tinues as large-and mid-size banks from different parts of our country merge or acquire one another. One of the most recent examples of this trend is the merger of Bank One in Chicago with J.P. Morgan Chase in New York. Under the current finance board rules, individual bank members of the FHLB system are not permitted to belong to more than one FHLB. If two members merge or one acquires the other, the surviving bank must withdraw from membership in one of the home loan banks districts.

The concern I and other members have is the impact that such a rule has on the distribution of affordable housing program funds, which are linked to business and profits of each of the FHLBS. While a new merged bank continues to do retail business in both of the eight FHLB districts, all advances and mortgage purchases must be conducted only through one of the FHLBS, where it retains its membership. When the Finance Board asked for comments on this issue some time ago, the Chicago Home Loan Bank proposed a compromise that would apply in the limited circumstances in which a bank belonging to one home loan bank is acquired or merged with a bank belonging to a different one.

In this case, the surviving bank retains its membership. The surviving bank emerged, Bank One, J.P. Morgan, the survivors unfortunately for Chicago is J.P. Morgan Chase. It gets to retain them. The advantages of this proposal is that it helps better ensure that funds supporting affordable housing are retained and distributed in the district where they were generated. Can I just have your thoughts on this compromise and your thoughts in general on this issue?

Ms. CASTANEDA. Thank you, Congressman Gutierrez, and thank you very much for pronouncing my last name so well. I give you a 10.

[Laughter.]

Finance Board rules do not prevent a federal home loan bank from funding projects from outside their districts. As a matter of fact, the Finance Board rules approve and most of the banks now do allow funding from out-of-district projects. So when a merger occurs, it is very likely that all the funding for a particular community be comprised of in-district and out-of-district funding. That said, I cannot forecast whether the total funding of the bank district that loses a member could have less funding for particular projects.

The data that the Finance Board has collected shows that it is very common for a federal home loan bank that loses members in one year to gain new members in the following year. The overall impact of merger and acquisitions on affordable housing funding has generally balanced out through the time and across the system. In other words, the data shows that there has not been any significant impact because of the mergers and acquisitions.

I would be more than happy to have the Finance Board staff share some of this data with your staff.

Mr. GUTIERREZ. I would appreciate it, because I guess when you are the loser, I mean in one of these situations, we have New York, we have Chicago and we have the home loan bank. We have raised issues outside of your concern when banks do those kinds of things. In Chicago, we are wondering where are the jobs going to go; where

is the corporate giving of the institution. It has a harmful impact. We would just like to get that information from you to see that we do not lose, specifically around housing programs, which we have seen. I have friends at Freddie and Fannie that are not too crazy about what the federal home loan bank does, but I think more competition is good competition. I want to make sure that competition does not get somehow sidetracked.

Thank you very much, Chairwoman Castaneda, and welcome once again Director Falcon.

Mr. FALCON. Thank you, Congressman.

Ms. CASTANEDA. Thank you.

Chairwoman KELLY. Thank you.

Chairman Baker?

Mr. BAKER. Thank you, Chairwoman Kelly.

Mr. Falcon, it has been some time since we visited. I appreciate your participation here today.

I have a series of questions that I would just like to give to you, and then as time permits have you respond today or as you are comfortable in writing at a later time. I understand that you are moving forward with finalization of your proposed corporate governance reforms. Both GSEs have filed statements of some objection to a number of the provisions. Have you set a deadline for completion of this corporate governance reform? If so, could you at the appropriate time inform the committee as to how you intend to achieve that end conclusion?

Number two, I continue to be very interested in the ongoing forensic accounting review now under way at Fannie Mae. It is my opinion, based on other revelations in public operating companies over the past several years, that if the corporation is not cooperative in disclosure that an accounting overview of some effectiveness may be questionable in its outcome. Therefore, do you believe the enterprise is making information, documents, access to personnel available in a timely and appropriate manner to meet your concerns and those of the auditor?

Number three, in response to your specific corporate governance reform relative to reasonable and appropriate executive compensation, Mr. William McDonough, Chairman of the Public Corporation Accountability Oversight Board, appeared before the committee recently and said something to the effect that executive compensation is an area where congressional review would be highly appropriate, and if either the compensation committees or shareholders cannot bring about appropriate reform, that Congress should act.

To that end, I note in the response, particularly by Fannie, to that specific recommendation, and I am relying on an American Banker article that states that the term "appropriate" is not defined by your proposal and therefore does not allow companies to determine what standards will apply when determining compliance. The law prohibits executive compensation that is not reasonable and comparable, that is the 1992 law which Fannie is suggesting as appropriate language. "Comparability" would therefore mean disclosure of executive compensation levels. There has been some controversy surrounding disclosure of the top 20 executives's compensation for either or both enterprises.

I will follow this discussion with a specific letter asking that in order to achieve Fannie's suggested comparability standard that you make available to the committee Fannie, Freddie, at whatever level, 10 or 20, it does not matter to me, and in addition some single line of financial service industry comparable. For example, a sophisticated S&L, if there is nobody of asset size comparable, but who has a single line of business principally. I will follow this hearing up with a letter on that matter.

In the time remaining, I want to plow new ground which we have not previously talked about, relative to what are known as guarantee fees, fees which the enterprises charge originators when purchasing loans. A cursory review of data I have been able to obtain, and I certainly do not have access that you would have, indicates that the GSEs credit loss ratios have declined due to improvements in their underwriting and risk management, meaning they are not taking as many poor people as they used to take, apparently, while loan loss reserves in the same period of review have declined principally attributable to reduced losses.

However, it appears that the guarantee fees that mitigate potential losses have remained constant in the historic decline of losses, and at the same time declining loan loss reserves. Where is the money going? If it is not going to build up loan loss reserves, and by way of disclosure it is my understanding, let's just pick the year 1995, that the average G rate was 22 basis points, with a credit loss ratio of 5 basis points. Today, it is down to a .6 basis point CLR with a G fee rate of 20.2. The difference being in 1995 there was a return on equity of 21 percent; today in the case of this GSE, it is 50 percent.

At the same time from 1995 to 2003, loan loss reserves as a percentage of assets have declined from .25 basis points down to .08. The public policy concern I have is that the money is not flowing the loan loss reserve account to insulate against the three-fold increase in asset value on Fannie's side, a six-fold increase on the Freddie side. At the same time, the loss ratios have dropped, meaning the risk to the enterprises has for some reason been mitigated, but yet the income flow net to the corporation would appear on its surface to have been increased rather dramatically.

I do not have access to the cash-flow numbers to indicate to me what this means to the corporation in terms of gross or net returns on equity, but I would very much appreciate some detailed analysis of this area of business and again a report back to the committee, not in any urgency, but the first of the year, after the first of the year. My time has expired. I will wrap both of those requests into a single letter. If you have a chance to just touch on the corporate governance reform issues and the compliance with forensic accounting requests, and with the Chairwoman's diligence, maybe with those two you can jump in. Thank you.

I appreciate the Chairlady's tolerance.

Chairwoman KELLY. Thank you, Mr. Baker.

Mr. Frank?

Mr. FRANK. Thank you, Madam Chair.

We are probably guilty. Part of my frustration in dealing with these issues is that we have before us two entities which are very important with regard to affordable housing, a crisis in this coun

try. But our own committee structure fails to fully take account of that. We had a very important hearing today on homelessness and housing for the Housing Subcommittee. Now we have two other subcommittees, and the Housing Subcommittee is not part of it. I regret that. The media that cover these institutions, particularly the GSES, tend to be more in the financial area than the housing area, and I really hope we can increase attention to that.

To Chairwoman Castaneda, let me say that Mr. Gutierrez's question is my question. I understand your argument that it sort of balances out, but I do not want to rely on that. The affordable housing program of the federal home loan bank is one of the best things we have. Director Falcon in fact was here under the leadership of Chairman Gonzalez when we enacted that. It was hard-fought and it is an excellent program. But it follows the CRA principle, which is money raised by the banks in an area which then contributes to FHLB profits are to be spent in the area. That is very important. I was here when we did that under Mr. Gonzalez's leadership.

At that point, bank mergers were not a big deal, particularly with thrifts. Now, mergers are a big deal. Back then, we were called the Committee on Banking. If we ever change the name again, I think we are going to change the name to the Committee on the Bank, because there will probably only be one.

[Laughter.]

But what this has meant is that there is a consolidation, and we are losing the principle that money generated in one place should be in another. I know there are people who are worried about domination by some large entities. I do not see any problem. I want to continue to pursue this with you. I am just saying that particularly where there has been a merger, an entity that was bought up, that had been a member of a federal home loan bank, that that portion of what it earned should be credited to its regional bank and not elsewhere. I intend to keep pursuing that.

The second point I want to make to both of you, and it touches both, but more to Director Falcon, is one of the tensions we have had. There are tensions involved in the way we do things. We were talking just as an example, but touching on some of what you do, in predatory lending, there is a tension between doing away with predatory lending and redlining. We did not used to have predatory lending. We had redlining. You go too far in one direction here you can lose things.

Here, the tension is between safety and soundness on the one hand, financial stability, and on the other hand getting into housing. I must say to Director Falcon, as he knows, one of the concerns some of us have with some of the legislative proposals that come from the Administration is the fear that, and I think the Administration has been somewhat inconsistent. On the one hand, they talk about the need to do more affordable housing, where I am supportive; but on the other, to put so much emphasis administratively and elsewhere on safety and soundness, that we would lose that. I have one specific example relevant to both of you. It is relevant to Fannie and somewhat to Freddie. It is relevant to the New York Federal Home Loan Bank, and that is the issue of manufactured housing. Without manufactured housing, you will not get significant homeownership among moderate-income people. It is a very

important resource. It has been historically underutilized. It has been ridiculed. We are coming to an understanding of the importance of manufactured housing.

It is not either/or. I am very proud of my relationship with the homebuilders. We need both. But clearly, manufactured housing is improving in quality, and we have not in a regulatory way quite caught up with that, I mean in terms of property laws, et cetera. But here is the problem: Your New York regional bank was downgraded by one of the rating agencies because of its manufactured housing. Director Falcon, you have raised questions about manufactured housing. I understand that manufactured housing has a problematic past, but the quality of the housing has significantly increased; our understanding of it has increased.

What I would urge both of you is, I need you both to reassure me, that we are going forward and are going to find a way to encourage the entities under your various supervisions to go forward in manufactured housing. What I am afraid of is that a focus only on the problems with the past financial inventory is going to drive them out of it. I must say I think that that has been one of my concerns about OFHEO. I need people to reassure me, for me to feel comfortable about this, that we are going to recognize it.

Let's put it this way. There has got to be a way to deal with whatever problem that used to be there with manufactured housing, and that we will not let the hangover from some of the bad practices be a deterrent to them going aggressively forward in the future. I think that is a very important test, frankly, for both regulators, of your ability to preserve financial soundness without impinging on the affordable housing issue, which we all say we are for.

Let me start with Director Falcon.

Mr. FALCON. Thank you, Congressman.

Like you, I believe very much in the mission of the two companies that we regulate. I believe in their housing mission, including this area with manufactured housing. Our concern about it was related to the accounting for these assets, not so much just these, but impairments in general. They apply primarily to the portfolio of manufactured housing loans. What we have sought to do is put in place the proper accounting for those assets if and when they did deteriorate. In the case of these, they did.

I will pledge to you that we do seek to strike the balance between safety and soundness, cognizant of the mission of these two companies. I believe the mission of my agency is in some regards also a housing mission, not just a safety and soundness mission. So we are very aware of that. I think all the employees of the agency feel that way.

if

Mr. FRANK. If I might just make a specific suggestion, which is, you feel the need for some reason to talk about the manufactured housing, nothing stops you from saying, and we say this in the context of believing that going forward they should remain an important part of the portfolio and encourage them to do that. When all people hear are the negatives, it drives away the enterprises; it drives away lenders; it accumulates.

Mr. FALCON. That is right. It is just a matter of going forward and making sure there are adequate risk management practices in