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Chairman SHELBY. Or large banks.
Senator REED. Or large banks.

Mr. WALKER. Or large banks. Nonetheless, there is a broad-based market perception that the Federal Government stands behind this entity, and that clearly has an impact.

Senator REED. I think your comments are useful because this perception is not exclusive to Fannie Mae and Freddie Mac. As the Chairman points out, I think most people in the market would assume we would not let our largest or second largest bank fail because of the consequences.

Mr. WALKER. That is correct. There are other important entities where the Government would be presumed to step in. Whether or not that will occur one can debate.

Senator REED. Thank you, Mr. Walker.
Thank you, Mr. Chairman.
Chairman SHELBY. Senator Crapo.

Senator CRAPO. Thank you very much, Mr. Chairman.

Mr. Walker, if we were to proceed with legislation that would establish a new independent regulator for both Fannie and Freddie and the Federal Home Loan Banks, it seems to me that one area of obvious difference is the statutory capital structure for the GSE's. Do you have any insight that you could share with us with regard to how we might contend with that difference in the legislation that would be developed?

Mr. WALKER. Tom, I would ask if you have any thoughts on that based on our past work.

Mr. McCool. I think that, again, it is different to have a capital framework written in statute. If you look at OFHEO's capital statute versus the Finance Board or the bank regulators, OFHEO has the one that is written in statute. I think that our view would be that Congress can write a capital standard and put it in the statute, but it would be useful to give the regulator some ability to have the flexibility to go above that minimum in cases where either new risks arise or new situations arise that were not foreseen by the legislation.

Senator CRAPO. So are you saying that we would have the same structure for all entities, or would the new regulator have the ability to have different structures?

Mr. McCool. I believe that, again, the point would be that you want a risk-based capital approach that dealt with the risks that the entities were undertaking, and whether they are Home Loan Banks or Fannie and Freddie, for example, if you combine their reuglation, they would all have the same risks although not in the same combinations. But you would want the same capital to be applied to the same risk.

Mr. WALKER. Senator, I think you may want to have a statutory structure or framework. At the same time, I think it is important for the regulator, as we note in our testimony, to have reasonable flexibility to be able to make judgments about what the appropriate capital requirements should be given the risk involved. And one would have to assess that issue in connection with each of the various entities that they are being regulated. So it would be based

on the substance or the nature of what the relative risk is. If the facts were the same, you would get the same answer. But the facts may not be the same between these different entities.

Senator CRAPO. So how would we have a statutory capital structure but then have the regulatory flexibility? Are you saying we would define the capital risk by statute and then have the regulator determine how to apply that risk?

Mr. McCool. Well, actually, let me back up. It may be that the best thing to do would be not to have a statutory capital structure and to give the regulator criteria for applying capital to risk, which, again, is more or less the way it works for bank regulators. The bank regulators do not have a statutory capital structure, but they are supposed to provide a capital structure that is consistent with the risks that the institutions undertake. So rather than define broad criteria, it might be best to give the regulator flexibility within the context of particular activities to define capital in accordance with the risk undertaken.

Senator CRAPO. Mr. Walker, do you agree with that?

Mr. WALKER. I do. We are saying the same thing in a different way.

Senator CRAPO. All right. Thank you very much.
Chairman SHELBY. Senator Corzine.


Let me just pursue that question. I want to make sure I understand this correctly. You are talking about flexibility with regard to the definition of the risk-based capital rules that the regulator would provide. Are you distinguished between absolute minimum capital requirements and risk-based capital? Or are you underscoring the need for flexibility with one or both?

Mr. McCool. Again, currently there is a statutory minimum for Fannie and Freddie in terms of their leverage ratios or effectively their minimum capital standards. I think that one could put in place, again, minimum capital standards in legislation that were not necessarily risk based, but the point would be you would want to give the regulator the flexibility to set risk-based capital standards that were, again, consistent with the level of risk undertaken by the entities. So that if different entities did similar things, they would face similar capital charges. And if they did different things, the differences would be reflected in the capital charges.

Mr. WALKER. Senator, a different way of saying it you may want to establish the floor, but you may not want to establish the ceiling, and make sure that you have criteria such that the regulator can apply the facts and circumstances to determine what the appropriate capital requirement would be given applicable those facts and circumstances.

Senator CORZINE. I think that is actually one of the difficult judgments that we are going to have to make, and, you know, how do you then figure out what is the appropriate minimum capital standard. It is true, though, that banks operate off of a risk-based system than these more modern regulatory structures that people are trying to appropriate.

Let me ask, are there any clear or are there any objective standards on why one might think that a regulatory agency should be in a group of regulatory elements? I heard you talk about structure and authorities, but you left out synergies. When one would consider the model of it being within the Treasury, one might say that having a stand-alone entity does not allow for the synergies of staying current with the latest financial knowledge base in the same way that you would if you were in a broader organization that had a culture of dealing with regulation or the common use of software and other elements that may be appropriate. You are going to have to build a whole bureaucracy that would not otherwise exist.

Are there objective standards or objective metrics that you would use to justify one versus the stand-alone agency that might be outside of just the structural issues and authorities that you spoke to?

Mr. WALKER. I think there are certain issues, Senator, that have to be addressed irrespective of whether you are within a particular department or agency like the Treasury or whether you are independent. I mean, do you have a critical mass? Do you have the right type of skills and knowledge? Do you have the right type of authorities? Do you have enough credibility, if you will, and capability to get the job done?

I do, however, believe there is a difference between coordination and integration, and if you are an entity that is an independent entity within a larger entity, then the odds are you are going to end up having more ongoing interaction and more questions being asked as to there are opportunities to do things in the same way or in a synergistic manner, and there could be some incremental benefit that could be achieved.

But I think the more important issues are the critical mass, the capabilities, the credibility, and the authorities. Those are the more important issues, I believe.

Senator CORZINE. Did you feel when you looked at OFHEO whether it failed in matching up against or at least was weaker than it would have otherwise been against those criteria, whether structure, critical mass, authorities, and maybe even synergies where there might be checks and balances within the system?

Mr. WALKER. We believe that there would be a significant plus to combine the regulators, to have a single regulator for safety, soundness, and mission, and that that regulator needs additional authorities above and beyond what authorities that OFHEO does not have right now.

Tom, do you have anything to add?

Mr. McCOOL. Again, that part of the issue is that I think we believe that having the Federal Home Loan Banks and Fannie and Freddie in the same entity, being regulated by this entity would create synergies. It would allow you to provide more of a career track for examiners. It could grow from more simple home loan banks, up through more complicated home loan banks, up to Fannie and Freddie, and would allow more cross-matching across various types of expertise within, again, a regulator with more critical mass.

Senator CORZINE. But coming back to that, you get that critical mass by combining the different regulators. Then it is a separate issue as to whether or not you get any additional synergy-you get

synergy that way. You get critical mass and synergy that way. Then there is a debate as to whether or not you are going to get that much more synergy because it happens to be within a department or agency. So the most synergy you are going to get is going to be through combining the potential regulators into one. You could get some more by having it within a department or agency.

Thank you.
Chairman SHELBY. Senator Sununu.
Senator SUNUNU. Thank you, Mr. Chairman.

Mr. Walker, as I understand it, the GAO has studied this issue and issued reports in 1991, 1993, and 1997. I might have missed one in there. In each of those cases, aside from the proposal that you spoke to Senator Reed about regarding the board structure and the directors that you have included this time, in each of those studies is it correct that the GAO, whoever the Comptroller happened to be, has recommended an independent regulator that has responsibility for overseeing safety and soundness, capital standards, the various business activities that these GSE's are involved in and regulating the mission? Have all of those things been consistent in all of these studies?

Mr. WALKER. Yes, Senator. Those are consistent recommendations throughout.

Senator SUNUNU. And your recommendation is consistent with all of those other studies? It is not just because you are afraid to be different, is it?

Mr. WALKER. No. It is consistent, and in fact, we have had a number of serious subsequent events that have occurred since those reports, both within the public sector and the private sector that would lead me to believe it is even more important.

Senator SUNUNU. I appreciate that. I am being a little facetious given your statements recently about other budgetary matters. I do not think anyone can claim you are not someone who is unwilling to speak their mind. And I appreciate that. I think that is extremely helpful for this Committee to have someone that is willing to at least step up on a somewhat political issue like this and speak their mind.

You mentioned receivership and your feeling that some provision addressing receivership might be helpful or valuable. It is my understanding that this model was used in the S&L bailout and restructuring. Did it work reasonably well as a mechanism for the S&L crisis?

Mr. WALKER. Based on my experience—and I want to ask for Tom to comment because he was at GAO at the time I believe it had mixed results with regard to what happened with the S&L situation.

Mr. McCool. Right. But I think a lot of it had to do with when receivership was imposed as much as whether it was receivership versus conservatorship. I think what part of the issue has been, and to some extent still is, is the question of when you close down an institution. I think once you decide to close down an institution, receivership has a lot of advantages compared with conservatorship, but the question about when you make that call has always been an issue, and as I said, we have seen instances recently where it still is an issue.

Senator SUNUNU. I mentioned the consistency in these evaluations by the GAO going back now more than 12 years, uniform recommendations that all the capital standards, all the business activities, all the mission-related activity as well, be included under an independent regulator.

What about the issue of the type and the amount of nonmortgage-related assets held by the GSE's; should that fall within the scope of the independent regulator, and does your report include specific recommendations?

Mr. WALKER. We do reference the fact that that is an area that would be subject to oversight by these new independent entity. How does it relate to the related risk and the public purpose for these entities? Not a per se preclusion by any means, but it is something that I think the regulator has to be able to consider.

Senator SUNUNU. Something that they should be able to con-sider.

Senator Reed talked about or raised the concern of politics, and I think that is important, in the board structure, cabinet secretaries, Treasury, HUD, which you mentioned would naturally have an interest and an expertise here. But there are natural concerns because those are cabinet positions. In previous reports the GAO has recommended that the Chairman of the Federal Reserve be part of the board. Having the Chairman of the Fed as part of the board would seemingly address many of the concerns raised by Senator Reed. Is that a recommendation that you would stand by or support?

Mr. WALKER. I believe that is something the Chairman of the Federal Reserve may or may not want to do, but that would clearly be a positive step.

I think the other thing, Senator, that one might want to consider–because I am on another board with the Chairman of the Federal Reserve right now dealing with the airline industry—the other thing you may want to consider is there are other board models out there that are hybrids. In addition to the one that I mentioned, I was a trustee of Social Security and Medicare for 5 years, and on that you have three cabinet secretaries and you have two people from the private sector who meet certain experience requirements. So in addition to the Chairman of the Federal Reserve and potentially others, you may want to think about whether or not you have some public members who are not Government employees.

Senator SUNUNU. One final question about the mission. GAO, I think in the 1997 report, highlighted or discussed that when mission and safety and soundness regulations are performed by different regulators, even with some coordination there is the potential for the GSE's to try to pit the regulators against one another. Could you talk a little bit about examples, the specific examples where this had occurred, and whether that was behind your recommendation that it all be included in the new regulator?

Mr. WALKER. I will make a comment, then ask Tom for some specific examples. There is no question that to the extent that you have different regulators and they have different rules and different authorities, that there is going to be some human tendency to try to do that. That is just human nature. Our view is that for critical mass, for credibility, for capability, potentially for synergy

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