Funding Process Independent boards have advantages and disadvantages_compared to both the OCC/OTS model and to a less autonomous bureau within Treasury. One strength of an independent board is that budgets set by action of the Finance Board, for example, in public meetings provide a suitable degree of accountability in resource allocation without compromising independence through Congressional or OMB review. Capital Regime The minimum leverage requirements and risk-based capital requirements now in force for FHLBanks appear to be appropriate. Importantly, the Federal Home Loan Bank Act permits the Finance Board to increase or tailor these standards if experience demonstrates a need. SEC Registration Only through conservative management and superior transparency and governance will all 14 housing GSE's maintain the highest measure of market confidence. I believe superior transparency requires that each FHLBank commit to voluntarily meet the quarterly and annual financial reporting requirements of Section 12(g) of the Securities Exchange Act of 1934, as administered and enforced by the Securities and Exchange Commission (SEC). SEC registration and disclosure will enable markets to place greater reliance on and maintain greater confidence in the balance sheets, business prospects, and corporate governance of the FHLBanks. That is why, at its September 10, 2003, meeting, the Finance Board unanimously adopted and subsequently published for comment a proposed regulation requiring FHLBank 1934 Act registration. Office of Finance Before closing this discussion of the possible or feared effects of housing GSE regulator reform on the funding of FHLBanks, I must alert the Committee to a question requiring considerable study before attempting any transfer of responsibility for administration of the FHLBank Act. The Act ratified the Federal Home Loan Bank Board's establishment of the Office of Finance (OF) to issue consolidated obligations (bonds and notes) on behalf of the FHLBanks. Several years ago, the Finance Board devolved authority over management of the OF to a board of directors appointed by the Finance Board. The OF has also been assigned the task of compiling and issuing combined financial reports for the 12 FHLBanks. But OF is an unusual corporate posture. It is not incorporated and has no balance sheet and no executive control of any FHLBank. OF instead acts as an agent for the FHLBanks and is the "name and face" shown to capital markets-which are not offered obligations in the name of any specific FHLBank, but rather "System" obligations issued through OF and backed by the joint and several liability of all 12 FHLBanks. Understanding Treasury's apparent wish to avoid providing any reenforcement of the perception of an implied taxpayer guarantee behind housing GSE debt, Treasury's views should be included in determining whether and how to shift authority over OF to Treasury. Conclusion Legislating the best set of tools and best structure for housing GSE supervision is an area of economic and housing policy that must be addressed. Before again locking into statute a system of supervision for some or all housing GSE's that is not world-class, policymakers from Congress, Treasury, HUD, and all 14 housing GSE's should begin the more comprehensive charter reform debate outlined above. That comprehensive reform debate should sort out-70 years after creation of GSE's and long-term amortizing mortgages-the most constructive role for housing GSE's in the mortgage finance marketplace of the 21st century. The questions policymakers should consider asking include: • What is the right level of competition between housing GSE's and other mortgage financiers? • What is the right level of competition among the housing GSE's themselves? • What is the right level of risk to the taxpayers in proportion to the benefits the housing GSE's confer on the Nation's housing finance system? Once a coherent national policy clearly outlining Government and private roles in the future is in place, all parties to the debate will be fully equipped to design a world-class supervisor able to evolve along with housing GSE's appropriately sized and appropriately directed to best support but not interfere with the markets of to morrow. I know of no immediate or imminent safety and soundness or liquidity imperative forcing us to do the job any way but the right way, and I think everyone is aware the stakes are high if the result is muddled. I suggest, therefore, that the housing GSE reform effort move in a logical, deliberate manner to define the roles Freddie Mac, Fannie Mae, and the Federal Home Loan Banks should play in a continually innovating mortgage finance market, to define the appropriate risks to assume in the institutions fulfilling those roles, and then to determine how best to regulate the roles and risks and innovations that result. Again, thank you for the asking me to speak to you today and for the attention this Committee gives to homeownership, housing affordability, and housing GSE issues. APPENDIX Testimony of John T. Korsmo, Chairman, Federal Housing Finance Board, Before the Senate Committee on Banking, Housing, and Urban Affairs October 23, 2003 Initiatives at the Federal Housing Finance Board to improve oversight For most of their history, the Federal Home Loan Banks were overseen by the Federal Home Loan Bank Board. That agency had a mixed mandate to help operate the Banks, to regulate the Banks' owners - federally insured thrifts - and to promote the Federal Home Loan Banks and thrifts. Congress sorted out this puzzle with the passage of the Financial Institutions Reform Recovery and Enforcement Act (FIRREA) in 1989. Nevertheless, in a 1998 report, the General Accounting Office (GAO) found that the Federal Housing Finance Board - nine years after its creation – remained inadequately focused on safety and soundness supervision and too closely involved in operating the Banks, and at times appeared to be a cheerleader for the Banks, rather than an arm's length regulator. Upon becoming chairman in December 2001, Chairman Korsmo determined these problems still existed and had to be corrected for the Finance Board to effectively oversee the Federal Home Loan Banks and Office of Finance for safety and soundness and achievement of their housing finance mission. Just one example demonstrates this point: At the time of the Chairman's appointment, the Finance Board had only eight bank examiners on staff to review and supervise a dozen financial institutions with, at the time, more than $700 billion in assets, more than $30 billion in capital, and some $650 billion in outstanding debt. Yet, at the same time, the agency also had eight people in its Office of Public Affairs. The relative allocation of resources simply did not meet the agency's statutory mandates. In addition to being understaffed, the examination function insufficiently focused on the Banks' risk assessment processes and the Banks' internal control systems. Such shortcomings had been identified in the 1998 GAO report on the Finance Board's examination program. These circumstances called for an immediate and vigorous response, beginning with the recruitment of new leadership for the agency's Office of Supervision. Following a national search, the Finance Board brought on a new director and a new deputy director of supervision, who between them have 40 years of regulatory experience with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC). The agency also hired an Associate Director for Examinations who oversees all our safety and soundness examiners. She has more than 15 years of bank regulatory experience with the FDIC. In addition, a newly hired Senior Advisor to the Director of Supervision to provide support to the Risk Modeling and Risk Monitoring Divisions. That Senior Advisor possesses some 30 years of bank supervision, capital markets, and capital regulation experience with the Board of Governors of the Federal Reserve System and the Office of Thrift Supervision. Examiners represent the foundation of the Federal Housing Finance Board's oversight function. The Finance Board has increased the resources available to fortify that foundation, expanding the agency's examination staff to 18 full-time bank examiners as of October. The goal is to have 30 in place by the end of this fiscal year. The examination staff, including the Deputy Director of the Office of Supervision, averages more than 17 years of professional experience in banking, mortgage finance, and bank examinations. All examiners are commissioned examiners or have a professional accreditation, and many have both. (See chart.) In addition to adding highly qualified and experienced examiners to the staff of the Federal Housing Finance Board, the agency has also made a fundamental – and necessary - change in approach in the examination function. The Finance Board is now conducting more thorough, risk-focused examinations, and communicating the results of those examinations more effectively to the Banks. Examinations now recognize that banking - including AAA-rated, GSE banking is a business of managing risks, and the responsibility of bank supervisors is to ensure that the institutions they regulate understand those risks and monitor and control them through prudent risk management practices. To enhance analysis and oversight in the risk management area, two risk units have been established – a Risk Modeling Division and a Risk Monitoring Division. The Risk Modeling Division is responsible for the development of our asset/liability modeling and for monitoring the Bank's internal interest rate risk models. The Risk Monitoring Division pulls together agency data and the Banks' own financial reporting into a risk-monitoring framework. While on-site examinations remain the primary tool of supervisors, the agency now complements exams with off-site monitoring and regular communication with the Banks. The new "Bank Analyst Program" charges a member of the Office of Supervision with following an individual Bank and reviewing monthly and quarterly financial reports for trends and changes, while also keeping abreast of issues in the financial and housing industries to determine their effect on each Bank. The Office of General Counsel has also assigned attorneys who serve as points of contact for the examiners on issues concerning particular Banks. In short, the Finance Board's safety and soundness oversight of the Federal Home Loan Banks has improved dramatically. More work remains to be done, but the Finance Board is a much stronger and more capable regulatory agency than it was as recently as 12 months ago. 1 Accepted position. Starts at Finance Board in October. |