which in turn, use these funds to finance home loans and other residential mortgages. The System has over 8,000 financial institution members at the end of 2002 and assets of over $700 billion. My written testimony today focuses largely on issues of oversight structure pertaining to Fannie Mae and Freddie Mac and not the FHLBanks since this seems to be the most immediate focus of the committee's deliberations. However, we are prepared to supplement this testimony by providing additional views on the merits of combining FHLB oversight what that of Fannie Mae and Freddie Mac.

Freddie Mac's announcement of plans to make a substantial restatement of its earnings for prior years, coupled with more recent revelations about the departure of its three top executives and other reports of irregularities attracted considerable attention this summer and seemed to have unnerved the financial markets. The sheer size of the GSEs and their importance to the housing market mean that investors are sensitive to any hint of trouble. We are aware that members of this committee expressed concerns that these difficulties were not detected earlier by regulators and do not believe the current structure has the capabilities to provide adequate oversight in this area.

Still others had called for a regulatory overhaul even before these recent developments came to light. Unquestionably, the tremendous growth in the size of the GSES over the past decade has raised the stakes for regulatory oversight. Indeed, Fannie Mae's and Freddie Mac's mortgage investments have increased by over 620 percent and the GSES today are two of the largest private debt issuers in the world (CRS Report to Congress, September 8, 2003, 2). Similarly, the FHLB System's business has sextupled and its membership has more than tripled since 1992, with commercial banks instead of savings institutions now constituting a majority of the system's membership. Government, the GSES, consumers, residents of underserved communities, lenders, the housing industry and taxpayers all have a strong interest in effective oversight of enterprises financial condition. Thus, it would be hard to argue against the need for Congress to review the adequacy of a regulatory structure that was put into place a decade or more ago.

The existing regulatory structure governing Fannie Mae and Freddie was established in 1992 as part of the Federal Housing Enterprises Safety and Soundness Act (or GSE Act). The GSE Act established OFHEO as an independent agency, within the U.S. Housing and Urban Development (HUD) to oversee the safety and soundness of the two enterprises and to help ensure that they are adequately capitalized. The GSE Act also reaffirmed HUD as the GSES' mission regulator, with general regulatory responsibility for ensuring that Fannie Mae and Freddie Mac operate within their public charters and otherwise fulfill their statutory mandates, including authority to review the GSEs new mortgage programs, establish and monitor the GSES' fulfillment of their annual affordable housing performance goals, and ensure that they abide by fair lending requirements.

Review of Proposed Changes

There appears to be some consensus for taking steps to enhance the safety and soundness oversight of the GSES. There also is growing recognition that OFHEO does not have all

the powers it needs to perform this oversight. Unlike banking regulators, OFHEO does not have authority to assess the financial institutions it supervises for the full cost of oversight. Funds for its budget are provided through congressional appropriations although collected from Fannie Mae and Freddie Mac in the form of semi-annual assessments. This approach limits the agency's funding in comparison to the direct assessment approach used by federal banking regulators. For example, OFHEO`s budget for FY 2002 was just over $27 million. Rep. Baker and others have estimated that Office of the Comptroller of the Currency assessment for banks of the size of the GSES would be around $70 million.

In addition, OFHEO is not equipped with the full range of enforcement tools commonly afforded to financial regulators. It is my understanding, for example, that the agency's "cease and desist" authority is limited to capital related matters and does not encompass other areas of safety and soundness regulation. Enhancing the agency's authority in this area would appear to make sense.

Perhaps the simplest way to correct this problem, in our view, would be to upgrade OFHEO. But we know that some on this committee have concluded that a mere upgrade alone would not be sufficient and that further changes to the regulatory structure are also needed. For example, H.R. 2575 introduced by Capital Markets Subcommittee Chairman Baker would abolish OFHEO as an independent agency within HUD and transfer safety and soundness authority and general regulatory authority HUD now has to a revamped Office of Thrift Supervision, an independent unit within the Treasury Department that also regulates savings institutions. The bill would retain HUD as the supervisor of the affordable housing mandates, expanded enforcement authority for these mandates, and also provides the department with new authority to pre-approve any new activities the GSES want to undertake. H.R. 2575 would provide both HUD and the new regulator with authority to assess the GSEs directly for the costs of their oversight activities.

H.R. 2803 introduced by Rep. Royce generally follows a similar approach, although the bill also abolishes the Federal Housing Finance Board, which supervises the FHLBanks and designates the new office to handle combined oversight for all three GSES.

Secretary Snow and Secretary Martinez in their testimony before this committee earlier this month outlined their proposal for making even more extensive changes to the existing regulatory restructure. Their plan calls for a major shifting of regulatory functions to a new cabinet department. It would reconstitute the safety and soundness regulator, along with HUD's general mission oversight and what expanded authority to review "new lines of business, new types of investments, and acquisitions" into a single new bureau to be located at the Treasury Department. HUD still would retain authority to oversee the GSEs' affordable housing goals and fair lending enforcement, but not much else. The two Secretaries also proposed that supervision of the FHLBanks would eventually come under the purview of this new bureau as well.

Strengthened financial oversight can be achieved without making major changes to the existing regulatory structure

CFA is supportive of steps to enhance GSE safety and soundness oversight. Along these lines, we believe that providing GSE regulators with authority to assess the enterprises themselves for the reasonable costs of oversight and removing funding for these activities from the annual appropriations process would go a long way in addressing many of the concerns cited. Banking regulators fund their supervisory activities this way and so should the GSE regulators. Improving the mechanism used to fund the cost of GSE oversight would enable these regulators to increase their capacity and bring on additional financial expertise needed to perform their important functions.

However, we are not convinced that OFHEO is inherently flawed in its capacity to serve as the safety and soundness regulator. Accordingly, we question whether creating a new agency is the wisest and most efficient means for achieving the immediate impact that many say are needed. Those that favor the transfer to Treasury apparently believe, as Secretary Snow testified, that it would confer "additional benefits of stature and policy support." In other words, that the GSE regulator could benefit from Treasury's financial expertise and prominence as a cabinet agency. The connection could also reinforce the importance of safety and soundness oversight, which may help to calm down market jitters raised by the events at Freddie Mac.

Yet moving the GSE regulator to Treasury could also carry with it disadvantages. Because Fannie Mae, Freddie Mac, and Treasury are the major issuers of debt in the capital markets, questions about potential conflicts of interest could conceivably arise from the department's exercise of its new oversight powers over GSE activities. Also, it seems inevitable that the transition would create administrative disruptions that would work at cross purposes with the objective of enhanced oversight, at least in the short term. We also are troubled by the suggestion that the new Treasury bureau would not be fully independent along the lines of the OCC and OTS. Secretary Snow indicated that this would be case by stating that the new bureau would be "required to clear new regulations and congressional testimony through the department."

CFA also has great concerns with other aspects of the plan being proposed. We believe strongly that the general charter oversight and new program approval should remain at HUD. Switching this authority to Treasury we fear would detract from maintaining important regulatory focus on GSE housing mission performance. Treasury's primary focus on safety and soundness concerns must be balanced carefully with an equally strong regulator that is in a position to offer different policy perspectives on regulatory matters, particularly as they pertain to mission related concerns. Experience should teach us that there will be tensions from time to time between safety and soundness and mission considerations. Thus, both functions should be afforded a comparable seat at the decision-making table to resolve these differences, otherwise the safety and soundness perspective will tend to override other legitimate considerations. We believe it would be

more difficult for this proper balancing to be achieved should both functions be combined under one roof at Treasury.

In opposing this transfer, we are mindful that the two Secretaries sought to assure this committee that HUD would be consulted on mission matters. But consultation does not equate with decision-making authority. Moreover, downsizing HUD authority in these two areas is likely to undercut the department's ability to perform its remaining functions (i.e., affordable housing goals and fair lending oversight). In any event, this shift would clearly establish HUD as a second tier GSE regulator.

Further, we believe that Treasury is not necessarily in the best position make important determinations about whether the GSES are acting within their charters and undertaking housing finance programs that serve the public interest. HUD as the principal federal department responsible for housing is uniquely suited to provide important housing policy perspective in deciding these matters. Whatever changes in oversight, if any, may occur we would anticipate that HUD would continue to work in conjunction with the safety and soundness regulator, as it presently does with OFHEO, whenever issues of financial condition arise. However, we believe maintaining the current arrangement is far less cumbersome than requiring a new bureau at Treasury to bulk up its capacity to undertake supervision of issues with broad housing impact.

Please do no harm to the housing mission

I also would like to comment on proposals that are being considered by this committee to make changes to other key aspects of GSE regulation: the program approval process and the capital requirements.

First, with respect to the program approval process. The 1992 GSE Act reaffirmed HUD's authority to approve new programs initiated by Fannie Mae and Freddie Mac. At the same time, the statute narrowly prescribed the scope and circumstances under which this review can be undertaken. The statute defines "new program" basically in the context of a mortgage related program that is either "significantly different from programs that have been previously approved, either under the GSE Act or engaged in before this 1992 legislation was enacted. The statute provides that new programs must be approved UNLESS HUD first determines that the program: 1) is not authorized by specific sections of the GSES' Charter Acts; 2) is not in the public interest; and/or 3) OFHEO determines that the program would risk significant deterioration of the financial conditions of the enterprise. Thus, the burden is on HUD to determine whether there are sufficient reasons to keep the GSE from going ahead with its new initiative.

It has been my experience that the statutory prescriptions I described and the limited staffing that HUD traditionally has devoted to the performance of this function have combined to limit the occasions for these reviews. To my count, HUD has approved only three new programs from 1995-2000 and may have approved one other since then. At the same time, the department has elected not to review major new GSE initiatives, such as

GSE entry into the subprime market and implementation of automated underwriting systems.

H.R. 2575 proposes to expand authority with HUD, but expand the authority to all new "activities" rather than just "programs." "New Activity" is defined by the bill as meaning "any program, activity, business process, or investment” that directly or indirectly affects the financing and other services related to mortgages. While H.R. 2575 incorporates standards for approval comparable to existing HUD authority, the bill requires prior approval for these activities and eliminates the 45 day time frame for review that is part of the present requirement. In effect, this provision shifts the burden to the GSE to demonstrate how the program meets the statutory criteria and should therefore be approved.

Given the limited use of review authority up to now it appears that improvements in the process are needed. However, program review should remain centered around public purpose objectives. Unless carefully crafted revising the provisions governing program reviews could end up the regulators micromanaging each GSE's day-to-day business. This outcome would be counter-productive and hamstring the ability of the GSEs to bring new products to market and to otherwise perform their housing mission. Thus, we urge the committee to move with care in this area and avoid the establishment of an overly bureaucratic and unnecessarily complex approval regimen.

Similarly, making changes to the GSEs capital requirements as part of regulatory restructuring legislation is another area that could have far reaching ramifications for the GSES housing mission and affordable housing activities. Inevitably there will be tensions and tradeoffs between steps aimed at addressing the GSEs' financial exposure and their ability to increase funding for important mortgage related activities. Moreover, the GSES' charters provide safeguards to help ensure proper balance in oversight and explicitly recognize that "activities relating to mortgages on housing for low and moderate income families involving a reasonable economic return that may be less than they return earned on other activities. . ." (12 U.S.C. Section 1431 note, 1716) The existing capital rules in place were a long time in coming and are based on statutory guidelines and were fashioned after much deliberation. Congress should proceed cautiously in providing new authority to make frequent changes to capital rules, which may ultimately serve to detract from the GSES' ability to carry out their mission.

Strengthening oversight of the affordable housing goals

Finally, let me also use this opportunity to comment on HUD's oversight of the GSES affordable housing goals and on ways that this function can be strengthened. The 1992 GSE Act established a procedure for setting three percentage of business goals for Fannie Mae and Freddie Mac a Low and Moderate Income Goal (with at least 50 percent of the dwelling units financed by a GSE's mortgage purchases must be for families with incomes no greater than the areas median income), a Special Affordable Goal (with at least 20 percent of dwelling units financed by a GSE's mortgage purchases must be for very low income families (below 60 percent of area median income) or for low income