providing funds directly was done with the Federal Farm Credit System in the 1980's. Senator BENNETT. But there is not a subsidy like a farm subsidy that we can quantify every year. If we were to eliminate the GSE's, presumably there would be an elimination of risk, but there would not be an immediate amount of money showing up in the Treasury if we eliminated the GSE's. Mr. HOLTZ-EAKIN. There would not be a cashflow to the Treasury, but the situation is similar to credit reform, where we could reflect on the budget the implicit cost of that risk and take account of it in budgetary deliberations. Senator BENNETT. Is there a budget figure for implied risk? Mr. HOLTZ-EAKIN. Not in this area, but in other areas where guarantees are provided by the Federal Government credit reform does allow for an explicit entry in the budget for the value of that guarantee. Senator SARBANES. Yes, but the more you talk that way, the more explicit the guarantee becomes and everyone runs around saying this is not an explicit guarantee and they are required to state it absolutely. Then everyone comes along here, it is-I mean you are sitting there at the table taking an implicit guarantee and making it explicit, are you not? Mr. HOLTZ-EAKIN. I am not. I am not in any way advocating a particular budgetary treatment. I am trying to explain that to the extent that it is perceived to be a guarantee, it has consequences for the real provision of resources and perhaps for the Government. Senator BENNETT. There is no cashflow subsidy. Mr. HOLTZ-EAKIN. Not at present. Senator BENNETT. The only other question. We talk about taxpayer risk, and I admit there is an implication of some taxpayer risk, but isn't the first line of risk the shareholders? They stand to lose everything if the GSE's fail, do they not? Mr. HOLTZ-EAKIN. Absolutely. And the empirical question is the degree to which that line of defense is adequate. As was mentioned, I think in Mr. Falcon's opening remarks, capital is the bulwark against which you would place these risks, and the question is whether the capital is adequate. Senator BENNETT. And if the capital is attracted to the GSE by the noncash subsidy and the risk is borne by the capital, maybe this is a good idea. Mr. HOLTZ-EAKIN. The outcome is that the GSE's, as compared to simliarly rated private sector entities, have less capital. There is less there, and there is a higher rate of return because of this lower capital. Senator BENNETT. Now we get into the Chairman's question about the reason there is less capital is that there is less risk because they do not issue credit cards, they stay with mortgages. And that is another philosophical argument. I simply wanted to be sure I understood the terms we are using here and when we are talking about subsidy we are not talking about a cash subsidy, we are talking about an implied subsidy, and when we are talking about risk, it is true that the risk is all held by the shareholders, and there is an implied risk for tax holders, but again, we cannot truly quan tify it until we see how much of a disaster the shareholders have to absorb. Mr. HOLTZ-EAKIN. The degree to which it can be quantified, we have taken one approach in our past studies which is to compare borrowing costs of comparable private sector entities with the GSE's. There is another approach basically called an options value approach-where by you could, in the same way, try to quantify the magnitudes involved, and if that was something of interest, we would be happy to work with you on that. Senator BENNETT. Thank you, Mr. Chairman. Chairman SHELBY. When we are talking about risk, the 2.5 versus the 4, have there been any studies that any of you know done showing the real risk in the marketplace there? In other words, what is the percentage of losses of Freddie and Fannie compared to an ordinary bank that is into all kinds of other risk? See, they, by statute, are limited to what they can invest in. Is that not right, Mr. Falcon? Mr. FALCON. Yes, sir. Chairman SHELBY. Go ahead. Do you know if there are any studies showing this, if there are risks, and then their risks? Mr. HOLTZ-EAKIN. I think the spirit of the question is what are the outcomes that you can look at. You can look at the default rates and outcomes for comparable private-sector entities. In my testimony, I reference this. Over a 15-year period for comparably rated private sector entities, that rate is nearly 2 percent. Chairman SHELBY. Gentlemen, we thank you for your testimony here today and participating. I apologize for having to leave and come back, but I am Chairman of a Subcommittee on Appropriations that has opened up on the floor, so I will be on the floor a lot today. Thank you. Chairman SHELBY. We will now move to our second panel. All of your written testimony will be made part of the hearing record in its entirety, and if you would take 5 minutes apiece-I know that is compressing your time-to sum up your remarks, we would be very appreciative, and then we will get into the others. Mr. Koch, we will start with you. First, I want to yield to Senator Sarbanes for a statement. Senator SARBANES. Mr. Chairman, I join with you in welcoming the witnesses, but I particularly want to welcome Iona Harrison, who is here on behalf of the National Association of REALTORS®. Ms. Harrison is from Upper Marlboro, Maryland in nearby Prince George's County. She has long been active in her community there. She has played an important leadership role with the realtors, both in the Maryland chapter and nationally, and we are very pleased she is here today, and I am looking forward to her testimony. Thank you. Chairman SHELBY. Thank you. Mr. Koch. STATEMENT OF JOHN D. KOCH EXECUTIVE VICE PRESIDENT AND CHIEF LENDING OFFICER AMERICA'S COMMUNITY BANKERS Mr. KOCH. Chairman Shelby, Ranking Member Sarbanes, and Members of the Committee, I am John Koch, Executive Vice President and Chief Credit and Lending Officer for Charter One Bank in Cleveland, Ohio. I am also Chairman of America's Community Bankers GSE Policy Committee and a member of ACB's board. Many of our members are specialists in mortgage lending and actively involved in the secondary market. Therefore, we appreciate this opportunity to provide our comments to the Committee. ACB has intense interest in GSE regulatory reform for several reasons. We strongly support efforts to improve regulation of all the housing GSE's including the Federal Home Loan Banks to better ensure safety and soundness. We strongly support the secondary market role of Fannie Mae and Freddie Mac and their important housing mission. We particularly note their contribution to our underserved communities, which has been most substantial, but we further note that significant disparities still sadly exist in homeownership rates for low- and moderate-income households in this country. Our members are also substantial stockholders and borrowers in the Federal Home Loan Bank System. For example, my own institution has active relationships with all these entities. Charter One Bank services over $15 billion in home mortgages for Fannie Mae and Freddie Mac. Our Federal Home Loan Bank advances total nearly $10 billion. Our investment in the Federal Home Loan Bank System totals $700 million, which is our largest investment by far. So the safety and soundness of the Federal Home Loan Bank System is of paramount interest to us and to the members and to our bankers members across the United States. ACB recognizes that the legislative situation we face is very fluid. During the House Committee's consideration of this issue, we supported shifting regulation of Fannie Mae and Freddie Mac to a fully funded independent regulator within the Treasury. We also support an amendment to include the Federal Home Loan Banks in that agency. We continue to support both of these concepts and strongly urge you to consider including them in your legislation. It is essential that this new agency be independent. My written testimony details the key elements of independence that are currently provided to other financial regulators at this point in time. If the Treasury can not accept an independent agency within the Department, ACB would consider and support a stand-alone agency. Regardless of location, however, the new agency must also be able to fund itself without going through the annual appropriations process. It must have sufficient resources to get its job done. ACB strongly endorses the Administration's position that the new agency have the authority to review both current and future programs of Fannie Mae and Freddie Mac. For over a decade, HUD has not exercised its current program approval authority. As a result, Fannie Mae and Freddie Mac have engaged in or attempted to engage in activities inconsistent with their secondary market responsibilities. Most importantly, these activities further raise the risk profile of these institutions. New initiatives such as acquisition and development lending underscore this point, that the review process and the authority needs to be shifted into one regulator. This process after all is good enough for all the banks of this country throughout the entire banking system. ACB strongly agrees with the Administration's position that there should be no limit to the new agency's ability to adjust capital requirements for Fannie Mae and Freddie Mac. Let me be clear that we are not proposing that capital requirements be increased at this time, but capital is the foundation for the safety and soundness of our financial system, and must remain a flexible regulatory tool. Without capital authority the new regulator's power is gutted. While supporting the regulator for the housing GSE's, the new agency should administer the unique statutory arrangements that apply to each. The Federal Home Loan Banks are cooperatives, not public companies, and pose different regulatory issues. While acknowledging key differences, we note that the Federal Home Loan Banks, Fannie Mae, and Freddie Mac are all engaged in extensive interest rate management. A combined agency would be better able to supervise these risks. Concentrating all the expertise in one agency would provide good regulatory leverage for analysis of hedging risks, for example, investment concentrations, et cetera. This would be more efficient Government. I wish to again express ACB's appreciation for the invitation to testify to these important issues. We certainly support the Committee's efforts to strengthen the regulation of Fannie Mae, Freddie Mac, and Federal Home Loan Banks. We look forward to working with you as you craft legislation to accomplish this goal. Chairman SHELBY. Thank you. Mr. Torpey. STATEMENT OF DALE J. TORPEY PRESIDENT AND CEO FEDERATION BANK, WASHINGTON, IOWA ON BEHALF OF INDEPENDENT COMMUNITY BANKERS OF AMERICA Mr. TORPEY. Chairman Shelby, Ranking Member Sarbanes and Senate Banking Committee Members, I appreciate this opportunity to present ICBA's views on proposals for improving housing GSE regulation. This is a matter of critical importance to community banking. I am Dale Torpey, President and CEO of Federation Bank in Washington, Iowa. I serve as Chairman of the ICBA's Lending Committee. I also chair the board of directors of the Federal Home Loan Bank of Des Moines. But my testimony today is delivered exclusively on ICBA's behalf. As a general principle, we do not believe the Treasury should direct the housing policy, just as it should not run the monetary policy of our Nation. In our view should Treasury be granted oversight of either Fannie Mae, Freddie Mac, or all three of the housing GSE's, its tax and fiscal policy responsibilities would likely present clear conflicts of interest with housing policy. We also share concerns expressed by others regarding the historical absence of housing policy expertise at Treasury. Since the Gramm-Leach-Bliley Act of 1999 widened membership in the Federal Home Loan Bank System and expanded the categories of eligible collateral for Federal Home Loan Banks' advances, thousands of community banks use advances as a competitive and flexible funding tool. Our ability to continue to use this increasingly important funding source is crucial to safe and sound asset liability management and to provide lendable funds for our communities. Similarly, the fact that Federal Deposit Insurance coverage levels have not increased since 1980 has given communities banks further incentive to turn to FHLB advances as a stable alternative funding source. ICBA continues to believe that Federal Home Loan Banks should be regulated by a separate and independent agency, a status the existing Federal Housing Finance Board already enjoys. Under FHFB's regulatory's guidance, the FHLB's have a near impeccable record of providing well collateralized advances to thousands of institutions. The FHFB has and continues to take important steps to upgrade its examination and supervision capacities. ICBA has long supported independent financial regulatory agencies such as the Federal Reserve, FDIC, and the SEC. Earlier this month the ICBA Board of Directors discussed FHLB regulation at length. Our board voted unanimously to oppose, including the FHLB's, in any new proposed new Fannie/Freddie regulatory structure in Treasury. Our board did not discuss the concept of a new independent regulatory structure outside Treasury for Fannie/Freddie and the FHLB's, a concept voiced by some in recent days. While not our first preference, ICBA may not oppose the concept of a new independent regulator for all three housing GSE's outside Treasury depending on how the details flesh out. First, the specific regulatory powers of such an agency would have to be determined. We note that the FHFB and OFHEO do not currently have the same powers. Second, the unique ownership, operational, and capital structure and mission of the FHLB's would have to be recognized and preserved. Community banks are significant direct and indirect users of Fannie/Freddie conduits into the secondary mortgage market, and the sale of mortgages originated by community banks into the secondary market increases our liquidity and in turn allows us to make more loans in our communities. The current system has enabled us to reach record homeownership levels and to accommodate consumer refinancing needs in the recent low interest rate environment. We must be careful not to jeopardize this success. Regarding proposals to bring Fannie/Freddie regulation under Treasury, the ICBA reiterates its staunchly held view that any such entity must be politically independent in order to be a world class financial regulator. We strongly urge Congress to ensure that any potential legislation contain appropriate firewalls and independence between Fannie, Freddie, and Treasury's politically appointed policymakers. In closing, the ICBA urges the Committee to carefully and fully consider the issues associated with housing GSE regulation before |