Mr. FALCON. I think what would weigh heavily on my mind is the fact that what powers you give us can also be taken away. If we abuse the authority that you would give us at OFHEO to set our own budget outside the appropriations process, and we abuse that authority by not being responsible with how we set our budgets, then you would have every opportunity to put us back in the appropriations process. But our budget process would be very transparent, and our assessments would be based on a regulation that would be set in formula, would be predictable to the companies that we regulate, and they would not be set without their input through the regulatory process. Senator ALLARD. You imply in your comments that somehow it is always easy to get legislation through the Senate. It is not. [Laughter.] How is it that we have, again, I come back to accountability, and Mr. Korsmo, maybe you want to speak on that. Mr. KORSMO. I think Dr. Holtz-Eakin is right. It is the transparency of the process that is significant, and that is why one of the things we have done in the last 2 years at the Finance Board is to adopt the budget in an open meeting. Previously, it was done by notational vote. One year it was adopted by fiat of the chairman. I think the assurance of accountability that lies at least in the structure of the current Federal Housing Finance Board, besides the obvious element of transparency is the fact that the 8,008 financial institutions who are members of one or another of the 12 Federal Home Loan Banks and who pay those assessments ultimately, I suspect you would hear from them if they thought our level of assessment was inappropriate. Senator ALLARD. I am going to move on-my time is about ready to expire. Mr. Chairman, if I may just briefly Senator BENNETT. Does anyone else have an additional question they would like to ask? Senator SARBANES. Yes, but why do you not Senator BENNETT. Why don't you go a little bit over time. And I have one additional question. Senator ALLARD. Then I do not have any questions. That will take care of it for me. So we have divided responsibility. How do we get communication channels open so regulators can communicate back and forth, and maybe if you all, Mr. Falcon and Mr. Korsmo, would talk about that a little bit. Mr. FALCON. It does occur through regulatory agencies. Our examiners are part of an interagency examination council, where they meet regularly to discuss evolving benchmarks, evolving regulatory practices, and best practices at the different entities that we all regulate. That occurs I think at different type of program levels within the agencies. It certainly, as issues come up that are of mutual interest to myself and the chairman, we certainly discuss those with each other. Mr. KORSMO. I think that is one limitation under which we operate that could be corrected. Our examiners do not belong to FFIEC, Federal Financial Institutions Examination Council. I think that is a shortcoming. The ability for us to participate in that process would be very important, particularly the opportunity to interact. with other examiners of large financial institutions. Senator ALLARD. So this would be to your advantage then in that respect, to be brought in with Fannie Mae and Freddie Mac with a Treasury regulator. That would give you an— Mr. KORSMO. I think that is a larger issue, Senator. A simpler approach to it would just be to make the Federal Housing Finance Board a member of FFIEC, which it is not today. Senator ALLARD. I see. Thank you, Mr. Chairman. Senator BENNETT. Thank you. Senator Sarbanes. Senator SARBANES. Mr. Korsmo, you have been increasing the budget, but you could set the budget at the figure that you thought was necessary in order to adequately regulate, could you not? Mr. KORSMO. We could. Again, I will mention that in the 20 months I have been there, what we have tried to do is proceed in a deliberate, disciplined, and orderly fashion. One of the things Senator SARBANES. I understand that. I was prompted to ask you that question by your response to Senator Allard, saying that your member banks, you would presume, would protest if you were taking the budget up. But there is a conflict there, is there not? You are the regulator. If you do not think the budget is adequate you need to make it adequate whether they protest or not, do you not? Mr. KORSMO. That is absolutely correct, sir, which I think you will see reflected in the budget for fiscal year 2004 where we have made a fairly dramatic increase. Senator SARBANES. All right. I wanted to ask both you and Mr. Falcon this question. If an independent regulator were to be set up, perhaps not in the Treasury, or even in the Treasury, I mean wherever, should it be a single person regulator or a multiperson regulator, and why, or does it make any difference? Mr. FALCON. My preference would be for a single head of the agency as opposed to a board or commission structure. I have not had experience being the chairman of the board, regulatory agency run by a board, but I can tell you from my experiences as a single head of an agency that it provides me the ability to take quick and decisive action as necessary without the need to consult with a board. It provides me to clearly set the mission of the agency. It allows me to make sure that all the policies are consistent with those as in my best judgment I think are appropriate. Now, granted, you can have some of that with a board structure as well, but I think just as far as the ease in running the agency, the administrative functions, as well as setting policy, I much prefer a single head of an agency. Mr. KORSMO. As Director Falcon has only had the experience of the single member or single director institution, I have only functioned with a board. There are certainly limitations inherent, and he has outlined them, in functioning with a board. The flip side of that of course is there are certain advantages I think that are inherent in having five individuals who come from different backgrounds, different perspectives, the opportunity to participate in the decisionmaking process. If I were to construct an administrative process for the Finance Board, would I structure it precisely the way it is now? I am not sure that I would. But again, it is the only paradigm I have experienced. So, I would say it certainly works. Senator SARBANES. Thank you. Chairman SHELBY. [Presiding.] Thank you. Dr. Holtz-Eakin, your testimony indicates that when the GSE's hold more mortgages in portfolio the risk faced by the GSE's may be increased. You also indicate in your written testimony that this activity has increased over time. What are some of the possible explanations for the shift in activity by the GSE's, and what can you tell us about how the GSE's have managed the risk. Mr. HOLTZ-EAKIN. I can only speculate on the ultimate motivation for shifts in portfolios. The result is that by holding more risk there is a greater rate of return to these activities, and one would expect that to be reflected in return on equity, for example. The degree to which that risk is managed is very hard to quantify. Net positions on hedges and derivatives are very difficult for even the best examiners to keep up with on a day-to-day basis. It is one of the challenges that would face any regulator, and for that reason, quantifying the management of that risk is hard. The bottom line is, however, they have earned higher rates of return on equity than have comparable private-sector financial institutions, and that typically is associated with greater risk. Chairman SHELBY. To what extent is it necessary to achieve liquidity in the housing finance markets, to have the GSE's hold mortgage or MBS's in portfolio? Mr. HOLTZ-EAKIN. I do not think that is a central part of achieving liquidity. Financial markets will price the attributes of securities, not the names on them, and the risk characteristics—the interest rate risk, the prepayment risk-have little to do with who has actually got its name on the securities. For the Nation as a whole, there will be an outstanding stock of mortgages at any point in time, and the bearing of that risk is typi cally a voluntary action in private markets. The GSE's shift some to the taxpayer in a slightly different fashion. Chairman SHELBY. Mr. Falcon, you have indicated that you believe the new safety and soundness regulator should have program approval authority. Do you believe this would inhibit the GSES' ability to meet their mission of expanding homeownership? Mr. FALCON. I do not think it would. The authority would not be used in a manner to inhibit their ability to fulfill this affordable housing mission. In fact, as we have performed our regulatory duties, because we have some role in charter compliance presently, where we see a clear violation we will step in and tell the Enterprise that is not permissible. And as we put our risk-based capital standard in place, we did that in a way that did not provide any disruption to the company, it was a smooth implementation. And they are meeting the standard now. I think it is more a necessity for the risk for the safety and soundness regulator to be able to ensure that the companies are in compliance with the charters and that none of their activities are under a cloud. Chairman SHELBY. You also suggest a mechanism to ensure that the new regulator solicit and consider all views. How would such a process work in practice, just briefly? Mr. FALCON. I think what would be beneficial is that when the agency decided that there was an activity that needed to be reviewed for purposes of charter compliance, that it should put out a notice to all interested parties that the agency is considering that activity, and ask for comment from anyone who is interested about whether or not in their view the activity is or is not permissible, and the benefits and the downsides of the activity. Chairman SHELBY. Doctor, as you know, the minimum capital threshold of 2.5 percent that Fannie and Freddie are subject to is often compared to the 4 percent minimum capital standard that banks and thrifts must meet. Fannie and Freddie-and they have done it here that they do not need to hold as much capital as banks and thrifts because they pursue lower-risk activities, which there is some truth to. How would you respond to this assertion? If a 2.5 percent threshold was appropriate in 1992 how should the Congress evaluate whether it remains the appropriate threshold today? Mr. HOLTZ-EAKIN. I think there are two types of responses to that. The first is that I think the record is quite clear that the overall credit risk pursued by the GSE's is, in fact, relatively modest. However, that is only a narrow component of the overall types of risks that I outlined in my testimony. Judging the adequacy of capital standards against those other risks, which are, in fact, shared by the private sector, is probably a more fruitful way to go. In revisiting the minimum capital requirements, it is useful to keep in mind that one part of the purpose of those capital requirements would be to ensure not just the institutions but the overall impact of those institutions on financial markets against large disruption. That is a role that regulators should have a keen eye toward and may affect the decision on capital requirements. Chairman SHELBY. Mr. Korsmo, the Finance Board supports requiring each Federal Home Loan Bank to register with the Securities and Exchange Commission. I agree with enhancing disclosure, but I am not sure that all the appropriate issues have been addressed here. My question to you is: How does the Finance Board propose to address certain unique structural factors in the Federal Home Loan Bank System, such as joint and several liability of the system? Mr. KORSMO. That is an excellent question, Mr. Chairman. And our view on that has been that the best way to address those questions is to have the questions resolved between the 12 potential registrants and the SEC themselves. At least 5 of the Banks have been actively engaged in those discussions. There were certainly any number of threshold issues that we recognized that the Finance Board is having to have some successful resolution in terms of their accounting practice prior to moving ahead. I think we have made sufficient progress, that the final progress needs to be made between the staff of the SEC and the staffs of the 12 potential registrants. Chairman SHELBY. Senator Corzine. Senator CORZINE. Thank you, Mr. Chairman. Let me just follow on on this joint and several concept. Do you have joint oversight of the consolidated balance sheet? Do you look at balance sheet and the risk-based capital standards? Are they applied on a consolidated basis? Mr. KORSMO. I understand that joint and several liability only applies to consolidated obligations. I guess the short answer to your question is yes. Senator CORZINE. So you look at the minimum capital standards and the risk-based capital standards for the overall balance sheet even though the joint and several only relates to the Mr. KORSMO. No, no. I am sorry. Senator CORZINE. You look at the individual unit banks. Senator CORZINE. I just have a question then. The main financing technique for the Banks is through the consolidated borrowing debentures. One last question that I had. Mr. Falcon, I think I used the term "mind boggling" last time when I talked about a $1.5 to $3 billion estimate, under reported earnings, and that seemingly has grown from that $1.5 to $3 to $4.5. Are there any obvious explanations on the size of what moved us out of that range, and when do we feel that a full accounting for the difference in Freddie Mac can actually be explained? Mr. FALCON. The process is on track to be concluded sometime in mid-November, and so they will then be issuing statements, assuming everything goes as planned. That is just the magnitude of which earnings were moved into future time periods, rather than being recognized in the earlier time periods if the proper accounting rules were utilized. It is just a reflection of the cumulative impact of all the different transactions that we are engaged in to try to smooth out these earnings over time. Senator CORZINE. Was there a standard procedure that was used that was used to move forward earnings? Mr. FALCON. There was a wide variety of different types of transactions. Senator CORZINE. Pardon? Mr. FALCON. There was a wide variety of different types of transactions. Senator CORZINE. It was not just one kind. Mr. FALCON. Right, right. Senator CORZINE. It was not a generic methodology. Mr. FALCON. No. Senator CORZINE. Thank you. Chairman SHELBY. Senator Bennett. Senator BENNETT. Thank you, Mr. Chairman. Two quick questions. Simply the terminology that has been used around here. There has been reference to the taxpayer subsidy. Subsidy usually means that if it is not done, money ends up in the Treasury. Is there a suggestion that if the GSE's were eliminated there would be an extra $10 billion in the Treasury? Mr. HOLTZ-EAKIN. The nature of the subsidy is the lower borrowing costs to the GSE's and the budgetary reflection of that is the low probability, over long periods of time, that there would be an event which would place the taxpayer at the risk of actually |