in maintaining a stable economy and providing affordable housing for all Americans.

While there is a consensus regarding the safety and soundness regulator, I am anxious to hear from our many witnesses today on what they believe should be done with the HUD's oversight responsibility for the housing missions and enterprises, including approval authority for any new program and enforcement compliance with affordable housing goals.

These issues have received a significant amount of attention since the hearing a few weeks ago, and I look forward to asking some specific questions about them.

I would also like to make one personal observation on the regulation of GSES. I believe it is important in any legislation we may consider to allow the housing GSES to have sufficient flexibility to adapt to a changing mortgage market.

The liquidity that Fannie and Freddie provide to the market should not be compromised by unnecessary government regulation. As I said before, I believe there are several important components that have been integral to providing enhanced regulation for GSES while not impeding their ability to support affordable housing in America.

For example, I think it is imperative for HUD to continue to have an important role as it relates to the mission, charter and affordable housing goals of Fannie Mae and Freddie Mac. I have no doubt that the Treasury Department is unparalleled in its ability to manage safety and soundness for these corporations. However, Congress has charged HUD with the job of supervising affordable and minority housing in our country.

I am interested to hear what our witnesses think should be done regarding the capital requirements for Freddie Mac and Fannie Mae, if anything at all. Personally, I believe that the requirements Congress had mandated for GSEs have done a good job of setting a strong safety and soundness standard.

Likewise, I believe that while we must give the regulators the authority they need to keep the risk-based capital regulation relevant to the changing marketplace, we have to also allow the newly required risk-based capital requirements to take hold before we begin questioning it.

I know that there are critics of OFHEO risk-based capital regulation. However, it has been in place for less than a year, and we should allow a decent amount of time to evaluate its effects before we begin to dismantle it.

Finally, I want to make it clear that I believe the Department of Housing and Urban Development must maintain its role in leadership in promoting housing. This agency has an important role in ensuring our nation is focused on providing decent and affordable housing for all Americans. We have to respect that mission.

I also want to say hello and welcome to Mr. Falcon today for the job he has been undertaking here.

Again, Mr. Chairman, I thank you for holding this hearing and our witnesses for taking the time to be here. I look forward to the hearing. Thank you.

The CHAIRMAN. The gentleman yields back.
Are there further opening statements?

The gentleman from California, Mr. Baca seeks recognition?
Mr. BACA. Thank you very much, Mr. Chairman.

First of all, I would like to commend you for having this important hearing this morning.

Mr. Chairman, as we move forward on deliberation actions on the issues of GSE regulations I want to underscore what I heard many of my colleagues say that at the last hearing that is that we would oppose any changes in mission, charter or status of governmental-sponsored enterprises.

As our ranking member said at the last hearing, there is no crisis regarding the GSES. We have two companies that are remarkably effective in the mission of providing affordable mortgage financing, to move more low-income families into home owning.

Fannie Mae plays an essential role in helping to finance affordable housing throughout the United States. One reason Fannie Mae has been successful is because the current status encourages them to be innovative, I state, be innovative, to introduce new products and to partner with other institutions to be proactive in reaching out to low-income families, I state, low-income families unembedded with corporate culture.

When you change this mission, the status or charter, you risk losing the focus, intensity and drive that bring on the challenge of providing, and I state, on providing the challenge of home ownership opportunities to low-income families.

Regarding the GSES, safety and soundness is important, but whatever this committee does, we should not interfere with GSES ability to innovate, to meet the needs of low-income families in underserved areas, and I state, underserved areas throughout the United States, such as my area, where the majority of the growth is in the Inland Empire.

GSE must have the flexibility and the products to develop and fulfill the responsibility of their congressional charter and housing mission.

Thank you again, Mr. Chairman, for having this hearing. I look forward to hearing the witnesses.

The CHAIRMAN. The gentleman yields back.

Are there further opening statements?

Having none, we now turn to our first distinguished panel, the Honorable Armando Falcon, Jr., Director of Federal Housing Enterprise Oversight; the Honorable John T. Korsmo, Chairman, Federal Housing Finance Board.

Gentlemen, welcome to the committee.

And, Mr. Falcon, we will begin with you.

STATEMENT OF ARMANDO FALCON JR., DIRECTOR, OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

Mr. FALCON. Thank you, Mr. Chairman.

Chairman Oxley, Ranking Member Frank and members of the committee, thank you for inviting me to appear before you today. I am pleased to provide my views on improvements that can and should be made to the regulatory oversight of Fannie Mae and Freddie Mac.

My views are my own and are not necessarily those of the President or the Secretary of Housing and Urban Development.

I would like to begin by stating up front that I support legislation to strengthen the supervision of Fannie Mae and Freddie Mac. Upon taking office as Director of OFHEO in October of 1999, I quickly realized that the agency's long-term success was jeopardized by inadequate resources, a constraining funding mechanism and the lack of powers equal to those of other regulators.

Over the past four years, I have been a consistent advocate of legislation designed to address those shortcomings. And so I was encouraged by the Administration's comprehensive proposal and your efforts, Mr. Chairman, to move forward.

While I am in general agreement with the well-considered proposal that Secretaries Snow and Martinez have presented to the committee, I do have a few concerns that I hope can be properly addressed.

I would like to outline my views in the context of five guiding principles. They are, one, the regulator should remain independent; two, the regulator should be permanently funded outside the appropriations process; three, the regulator should have powers equal to those of other safety and soundness regulators; four, the regulator should have full discretion in setting capital standards; and, five, legislation should build on progress made.

Adherence to each of these principles would strengthen supervision and the safe and sound operation of the enterprises. Our ultimate goal and benchmark should be to establish a regulator that is on an equal plane with the Office of the Comptroller of the Currency and the Office of Thrift Supervision, both of which operate as independent safety and soundness regulators within the Treasury Department.

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I would like to elaborate on the five principles.

First, the regulator should remain independent. The concept of an independent regulator to oversee Fannie Mae and Freddie Mac was established in the legislative history of the 1992 act that created OFHEO.

The need for regulatory independence was born out of the Congress' experience with the savings and loan crisis.

I had the privilege, Mr. Chairman, of serving as counsel to this committee for eight years, this committee's predecessor, during that difficult period.

One of the clear lessons learned was that all safety and soundness regulators should be objective, nonpartisan and protected from political interference.

This is especially critical at times when regulators must make difficult and sometimes politically unpopular decisions.

In addition, independent regulation protects Congress' ability to receive the regulators' best judgment on regulatory matters unfiltered and without delay.

With billions of dollars of potential taxpayer liability at stake, it is in everyone's interest that this important safeguard not be weakened.

Like OFHEO, the Office of Thrift Supervision is another useful example of how a new independent regulator should be established as part of a departmental organization.

In 1989, Congress transferred responsibility for thrift regulation from the Federal Home Loan Bank Board to the newly created Of

fice of Thrift Supervision within the Treasury Department. The Office of Thrift Supervision was established as a fully independent regulator. It has the same powers and unfettered ability to use those powers as the OCC.

So I believe Congress should ensure that the new regulator has full independence.

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Second, the regulator should be permanently funded outside the appropriations process. Currently, OFHEO is funded annually through the federal budget and appropriations process, though the agency does not utilize any taxpayer funds. OFHEO is funded through assessments on the enterprises, but those assessments cannot occur until approved by an appropriations bill and at a level set by the bill.

OFHEO is the only safety and soundness regulator funded in this limited manner. At a minimum, this serious anomaly should be fixed.

Permanent funding will enable the regulator to fulfill its budgetary needs on a more reasonable basis, without the timing constraints associated with the annual appropriations process.

There should be clear authority for the agency to levy special assessments or establish a reserve fund as needed to meet emergencies. Currently, any additional funds required to meet urgent, unexpected needs can be attained only after a supplemental appropriation is enacted. This can delay action by the agency to resolve problems early, before they threaten the safety and soundness of an enterprise.

At this point let me state, Mr. Chairman, that I appreciate that the Administration has sent up a supplemental budget request for the agency of $7.5 million, and I ask for the committee's support in getting that supplemental appropriation enacted.

Third, the regulator should have powers equal to those of other regulators. While OFHEO's regulatory powers are fairly comparable to those of other financial safety and soundness regulators, certain authorities need to be provided and others clarified.

For example, a safety and soundness regulator should have receivership authority, independent litigation authority, enhanced hiring authority and the full range of enforcement powers provided to financial regulators.

Also, the law should be revised to provide clearly that the regulator is empowered to address misconduct by institution-affiliated parties and to exercise general supervisory powers.

I would be happy to provide the committee with a more comprehensive package if you so desire.

Fourth, the regulator should have full discretion in setting capital standards. Capital is one of the fundamental bulwarks of effective safety and soundness regulation.

The regulator should have broad discretion to exercise his or her best judgment, using all available information through the examinations process and otherwise to determine if capital adjustments are necessary. Other safety and soundness regulators have this discretion.

Going forward, the agency needs to have the authority to modify both minimum and risk-based capital standards. This authority would help meet the changing mix of the enterprises business, the

market environment in which they operate and the changing nature of risk measurements themselves.

As Secretary Snow said in his testimony before this committee, broad authority over capital standards and the ability to change them as appropriate are of vital importance to a credible, world class regulator. I agree.

Fifth, legislation should build on the progress we have made over the last 10 years. Regulating Fannie Mae and Freddie Mac requires a specialized skill set. The capacity to model the cash flows of all the mortgages, debt and other financial instruments of the enterprises, a necessity for the stress test, is unique among financial institution regulators.

Expertise in how these two secondary mortgage market companies manage mortgage risk, including the broad use of sophisticated derivative and callable debt, is vital for effective regulation. In addition, an understanding of how the enterprises are affected by the markets in which they operate is extremely important.

Over the past 10 years, OFHEO has developed the specialized expertise, from our examiners and financial analysts to our researchers and capital analysts, that is necessary to supervise these two unique companies.

The cost in terms of lost regulatory capacity spent while trying to rebuild that infrastructure would be substantial.

That is why I recommend that if a new regulator is established in the Treasury Department, OFHEO's personnel, regulations and administrative infrastructure should be transferred intact to the new agency. It would be highly counterproductive to do otherwise. There are a couple of other matters I would like to briefly dis

cuss.

First, I agree with Secretary Snow that the Presidentially appointed board positions should be discontinued. This is not a reflection of current or former Presidentially appointed directors. Rather, I think corporate governance would be enhanced if the shareholders were allowed to select all members of the board.

Also, I support granting authority to the safety and soundness regulator to determine whether activities of an enterprise are consistent with its charter. This would mean that a single regulator would have the ability to review all of the enterprises' activities, new and existing.

This would consolidate the supervision of the enterprises in a manner consistent with the authorities of other regulators once again.

I appreciate the concern expressed about the primacy of the enterprises' housing mission, if and when charter compliance responsibility is shifted. The goal, in fact, of enforcing charter compliance is to ensure that the enterprises remain properly focused on their housing mission and not stray into extraneous ventures.

Consistent with that goal, I think mechanisms could be instituted to ensure that the new regulator actively solicits and considers all views, including housing advocates, when exercising this authority.

The importance of their housing mission is actually why the enterprises exist. Strengthening their safety and soundness regulations supports that mission by ensuring that they are strong