particular attention to factors that may cause earnings to change in the future. Earnings in 2003 were strong for both Fannie Mae and Freddie Mac, amounting to $7.9 billion and $4.9 billion respectively. Fannie Mae's reported income represented a 71 percent increase from 2002, while Freddie Mac's was down 52 percent. However, the underlying economics of both enterprises was relatively stable.

Their two principal lines of business, credit guarantee and portfolio investment, continue to perform well at each enterprise, without deterioration in their risk characteristics. Credit losses remain exceptionally low, while spreads between interest rates earned on assets and interest rates paid on debt remain more than ample. OFHEO has been monitoring Freddie Mac's progress in compiling and issuing already delayed quarterly financial statements for 2004. We will continue to work with the company to resolve problems so that investors receive accurate and full disclosure of financial information on a timely basis.

Fifth, liquidity. We found that both companies demonstrated reliable access to sufficient sources of funds on cost-effective terms to remain liquid and meet their obligations throughout 2003.

Sixth is sensitivity. This describes the exposure and vulnerability of a company's earnings and capital movement in interest rates. I will summarize this point. We basically found that both companies have adequately managed their exposure to sensitivity risk.

Let me move to our budget now. OFHEO is seeking a total budget of $59 million to more fully staff a reorganized supervisory program. This budget supports 237 positions, compared to the 178 supported in our 2004 budget. It is an increase of 59 new positions, fully 85 percent of which are directly allocated to supervision of the two enterprises. These new examination and capital analyst positions will enhance and strengthen OFHEO's regulatory efforts by adding very necessary depth and breadth in our supervisory staff. I want to thank the leadership of the Financial Services Committee for their support for OFHEO's 2005 budget. Your support has been and continues to be critical to our success.

Also, as you mentioned Madam Chairwoman, we have reorganized OFHEO by doing basically three things: creating a new Office of Chief Accountant, a new Office of Compliance, and we have restructured the examination program to create two teams, one assigned to each enterprise led by an examiner-in-charge. We think these changes will help us best prepare OFHEO for any challenges that might arise in the future and make our program a more effective and strengthened supervisory program. My written testimony has more about the rationale underlying those actions.

Finally, we continue to flesh out our regulatory infrastructure project. The main rule we have pending right now are amendments to an already existing corporate governance rule. Some of the major changes in this rule have been mentioned by the committee, namely the separation of the chairman and CEO function, requiring auditor firm rotation, limiting the term of service on the board, and requiring higher standards for board independence. The comment period is closing on that rule, and we will take all comments into consideration and then promulgate a final rule as soon as possible.

Thank you, Madam Chairwoman and members of the subcommittees for your time. I appreciate it, and I will answer any questions at the right time.

[The prepared statement of Hon. Armando Falcon Jr. can be found on page 50 in the appendix.]

Chairwoman KELLY. Thank you, Mr. Falcon.

Just to remind both of you, your full written statements will be made part of the record and have been read by a number of us.

Now, we turn to you, Ms. Castaneda. Please push the button and pull the microphone as close to you as you can so we can pick up your voice.

STATEMENT OF ALICIA CASTANEDA, CHAIRMAN, THE
FEDERAL HOUSING FINANCE BOARD

Ms. CASTANEDA. Thank you, Chairwoman Kelly and Ranking Member Gutierrez. Thank you as well, Chairman Baker and Ranking Member Kanjorski.

This is my first appearance before Congress since I joined the Federal Housing Finance Board and became its Chairman in April. I am honored to appear before your two subcommittees to discuss the Federal Housing Finance Board and its oversight of the federal home loan bank system. I am speaking today as Chairman and my remarks do not necessarily represent the view of my board colleagues.

I came to the Finance Board after 28 years in commercial banking, experience that is proving very valuable in my new role as Chairman of the independent regulatory agency charged with oversight of the 12 federal home loan banks and the Office of Finance. As you know, the banks are government-sponsored enterprises and their members comprise more than 8,000 commercial banks, savings and loans, insurance companies and federally insured credit unions.

Today I can say with full confidence that the Finance Board is fulfilling the duties Congress gave it in the Federal Home Loan Bank Act: to ensure that the federal home loan banks operate in a financially safe and sound manner, carry out their housing finance mission, and remain adequately capitalized and able to raise funds in the capital markets.

Over the past 2 years, the Finance Board has made great strides in enhancing our capabilities to carry out these duties. The clearest evidence can be seen in the tripling of our examination staff. However, bank supervision is more than just examinations. We have also hired highly qualified mortgage specialists, bank analysts, community development specialists, accountants and economists. We are upgrading our technology and systems. These all contribute significantly to our oversight and supervision of the federal home loan banks.

While the agency has indeed come a long way, there is still more to do. I can assure this committee that, as Chairman, I am committed to a course of constant improvement. My intention is to continue building our staff, adding necessary resources, and fostering a world-class regulatory culture at the Finance Board.

As a regulator, the Finance Board's job is to do what needs to be done, when it needs to be done. That has been my approach

since I joined the Board in January, and it will be as long as I remain on the Board, which leads me to several recent developments that I think reflect our regulatory approach.

First, the Finance Board last month voted unanimously to require the home loan banks to register with the Securities and Exchange Commission under the Securities Exchange Act of 1934. The federal home loan banks are among the biggest debt issuers in the country, issuing roughly $500 billion in bonds annually in recent years. The home loans banks collectively had $765 billion in debt outstanding as of March 31, 2004.

Given these facts, the Finance Board called for consistent, enhanced and transparent disclosures from the individual banks to help achieve market discipline. Because investors in that market, as well as the banks' members and the public should and will know more about the risks faced by these financial institutions.

Registration will also ensure that home loan bank disclosure standards are fully comparable to those of the other housing GSES and large private financial institutions. Based on my experience as a banker and fixed-income trader, I believe this will help ensure that the banks are not disadvantaged in their access to capital markets. For all these reasons, we adopted the regulation, and the registration process is now under way. Each bank will be required to first file with the SEC by no later than June 30, 2005 and to have their registrations effective by no later than August 29, 2005. A second recent development occurred on the supervisory front. On June 30, the Finance Board and the Federal Home Loan Bank of Chicago entered into a written agreement to address certain shortcomings in the bank's risk management, internal audit, capital management, and accounting and financial recordkeeping practices.

These shortcomings were identified in recent Finance Board examinations of the bank. After a series of incremental steps dating back several years, my colleagues and I on the Finance Board determined that a formal written agreement was the necessary and appropriate next step to improve the bank's management and oversight of these issues.

Third, and finally, let me describe what the Finance Board is doing with respect to the affordable housing program. Beginning in 1990, Congress required the federal home loan banks to set aside 10 percent of their profits for low-income housing. Since its inception, the AHP program has provided some $2 billion in grants and subsidies for affordable housing.

The Finance Board is committed to ensuring that these programs operate in a safe and sound manner and help fulfill the home loan banks' housing finance mission. We are currently conducting a system-wide review of the home loan banks' AHP programs to help evaluate what they are doing in this area. We are also building a corps of examiners to focus solely on the affordable housing program, and have added new community development specialists to further assist in examinations.

Mr. Chairman, Madam Chairman, members of the subcommittees, thank you for allowing me this opportunity today to outline our activities at the Federal Housing Finance Board. I believe we have attained a level of expertise, experience and capabilities that

makes the Finance Board an accomplished, effective financial regulatory agency, one that serves the public in the way Congress intended, through rigorous oversight of the federal home loan banks and their housing finance and affordable housing missions.

Thank you, and I will delighted to answer any questions.

[The prepared statement of Hon. Alicia R. Castaneda can be found on page 46 in the appendix.]

Chairwoman KELLY. Thank you very much, Ms. Castaneda. Director Falcon, I understand that Fannie and Freddie have a policy which is just now being enforced that requires deductibles for wind damage insurance coverage to be less than 2 percent. In New York, comprehensive homeowners coverage has not been readily available or affordable, so a special advisory panel in New York strongly recommended deductibles as high as 5 percent to increase the availability of insurance coverage in certain areas. These recommendations were approved by the State of New York as a result of a series of special reports commissioned by the State legislature. I want to know if you are aware of the problem and of the costly impact it is having on the homeowners in New York, and if you will consult with New York's State Insurance Commissioner to try to resolve this.

Mr. FALCON. Madam Chairwoman, I was not aware prior to your mentioning this, but I will absolutely go back and take a look at it. As we look at the risk to the enterprises of different mortgage programs, we look at not just the risk, but the ability to manage the risk of the mortgages. They mitigate risks through the use of credit enhancements and other techniques. Certainly, we will look into the rationale underlying this policy judgment and report back to you on whether or not there is some way that possibly the risk of this, if they are excessive, can be mitigated through certain

means.

Chairwoman KELLY. I wish you would, sir, because your policy flies in the face of what the State legislature in New York passed, so it is important that we make these two laws congruent in any way possible. If you would get back to me on that, I would greatly appreciate it.

Chairman Castaneda, the Administration has indicated it will not make any presidential appointments to Fannie Mae and Freddie Mac's boards of directors. Is it their intent to also not appoint directors of the federal home loans banks, the 12 federal home loan banks? What is going to happen if the Finance Board's appointment process, what is going to happen to it actually, for this coming round of vacancies?

Ms. CASTANEDA. I have not heard anything from the White House regarding that issue. By statute, the Finance Board has to appoint some of the directors at each one of the banks. But to answer your question, I have not heard anything from the White House.

Chairwoman KELLY. I wonder, ma'am, if you would be willing to make an inquiry?

Ms. CASTANEDA. I certainly will.

Chairwoman KELLY. So that perhaps you would better answer that question. I think that is an important point that we need to clarify. You heard Mr. Kanjorski in his opening comments mention

that also. There is some concern about how this is all going to work, and we would be very interested if you could help us understand that, please.

Ms. CASTANEDA. I will make sure that the Finance Board staff will come back with an answer to you.

Chairwoman KELLY. Thank you.

I want to ask you both, the Financial Services Committee spearheaded corporate governance reforms in the Sarbanes-Oxley rules. I would like to ask you about some of the new corporate governance proposals your agencies are considering, which our committees are still reviewing. How closely have your agencies worked with the SEC on these issues, like the accounting restatements, the SEC registration, auditor rotation, separation of the CEO and the chairman? These are areas where we are all interested in hearing what you have to say about whether you have been closely working with the SEC on resolving issues there.

I am asking both of you. Take your pick.

Mr. FALCON. I will go ahead and go first. We do consult with the SEC on various issues. We did consult with the SEC on our current corporate governance rule. I am not suggesting that they endorse it or oppose it, but we did consult with them during the drafting process of the amendment that we have issued.

In addition, we work closely with the SEC on a variety of other matters. We work closely with them in preparation for Fannie Mae's and Freddie Mac's announcement to voluntarily register with the SEC. I think we consult as necessary, and certainly the SEC, I feel from their standpoint, recognizes our responsibility at OFHEO to do our job as a matter of safety and soundness, while they do their job as a matter of investor protection.

Chairwoman KELLY. The reason I am asking this is that the primary role of your agencies is to protect the taxpayers through safety and soundness oversight on the GSES. The SEC's primary responsibility is to protect investors. These are two very different goals. Because of that, that is the genesis of my question. Basically, we took a very serious look for instance at the audit firm rotation during the Sarbanes-Oxley debate. Some of these other things I really would like to hear more about from you.

I do not understand how, given the consolidation of the accounting industry that we are in, we are looking now at the final four firms. I do not see how this is going to get structure to avoid conflicts of interest. Deloitte is doing a forensic audit of OFHEO. PWC audits Freddie Mac. KPMG audits Fannie. Ernst and Young is working with Fannie Mae's law firm on the special audit. I am not sure how this is all working. I am not sure that this committee is clear on that, and I would really appreciate hearing back from you. I am out of time. I am going to turn now to Mr. Gutierrez. Mr. GUTIERREZ. Thank you.

I want to welcome you both here once again, and to say to Director Falcon, you are always welcome to come back. I enjoyed serving together with you on the Banking Committee. It was the Banking Committee before they changed its name mysteriously.

I have a question for Chairwoman Castaneda. The financial services industry has evolved as the barriers to interstate banking have been removed. Consolidation in the financial services industry con