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Because we have not yet completed the restatement, I am not in a position to comment further on Freddie Mac's accounting issues today. However, once the restatement is complete, I would be more than happy to answer whatever questions you may have.

Finally, I would like to say a few words about Freddie Mac's safety and soundness. Some have used the opportunity presented by Freddie Mac's accounting problems to suggest that the company is somehow too large, too complex and too risky. Nothing could be further from the truth. Freddie Mac's exposure to both credit risk and interestrate risk remains extremely low, despite a weak economy and a turbulent market environment. While there is absolutely no excuse for the issues that led to the need to restate earnings, Freddie Mac's business fundamentals remain rock solid. We will get through this difficult period, and emerge a much better company. We are working diligently to ensure that Freddie Mac's accounting expertise and disclosure practices measure up in every way to our time-tested risk management capabilities.

Now, let me return to the focus of this bearing: proposed legislation to strengthen the regulation of the housing government sponsored enterprises, or GSEs.

Regulatory Oversight Structure

Freddie Mac has long supported strong regulatory oversight. In October 2000, Freddie Mac and Fannie Mae joined with Chairman Baker, Representative Kanjorski and other members of the Committee to announce a set of public commitments to ensure that the two GSEs remain at the leading edge of financial risk management and risk disclosure. These commitments, which I will describe in greater detail below, continue to represent a high standard that few other financial institutions can meet.

In March 2001, we appeared before Chairman Baker's subcommittee and announced we had implemented five of the six commitments, with the sixth being implemented the following month. Several months later, in June 2001, we stated that a strong regulator is essential to maintaining the confidence of the Congress and the public that we can meet our mission. We outlined key principles for effective regulatory oversight and pledged to work with the Congress in that regard. Those principles are as follows:

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First, the regulator must be highly credible. We continue to firmly believe that the GSE regulator must have supervisory expertise, be adequately funded and be independent in its judgments. Credibility is absolutely fundamental to the continued confidence of the Congress, the public and the markets.

Second, the regulator must support housing. Not only is housing an important public policy objective, it has been an economic powerhouse for the past several years. The necessity of expanding affordable housing opportunities is more urgent than ever. Over the next 10 years, America's families will need an additional $8 trillion to fund their mortgages. By innovating new mortgage products and new mortgage investment vehicles, Freddie Mac will open doors for

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Testimony of George D. Gould

House Financial Services Committee Hearing

September 25, 2003

Page 3 of 9

the homebuyer of the future, who is more likely to be a low-income, minority or immigrant family, eager to realize the American dream. We continue to work diligently to fulfill our commitment to President Bush to significantly expand the number of minority homeowners by the end of the decade.

Third, and very importantly, the regulator must enjoy strong bi-partisan support. In this regard, I would like to commend Chairmen Oxley and Shelby for the joint statement they issued after last week's hearing. In the statement, they pledged to seek a timely bi-partisan resolution of questions relating to regulatory restructuring.

With these principles in mind, today I will comment briefly on key aspects of the regulatory proposal described by Secretary Snow and Secretary of the Department of Housing and Urban Development (HUD), Mel Martinez, on September 10 before this Committee.

Creation of New Regulatory Office Within Treasury

Freddie Mac would strongly support the creation of a new regulatory office within the Department of the Treasury, if Congress were to determine that this would enhance our safety and soundness oversight. We recommend that the new regulator have a Director appointed by the President, with the advice and consent of the Senate, for a five-year term of office. To ensure that the new regulator is able to exercise independent judgment, we would support applying the same operational controls as apply to the relationships between the Secretary of the Treasury and the Office of the Comptroller of the Currency and the Office of Thrift Supervision.

Funding of New Oversight Offices

We also are prepared to support providing both the new regulator and the Secretary of HUD authority to assess Freddie Mac outside the annual appropriations process to pay for the costs and expenses of carrying out their respective responsibilities vis-à-vis the GSES. Additionally, we recommend that the General Accounting Office regularly report to the Congress on the efficacy of the new regulatory structure and the reasonableness of the costs relative to other world-class financial regulators so that neither unnecessarily raise the cost of homeownership.

Supervisory and Enforcement Parity with Federal Banking Agencies

The current legislative structure provides our safety and soundness regulator an array of supervisory and enforcement authorities to ensure that Freddie Mac is adequately

'See 12 U.S.C. §§ 1, 250, 1462a(b)(2), (3) and (4).

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capitalized and operating safely. If Congress were to deem it appropriate, we would support providing the GSE safety and soundness regulator authorities similar to those accorded to the federal banking agencies. These enhanced powers would include broadening the individuals against whom the regulator could initiate cease-and-desist proceedings; new authority to initiate administrative enforcement proceedings for engaging in unsafe and unsound practices; new removal and suspension authority and authority to impose industry-wide prohibitions; and new authority to assess civil money and criminal penalties.

Conservatorship

In the unlikely event of extreme financial distress, we believe that conservatorship is the right approach. Although we believe that current law provides ample convervatorship powers, we would be willing to consider whether additional authorities could enhance Congress' and the public's confidence in our safe and sound operation. We agree with Secretary Snow that steps beyond potential enhancements to conservatorship would appropriately be left to the Congress and not to the GSE regulator.

Capital Adequacy

Adequate capital is the touchstone of investor confidence and is key to our ability to attract low-cost funds to finance homeownership in America. Freddie Mac's regulatory capital requirements incorporate two different measures: a traditional (leverage) capital requirement and a risk-based capital stress test that requires Freddie Mac to hold capital sufficient to survive 10 years of severe economic conditions. Freddie Mac consistently has exceeded both stringent capital standards.

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Freddie Mac's capital requirements were developed in keeping with our charter, which restricts us to lower-risk assets than banks. Since 1994, charge-off losses at the five largest banks have been, on average, 17 times larger each year than charge-offs at Freddie Mac. Even in these banks' best year, charge-offs were more than five times higher than Freddie Mac's worst year.' Limiting the comparison to mortgage assets, the residential mortgages found in bank portfolios typically entail greater risk than those in Freddie Mac's portfolio. Banks tend to hold a higher proportion of second mortgages, adjustable rate mortgages, subprime mortgages, and uninsured mortgages with high loan-to-value ratios. These historically present greater risk than the fixed-rate conforming loans that are the core of Freddie Mac's business. In 2002, FDIC-insured institutions had an

2"Comparison of Financial Institution Regulators' Enforcement and Prompt Corrective Action Authorities," GAO-01-322R, January 31, 2001.

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Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income and Freddie Mac annual reports for 1994 to 2001. For 2002 Freddie Mac credit information, see http://www.freddiemac.com/news/archives investors 2003/4ger02.html.

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average charge-off rate of 11 basis points on their mortgage portfolios, compared to 1 basis point for Freddie Mac.*

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In addition to our low exposure to mortgage credit risk, Freddie Mac maintains an extremely low interest-rate risk profile. Our risk management framework has performed exceptionally well through a number of challenging interest-rate cycles - and recent months are no exception. Despite the most turbulent market environment in eight years, our average monthly duration gap was just one month in July. Maintaining a low-risk profile that is durable through time is the hallmark of Freddie Mac's disciplined approach to managing interest-rate risk.

Given this lower risk exposure relative to banks, we agree with Secretary Snow that the GSE minimum capital requirement is adequate and need not be changed. The GSEs' minimum capital requirements are commensurate with our lower risk profile and the limitations of our charter. In addition, our rigorous risk-based capital stress test ensures that our risks remain low throughout a sustained period of severe economic conditions. According to an analysis prepared by L. William Seidman, former chairman of the FDIC, the stringent risk-based capital standard applicable to Freddie Mac could be extremely challenging if applied to most other financial institutions. More recently, the

Cap Analysis Group, LLC, concluded that the risk-based capital stress test is "a much more stringent test for judging the safety and soundness of a financial institution than is a traditional capital-requirements test.'

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Regulator Discretion on Risk-Based Capital

Conclusions about appropriate capital determinations will continue to evolve in the years ahead. Accordingly, our regulator must have adequate discretion to ensure that Freddie Mac's capital standard keeps pace with these developments. Although the basic parameters of the risk-based capital stress test are set in law, our present regulator has significant discretion in adjusting the risk-based capital requirements. Additional discretion, such as provided to federal banking agencies, could help ensure the GSE riskbased capital standard remains at the forefront of financial sophistication, while continuing to tie capital to risk.

Discretion must be balanced with continuity, however. A key component of a stable financial market is a stable regulatory environment. Unnecessarily changing the riskbased capital standard harms those who made investment decisions based on a particular set of rules, only to find later that the rules were changed. This sort of "regulatory risk" increases costs that are ultimately borne by mortgage borrowers. Therefore, until such

4 Federal Financial Institutions Examination Council, Consolidated Reports of Condition and Income and Freddie Mac. See http://www.freddiemac.com/news/archives/investors/2003/4ger02.html.

L. William Seidman, et al., Memorandum to Freddie Mac, March 29, 2000.

"The CapAnalysis Group, LLC, OFHEO Risk-Based Capital Stress Test Applied to U.S. Thrift Industry

Testimony of George D. Gould

House Financial Services Committee Hearing

September 25, 2003

Page 6 of 9

time as an overhaul of the risk-based capital stress test appears warranted, the regulator should be encouraged to continue to apply the existing risk-based capital rule. The rule has been in effect for less than one year and has yet to show signs of need for reform.

We also believe the new regulator should be encouraged to gather information over the entire business cycle before making changes. This could be accomplished by requiring that the current rule remain in place for a period of time and expressing congressional intent to this effect. When a new rule appears warranted, policymakers should ensure that certain fundamental principles remain firmly intact. Any future capital standard must continue to:

· Tie capital levels to risk

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Be based on an analysis of historical mortgage market data

Remain operationally workable and as transparent as possible; and
Accommodate innovation so the GSEs can carry out their missions.

It is imperative that any changes to the rule be accomplished through notice-andcomment rulemaking, with an adequate comment period for all interested parties to express their views, followed by an adequate transition period for the GSEs to make any necessary adjustments to comply with new requirements.

In summary, Freddie Mac supports granting the regulator greater discretion to set riskbased capital levels that accurately reflect the risks we undertake. However, changing capital standards unnecessarily, capriciously or frequently will reduce the amount of mortgage business the GSES can do, resulting in higher costs for homeowners and

renters.

Market Discipline Commitments

In October 2000, Freddie Mac and Fannie Mae announced a set of six public commitments to ensure the GSEs adhere to a high standard of financial risk management. Excluding the commitment to adhere to an interim risk-based capital standard (which was rendered obsolete with the completion of the current risk-based capital stress test) these commitments are as follows:

Periodic issuance of publicly traded and externally rated subordinated debt on a semiannual basis and in an amount such that the sum of core capital and outstanding subordinated debt will equal or exceed approximately 4 percent of on-balance-sheet assets. Because subordinated debt is unsecured and paid to the holders only after all other debt instruments are paid, the yield at which our subordinated debt trades provides a direct and quantitative market-based indication of our financial strength.

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