Loan Bank Commissioner decided that there should not be one, and it merged the bank with another.

You know, the Finance Board could do that today if they wanted to. They could merge or move the banks. When the Los Angeles bank sued, they lost because the court found that even if the orders to liquidate the bank, transfer its assets and readjust the bank district had been motivated by malice of the Federal Home Loan Bank Commissioner, if the auditors were otherwise justified by legal purpose, they were not otherwise illegal or subject to attack on their validity. That is pretty broad-based power.

That is power. The Finance Board clearly has it and seems to be using it appropriately at the moment, keeping in mind its obligation to serve the public good. I only wish that some agencies like the OCC would have similar power, and did not seem so afraid to use their power and fulfill their duty to the public when it requires them to act against the desires of their regulated institutions.

I want to thank you, Chairwoman Kelly and Mr. Baker and Mr. Kanjorski, for calling this hearing. I look forward to the testimony of our witnesses at this hearing.

Chairwoman KELLY. Thank you very much, Mr. Gutierrez.
Mr. Baker?

Mr. BAKER. Thank you, Chairwoman Kelly. I certainly appreciate your courtesy and cooperation in conducting this hearing. It is highly appropriate from an Oversight and from a Capital Markets perspective that the two committees focus on this particular responsibility. I appreciate the opportunity to work with you and Mr. Gutierrez.

As to Mr. Kanjorski's and my responsibility, there is no question that the committee has spent considerable time and effort in first attempting to understand functions of GSES, and secondly examining the regulatory adequacy of the current structure.

To both the Director and the Chairwoman today, I extend my appreciation for all your efforts over the past months, particularly Mr. Falcon, over many years of difficulty. I appreciate your commitment to bring about accountability. I will be very brief in my opening statement, as I have a fair number of questions I would like to move to, and certainly would want to hear the testimony of both our witnesses and move the hearing along.

With that, I would yield back the balance of my time.
Chairwoman KELLY. Thank you very much.

Mr. Kanjorski?

Mr. KANJORSKI. Thank you, Madam Chairman.

We meet today to examine the recent actions and pending proposals at the Office of Federal Housing Enterprise Oversight and the Federal Housing Finance Board. These two regulatory bodies help to ensure that Fannie Mae, Freddie Mac and the federal home loan banks continue to fulfill their public mission of advancing homeownership.

Our nation's system of housing finance is not only extremely successful, but it is also the envy of the world. More than 68 percent of Americans presently own the homes in which they live. Government-sponsored enterprises have contributed greatly to this accomplishment.

This success, however, should not stop us from asking whether and how we can do a better job with respect to regulating the housing government-sponsored enterprises and conducting congressional oversight regarding these matters. We should always examine ways by which we can improve regulatory efficiency and lower mortgage rates.

As you know, Madam Chairman, I am also one of the few remaining members of this committee who participated in the entire congressional battle to resolve the savings and loan crisis. I am therefore acutely aware of the need to protect taxpayers from risk. It is in the public's interest that we ensure that the housing government-sponsored enterprises continue to operate safely and soundly. We must further ensure that these public-private entities achieve their public responsibilities for advancing homeownership opportunities.

As we proceed today, I hope that our distinguished witnesses will share their views on corporate governance. I know that the Federal Housing Finance Board has carefully studied these issues in recent years and has worked to improve the performance and accountability of federal home loan bank executives and board directors.

Nevertheless, I have heard concerns about the need to improve the expertise on the boards, such as requiring at least one director to have experience with derivatives. I have also previously proposed extending the terms of directors from 3 years to 4 years to increase institutional memory at the federal home loan banks. I am additionally aware that one federal home loan bank may soon have no representative on its board with more than 3 years of experience, assuming that none of its current directors are reappointed later this year.

In recent months, the Office of Federal Housing Enterprise Oversight has also released its proposed minimum standards for corporate governance. These standards have sparked considerable debate, particularly regarding the decisions to separate the CEO and chairman functions and to mandate the rotation of external auditors. In addition, I am very concerned about the failure of the Bush Administration to appoint directors to serve on Fannie Mae's and Freddie Mac's boards. As a result of this decision, each board has five fewer individuals to serve than they usually had.

The failure to appoint presidential representatives on these boards has increased the burden that each of the remaining directors must carry. Moreover, it is important to note that three of the five presidential appointees on each of these boards had to represent particular concerns or have specific backgrounds, such as experience in the housing industry. Unfortunately and counter to congressional intent, neither Fannie Mae nor Freddie Mac is now benefiting from receiving these diverse viewpoints.

In closing, Madam Chairman, as I said at our very first hearing on GSE regulations in March 2000, we need to have strong, independent regulators that have the resources they need to get the job done. I continue to support strong GSE regulation. A strong regulator, in my view, will protect the continued viability of our capital markets, ensure against systemic risk, and expand housing opportunities for all Americans. I therefore look forward today to hearing from the leaders of the two regulatory entities overseeing the safe

ty and soundness of the housing government-sponsored enterprises, and yield back the remainder of my time.

[The prepared statement of Hon. Paul E. Kanjorski can be found on page 44 in the appendix.]

Chairwoman KELLY. Thank you very much, Mr. Kanjorski.

Mr. Garrett, do you have an opening statement?

Mr. GARRETT. Just to thank you for holding the hearings. I will defer my opening statement because there are three areas that I will be interested to see whether they are touched upon with regard to the comments we receive today. First of all, I am just coming from another meeting with regard to the money we are spending, and that is budgetary issues and the amount of money being requested. Secondly is GSEs involvement in foreign nations; and finally, with regard to the status of special examinations ongoing at Fannie Mae.

So I will be interested to hear your testimony on that, and probably will have follow-up questions at the conclusion. Again, thank you to the Chairs for holding the hearing.

Chairwoman KELLY. Thank you.

Mr. Hinojosa?

Mr. HINOJOSA. Thank you, Chairwoman Kelly.

I want to thank you for calling this hearing. It gives us an opportunity to hear form both witnesses. I look forward to your remarks. Thank you.

With that, I yield back the balance of my time.

Chairwoman KELLY. Thank you.

Mr. Scott?

Mr. SCOTT. Yes, just a couple of opening remarks, Ms. Chairlady. Chairwoman KELLY. That is okay. We know what you mean. [Laughter.]

Mr. SCOTT. Certainly in view of the fact that OFHEO is the primary regulator of Fannie Mae and Freddie Mac, and that your mission is to ensure the capital adequacy and financial safety and soundness of these two entities, last year Freddie Mac had one of the largest corporate financial restatements of earnings and saw the ouster of its top executives. The Office of Federal Housing Enterprise Oversight followed with an examination of Freddie Mac's accounting and management practices and a forensic audit is currently being conducted at Fannie Mae.

This committee has heard testimony that OFHEO was basically asleep at the switch and did not catch these accounting schemes early enough. There is general agreement that OFHEO needs to be strengthened in order to ensure the safety and soundness of these GSES as they expand rapidly and rely on complicated accounting methods.

As we know, legislation has stalled which would consolidate the functions of OFHEO and the Federal Housing Finance Board at the direction of the Administration. I believe that several of the issues that will be discussed today, including appropriations to fund the regulators and the authority to issue regulations, would be addressed if Congress were able to pass GSE legislation. If I understand right, you are asking for perhaps 50 percent more in funding, an increase of over $20 million from what you asked for last year.

So with that being said, I look forward to hearing the panel's testimony on the current safety and soundness of the GSE, and their current commitment to affordable housing goals.

I yield back the balance of my time.

Chairwoman KELLY. Thank you, Mr. Scott.

Ms. Capito?

Mrs. CAPITO. I have no questions, Madam Chairwoman. I look forward to the testimony.

Chairwoman KELLY. Thank you.

We now turn to our panel. The subcommittees are pleased to have with us the Director of the Office of Federal Housing Enterprise Oversight, Mr. Armando Falcon, and the Chairman of the Federal Housing Finance Board, Ms. Alicia Castaneda.

Director Falcon was confirmed as the head of the Office of Federal Housing Enterprise Oversight in 1999. As Director, he heads the federal agency responsible for ensuring the financial health of Fannie Mae and Freddie Mac. Mr. Falcon leads a diverse staff of examiners, financial analysts, IT professionals, attorneys and external affairs experts. Prior to this appointment, Mr. Falcon served for 8 years on the legal staff of the House Banking Committee.

Chairman Castaneda was confirmed by the Senate in December 2003. Ms. Castaneda brings more than 28 years of commercial banking experience to the Federal Housing Finance Board, most recently as senior vice president at Bank of America. Chairman Castaneda is the first Hispanic to be appointed to the Federal Housing Finance Board and is the first woman to serve as a director since the Finance Board became full-time in 1990. For that, madam, I certainly congratulate you heartily.

The committee thanks both witnesses for their appearance and testimony. Without objection, your written statements will be made part of the record. You will each be recognized for a 5-minute summary of your testimony. If you have done this before, you know that the box on the table has green, yellow and red lights. The green light means you have a full 5 minutes. The yellow light means you have 1 minute, and please start to summarize. The red light means your time is up.

Let us go to our first witness, Mr. Falcon.

STATEMENT OF HON. ARMANDO FALCON, JR., DIRECTOR, THE OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT Mr. FALCON. Madam Chairwoman, Mr. Chairman, and Ranking Members Gutierrez and Kanjorski, thank you for the opportunity to testify at today's oversight hearing. You mentioned my time working here at the committee. It is always a pleasure to be back in this hearing room, sometimes more pleasurable than others, but I do appreciate the opportunity to be here.

My testimony will discuss the financial condition of the enterprises as reported in OFHEO's 2004 annual report, the importance of additional resources to strengthen the regulatory supervision and my efforts to reshape OFHEO to meet the demands of the future.

OFHEO is required to report annually on the financial safety and soundness of each enterprise, including the results and conclusions of the annual examinations of the enterprises. OFHEO fulfills

this requirement through the annual report to Congress submitted each June 15. This year, OFHEO has adopted a CAMELS approach in the report on the condition of the enterprises. The federal banking regulators employ the CAMELS methodology as a summary for an institution's financial condition. CAMELS is an acronym for six areas of evaluation: capital adequacy, asset quality, management, earnings, liquidity and sensitivity. I will briefly review OFHEO's assessment in each category.

First, capital. Capital provides the means by which the enterprises withstand adverse economic conditions or situations. OFHEO monitors and assesses the capital position of Fannie Mae and Freddie Mac on an ongoing basis. Both enterprises exceeded their minimum and risk-based capital requirements for all quarters in 2003 and were classified as adequately capitalized.

Second, asset quality. OFHEO evaluates the credit risk management practices of each enterprise for both single-family and multifamily lines of business. As part of that evaluation, OFHEO conducts selected sampling and targeted reviews. Those reviews evaluate whether the practices of the enterprises meet safety and soundness standards and adequately protect the enterprise from the risk of loss associated with counter-party default. Based upon examination activities to date, it is the overall conclusion of OFHEO that Fannie Mae and Freddie Mac have strong asset quality and prudent credit risk management practices.

Third is management. OFHEO evaluates management of the enterprises in accordance with OFHEO's regulation, guidances and prudential standards applied in the course of an examination. Regarding Freddie Mac, OFHEO conducted a special examination of the events leading to the enterprise's restatement and replacement of senior management. Late last year, I submitted a report on the special examination of Freddie Mac. The report details a pattern of inappropriate conduct and improper management of earnings that led to the restatement and management restructuring of the company. As a result of the findings of the special examination, Freddie Mac agreed to implement corrective measures and pay civil money penalties of $125 million as part of a consent order with OFHEO. During the period of the consent order, the board of directors at Freddie Mac has elected a new chairman and has hired a number of senior executives as its management team. The company is making good progress on its remediation obligations and we will provide a full assessment on management in our next annual report.

Regarding Fannie Mae, OFHEO concluded that the overall management of operational risk at Fannie Mae comports with applicable safety and soundness standards, but that judgment may be subject to change as a result of a special examination. OFHEO has initiated a special examination of the accounting policies and practices at Fannie Mae. The scope of this review includes accounting policies and controls at the enterprise, including the identification of any control weaknesses or unusual transactions. Pending completion of that examination, a definitive assessment of Fannie Mae management must be deferred.

Fourth, earnings. OFHEO assesses enterprise earnings by analyzing the magnitude, trends, sources and quality of earnings, with