of its periodic reporting responsibilities to the SEC and to investors. I encourage Freddie Mac to complete its restatement so that it too can fulfill its commitment to become an SECregistered company. This will not be a panacea, however. The GAO reported in its October 2002 report, Financial Statement Restatements, that the number of restatements by SEC-registered companies due to accounting irregularities had grown significantly-about 145 percent from January 1997 through June 2002. Those 689 publicly traded companies lost billions of dollars in market capitalization as a result. The SEC faces a number of ongoing challenges in this regard.

I look forward to learning more about these matters. And I look forward to continuing my longstanding support for FASB and for high-quality and transparent accounting.

[Brief recess]

Mr. STEARNS. The subcommittee will reconvene, and I think we will start-Mr. Bass indicated he is going to waive his opening statement, so I think we will start with our witnesses, and we welcome all of them. Ms. Leslie F. Seidman, a member of the Financial Accounting Standards Board; Mr. Marty Baumann, Executive Vice President, Chief Financial Officer of Freddie Mac; Mr. Peter J. Wallison, the Resident Fellow of the American Enterprise Institute, and Dr. Thomas J. Linsmeier, Ph.D., CPA, at Russell E. Palmer Endowed Professor and Chairperson, Department of Accounting and Information Systems, Eli Broad College of Business, Michigan State University.

Let me welcome you, and I appreciate your patience. Ms. Seidman, I think we will start with you.