uct that you believed would undermine the safety and soundness of one of your regulated entities?

Mr. FALCON. Not that I am aware of, sir.

Senator REED. Do you see the difficulty there, where there could be a possibility of programmatic approval of something that would be unsafe or unsound? Wouldn't you object and wouldn't your objections-even though you technically do not have the authority, but your objections would be heard?

Mr. FALCON. Well, I think they would be taken into account. Our role still would continue to be to make sure there was adequate capital held against the activity. So if we thought something was an extraordinary risk, even if it was consistent with the charters, we would make sure that there was adequate capital to set aside against the potential risk of loss of the activity.

Senator REED. Just a general question, and, Mr. Korsmo, you might respond to it also. There has been some discussion of having one regulator for both Fannie and Freddie and for the Federal Home Loan Banks. I know you have alluded to this and commented on it. Once again your thoughts, and then, Mr. Falcon, if you could comment.

Mr. KORSMO. I certainly think there is the potential for advantages, and I will leave to the policymakers the decision as to whether or not those advantages outweigh the disadvantages. My only admonition along those lines is the one I made in my opening statement, and that is to remain cognizant of the very real differences that exist between the Federal Home Loan Banks and Fannie and Freddie in terms of charter and capital structure and membership structure. So long as those are recognized, the decision may be easier.

Senator REED. Mr. Falcon.

Mr. FALCON. I think as the Federal Home Loan Banks develop into more of a competitor of the enterprises, I think it would be a benefit to the regulator of each entity to be able to fully understand the operations and activities of each. The real question is to what extent you have any uniformity of regulatory policies as expressed in the regulations or guidances, and whether or not you require— or have an uniformity as those policies apply to each entity. I think that is the more difficult question.

Senator REED. Thank you.

Senator BENNETT. Thank you.

I would like to follow along on the comments that were made in response to Senator Hagel. Mr. Holtz-Eakin, you are suggesting the market would fill in for the GSE's if the GSE's were to disappear.

Mr. HOLTZ-EAKIN. I believe that there is a lot of evidence that the private markets can manage the finance of the U.S. housing sector, and at present the presence of an uneven playing field with taxpayers assuming a credit enhancement for the GSE's makes it impossible to observe them filling in, but in the absence of that there is good reason to believe they would.

Senator BENNETT. What would be the effect on cost? Would the price of mortgages go up if the GSE's were to disappear? You outline in your testimony or the GAO that the GSE's can borrow at lower rates of interest, and presumably that would go away. Would that not reflect in the higher cost in the housing market?

Mr. HOLTZ-EAKIN. The research we have done to date suggests that of the subsidy provided by taxpayers, about 25 basis points shows up in the form of lower rates to borrowers, the remainder is retained by the GSE's. Given our most recent estimates, there would be about a 25-basis-point impact on mortgage interest rates. Senator BENNETT. Let me be sure I understand what you are saying. Would the mortgage rates go up by 25 basis points if the GSE's were to disappear?

Mr. HOLTZ-EAKIN. With no other changes in the market, the elimination of the implicit guarantee would raise mortgage interest rates by 25 basis points.

Senator BENNETT. Is that not a social good that the Congress decides is worth the implied guarantee, to have lower-cost housing, particularly for the low-income Americans?

Mr. HOLTZ-EAKIN. It is clearly only one element of the overall benefit cost test: Whether the cost of having taxpayers assume more risk is outweighed by the benefits of this, particularly for lowincome individuals. The research suggests that 25 basis points alone would not move substantial numbers of low-income borrowers into homes, that a larger movement in interest rates, of around 2 percentage points, is needed to really have a substantial impact on homeownership rates among lower-income individuals.

Senator BENNETT. So you are saying 25 basis points is basically trivial.

Mr. HOLTZ-EAKIN. Trivial is in the eye of the beholder, but those are the magnitudes that we estimate would happen and the magnitudes the research community suggests are important.

Senator BENNETT. Thank you.

Now, following along the lines that Senator Reed raised, in our previous hearing and in post mortems of the previous hearing, it strikes me that one of the sticking points here is the question of the role of the regulator, assuming a new regulator is established within the Treasury, the role of the regulator and the role of HUD. I think that was the issue that Senator Reed's comments were getting toward.

Mr. Falcon, you have said you as the existing regulator have never seen HUD do anything that would in fact affect safety and soundness. The GSE's prefer to deal with HUD because they prefer the devil they know to the devil they do not know. They worked out an accommodation with HUD whereby new products are approved relatively rapidly, and their fear, as I understand it, is that a new regulator would ultimately end up approving the same new products, but do so in a manner that would take enough time, create some bureaucratic arterial sclerosis, that it never moves, and ultimately therefore there would be a delay in getting new products to the market.

Could you comment on that whole thing? I imagine you have given it some thought, and you are the only one who has had some practical experience with the dichotomy between HUD's role and a regulator's role.

Mr. FALCON. The way things are set up now, Senator, is with HUD as the mission regulator, and us as the safety and soundness regulator, we are also tasked for enforcing, as the enforcement arm for the Enterprises, even in most matters related to mission regula

tion. If HUD thought there was an issue, an activity that the Enterprises could not engage in and an enforcement action was necessary, it would be up to OFHEO to take the enforcement action. As the safety and soundness regulator and responsibility for assuring that the Enterprises are in compliance with all of the laws and regulations that apply to them, we have to make sure that we understand what is going on in the area of their activities, and if we saw that there was a clear violation of a law, including their charters, we would step in and advise the company that it was not permissible. We have done that before.

But where they operate in the vast gray area, we defer to HUD on what is permissible and what is not. What I am suggesting is that we just take it a step further and give the safety and soundness regulator the authority to also opine in this gray area. There are different ways to do this to make sure that HUD continues to have a role when the activity involves some affordable housing or low-income housing program. I think something could definitely be structured there. But I think it is just a matter of making sure that the regulator-we do not prefer that the agency is operating under a cloud and leave themselves open to a potential legal challenge, that it be clear what they can and cannot do.

That is why I think it is the interest of the safety and soundness regulator to have this type of authority as all the others do. Senator BENNETT. Senator Corzine.

COMMENTS OF SENATOR JON S. CORZINE

Senator CORZINE. Thank you, Chairman Bennett, and welcome to the panel. I apologize for not being here. I had another obligation. Just a quick question to Director Holtz-Eakin. This 25 basis points has to be an average, cannot possibly be every single element. I think that is what Senator Bennett was talking about. It is a range of benefits to different mortgage takers. I would presume that since there are credit spreads in the mortgage market, in the mortgage lending market, that some people, while they may be spending a lot more than they would otherwise be, it is still going to be a lower spread than otherwise. I presume it is an average. Mr. HOLTZ-EAKIN. There is certainly a spread, and this is an average result from our study.

Senator CORZINE. So that different elements of the market may benefit more than 25 basis points. Folks accessing with less quality credit or at least credit histories than other people, and therefore some of that might be more important for certain segments of the market than it would be others. It would not just be a standard 25 basis points.

Mr. HOLTZ-EAKIN. There will certainly be a spread, and what we will look at is those mortgages that qualify under Fannie's and Freddie's requirements.

Senator CORZINE. As you probably can recognize that sometimes the spread gets so much that supply and demand would actually allocate out some money at the long end of the widening of the spread, 200 basis points or 400 basis points for some element. It gets to a point where it is prohibitive or the market rate just gets to a marginal rate somebody cannot afford. I presume that at some level that occurs because of this.

Mr. HOLTZ-EAKIN. As an economist, I would never dispute the fact that some people get priced out of markets. I take that point. The degree to which that is an empirical phenomenon is not something we investigated.

Senator CORZINE. I think that when we are talking a about 25 basis point, I think I do not know what the outstanding mortgage lending money is, but on an average basis, on an annual basis, time discounted value over a period of time, that is actually a pretty substantial benefit to consumers, and since it would be different for different segments I still think it is a quite substantial benefit for mortgage production and homeownership which I think is one of the core cases of what we would be arguing, why GSE's have a reason to exist.

Mr. HOLTZ-EAKIN. In terms of the magnitudes, our estimate at the time was $10 to $15 billion a year in subsidy, of which something on the order of half to two-thirds shows up in the form of lower mortgage interest rates. So that is a way to divide up the degree to which the subsidy benefits consumers.

Senator CORZINE. It goes to the core of whether policymakers think that is an appropriate way to generate these kinds of issues enough.

Mr. HOLTZ-EAKIN. Absolutely.

Senator CORZINE. I have a question, Mr. Korsmo. I know these things could take months. What is the capital standards that the Federal Home Loan Banks have? We talked about minimum standards and there are risk-based standards, but what do they look like at the Federal Home Loan Banks? Maybe you answered that in your testimony.

Mr. KORSMO. Let me answer that question a couple of ways. Obviously, there is a statutory minimum of 4 percent that is included in the statute, a minimum leverage requirement that is based on the definition of capital that Congress has provided that goes to 5 percent. There is also a risk-based capital element that is established by regulation, as Mr. Falcon alluded to earlier with the case with Fannie and Freddie. The risk-based capital level that is provided by the regulatory definitions is below the statutory minimum, and so all the banks are operating under that 4 percent statutory minimum.

There is a variety of course among the 12 institutions-I should say there is a variety of levels of capital among the variety ofamong the 12 institutions I think they range from a low of about 4.2 percent maybe to a high in excess of 5.5. I know the Chicago Bank just announced their new level is approximately 5.15 percent. I can talk a little bit about what is included in the risk-based capital reg if that is

Senator CORZINE. But it has not really bitten.

Mr. KORSMO. No, it has not really bitten, that is correct.

Senator CORZINE. Have you looked at the nature of your riskbased capital standards relative to what OFHEO has developed with regard to the GSE's?

Mr. KORSMO. I have not. There is a comparison of course. The standards are different and the factors that go into the standard are different. For example, our scenarios are substantially different

than the scenarios under which OFHEO develops their risk-based capital standard. It is much more

Senator CORZINE. I see the red light is on. Are those differences a function of a different mission, different purpose, or are they a function of different intellectual framework?

Mr. KORSMO. I think they are different intellectual framework, different methodology.

Senator CORZINE. If there was a consolidation, then we would want to think about how

Mr. KORSMO. They would have to be reconciled, yes, sir.
Senator BENNETT. Thank you, Senator.

Senator Allard.

STATEMENT OF SENATOR WAYNE ALLARD

Senator ALLARD. Mr. Chairman, I would like to inquire about the Federal Housing Finance Board in its role as a nonappropriated agency, as you enact your own budget and assess the Banks on the cost of the operation. How important is this authority in your ability to carry out your mission?

Mr. KORSMO. I think it is significant, and I would certainly urge the policymakers to take a look at any new regulatory body or any change in the current regulatory structure to reflect the ability to generate a budget.

Senator ALLARD. So you think OFHEO or any new agency that we set up should have that capability?

Mr. KORSMO. Yes, sir, I do indeed. Obviously, there have to be some constraints. I think that the process at the Finance Board, whereby the budget is adopted by a majority vote at an open meeting provides the balance that is necessary to make sure that we are not penalizing the entities we regulate by the budget process.

Senator ALLARD. Dr. Holtz-Eakin, how do we apply accountability to a regulatory agency like this? I think back, for example, of the FDA. Before they approve drugs they go back to the industry and say, well, we are not going to approve any more applications for new drugs and we are going to slow down the process unless you work with us to increase fees on services. Is there a way that we can bring accountability into the budget process on that type of a proposal or do we already have it?

Mr. HOLTZ-EAKIN. I think accountability follows transparency on the part of both those being regulated and the regulator. So the degree to which the regulatory oversight process is transparent and made as clear as possible to all parties-the regulators, those regulated, and the Congress-will help accountability more probably than any other single factor, the observability of the actions of both parties. If I had to pick one thing, I would point to that.

Comparability across regulatory agencies is useful as well, so that in the same way that competition in private markets allows comparison shopping, having the same accounting standards and disclosure standards and being able to observe differences

across

Senator ALLARD. I would like to have both of you respond to this question. How do we know you, the regulator or regulators, have established a reasonable budget? If it does not go through the appropriation process? Any of you who would like to respond to that.