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and other purposes, that it makes sense to have one regulator for these types of entities.

Tom.

Mr. McCOOL. Again, I think that our experience with having a mission regulator without-under a different entity than the safety and soundness regulator, it was not so much that there were clashes, as that the mission regulator in the case of Fannie and Freddie, when it first set its goals in the mid-1990's, did not have much financial experience and did not have much ability to understand what pushing the goals a little higher would lead to in terms of potential risk or potential loss in profit, and I think that is what we think a regulator that understands the whole thing can do and do a better job of.

So our view, for example, is the first set of goals that HUD set were fairly conservative because they were operating without the full knowledge of everything that one regulator could have. Since then HUD has ratcheted up the goals and one could argue that the goals are maybe getting to where they should be, but without seeing the whole picture it is very hard to make that judgment. And we think a single regulator could do that.

Mr. WALKER. If I can come back real quickly, Senator. To me this is an issue like so many issues: It is a combination of value and risk. How can we try to maximize value and manage risk? In doing that I think you need to integrate the mission issues with the safety and soundness issues because there are tradeoffs. We are trying to achieve certain public purposes through these entities, and those need to be considered. But to the extent that you push the envelope too far one way, it can have an adverse effect on the other. So by integrating these issues I think you have a better chance of being able to make more informed judgments on the value/risk tradeoff.

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

STATEMENT OF SENATOR PAUL S. SARBANES Senator SARBANES. Thank you very much, Mr. Chairman. I am sorry I was not here at the outset, and I want to join with others in welcoming the Comptroller General again. We always very much appreciate his appearances and his testimony. And Mr. McCool, it is good to see you again.

Mr. Chairman, I do want to commend you for the very thorough and thoughtful way you are approaching this matter. This is the fourth hearing we have held on this issue. It is a very important issue, and I think we need obviously to build as strong and as thorough a record as we can as we consider moving ahead.

Fannie Mae and Freddie Mac, along with the FHA, have been key players in making the mortgage market in this country the deepest and most liquid in the world, and actually it is the accumulation of housing wealth and the ability of homeowners to tap into that wealth because of the efficiency of our mortgage markets that have been a strong support for our economy.

Most recently it is clear that the economy has been held up by people being able to draw on their housing wealth. So we have to be very careful, as we move ahead, that we do not impinge negatively on the secondary mortgage market to which Fannie and Freddie have contributed so much.

One way to exercise that responsibility is to make sure these institutions are subject to strong, effective supervision and regulation, that they are within a framework that can assure their safety and soundness. I would apply the same thinking to the Federal Home Loan Banks. Of course, there is concern now about the adequacy of the supervision drawn to our attention by Freddie Mac's recent problems.

I do, in fairness to OFHEO, want to say I do think they have responded appropriately, as I see it, to the Freddie Mac problems. They have moved ahead, and I am going to ask the Comptroller General whether they have a view on that particular current issue.

But we do have these important questions as to whether the regulators have sufficient resources, expertise, and authority to provide the effective supervision. We are trying to balance two important goals: Increase scrutiny and more effective regulation, and commitment to the housing mission.

I want to first ask the Comptroller General, what is your view about the adequacy of the housing mission of these institutions? How well is that being addressed? How important is it, and how do we ensure that if it is important that we are adequately addressing it?

Mr. WALKER. Senator, as you know, one of the primary reasons why these are GSE's is to promote homeownership in general, and also among those who can least afford to own a home.

As Director McCool mentioned earlier, Housing and Urban Development has had the responsibility to set those mission goals, and they significantly increased what those goals were, I think in 1998, if I am not mistaken.

I believe, as my testimony notes, that additional guidance might be necessary by this Congress on mission and what is trying to be accomplished. And I think that we have to keep in mind that in the case of Fannie Mae and Freddie Mac, they are public companies, and that therefore those who are on the board of directors of those entities have a fiduciary obligation to the shareholders.

At the same point in time at least the statutory appointees who are being put on the board to protect the public interest, need to pay special attention to the public purpose of these entities, and that more needs to be done in order for them to be able to demonstrate, other than lowering the average mortgage by 25 to 40 basis points, what else is being done and to what extent are these GSE's are adding value above and beyond value that other GSE's are adding, and to what extent these GSE's are doing a better job than non-Government Sponsored Enterprises with regard to mortgage lending. I think there are some very serious issues that need to be explored further.

Senator SARBANES. How would you ensure that the housing mission was being adequately addressed in any structure that is developed here?

Mr. WALKER. That is why I think that you should consider this hybrid model. I really believe that it is important to consider some type of a hybrid model with regard to overseeing the regulator that provides the capability, the credibility, and the ability to look at

both the public mission and also the safety and soundness issues. I believe that could help tremendously, in addition to other items that we laid out in the testimony.

Senator SARBANES. Mr. Chairman, I see my time is up. I have a couple more questions after the others finish.

Chairman SHELBY. Thank you.
Senator Hagel.

STATEMENT OF SENATOR CHUCK HAGEL
Senator HAGEL. Mr. Chairman, thank you.

Mr. McCool, Mr. Walker, thank you for coming before us this morning

I want to begin, Mr. Walker, with part of the exchange you had with Senator Reed regarding the concept of too big to fail

. In your view, have the housing GSĚ's and their relevance to the housing market approached the “too big to fail” position?

Mr. WALKER. Well, first let me say I do not think any entity is too big to fail, but I do think that we have to be careful to make sure that they do not fail because if one of these entities did fail, it would have a significant adverse ripple effect throughout the entire financial markets.

But, Tom, would you agree?

Mr. McCOOL. I agree. I mean that the question of whether something is too big to fail is fundamentally, ultimately a political call I guess is part of it. But to the extent you can keep it from becoming-reduce the prospects of failure by having effective oversight and regulation, that is where we need to focus our attention.

Again, we have not had to deal with a "too big to fail” situation, at least in the financial sector in a while, and we do not know, for example, in the banking sector whether the new rules and procedures put in place by FDICIA will work. We hope they will or hope they will allow a large institution to be at least unwound in an effective way, if not protecting it from failure.

But it is a concern because obviously when entities perceive themselves as too big to fail or are perceived as too big to fail, that has consequences for market discipline.

Senator HAGEL. Following up on your comments, your point about we need to do everything we can to assure that we do not get into a position like that. Would, for example, restricting the types and amounts of assets, be a useful regulatory tool, as we are thinking through possibilities as we start to develop a framework for a new regulator?

Mr. WALKER. I think that comes back to one of the questions that Senator Sununu and others mentioned, and that is, should the regulator have the ability to provide some type of restrictions on the amount or type of assets that they can hold including whether and to what extent derivatives are used to mitigate risk and to reduce risk, rather than to enhance earnings. I think these are things that should be within the portfolio of the regulator within reason.

Chairman SHELBY. Could you elaborate on that just a little bit? I know it is his time, but would you?

Mr. McCOOL. Well, as we know, derivatives can be Senator SARBANES. The Chairman just gave him additional time. [Laughter.]

Senator HAGEL. My time is your time, Mr. Chairman. That is fine.

Chairman SHELBY. Senator Hagel and Senator Sununu both have taken a big interest in showing a lot of leadership in this are, so I think this is important to what you are touching on.

Mr. WALKER. I mean the fact of the matter is, derivatives can be used to mitigate or moderate risk through matching concepts and a variety of other things, or they can, if not properly used, serve to increase risk and volatility. We have seen examples of this in some of the recent failures in the private sector, where activities were being engaged in in order to increase earnings, but at substantial risk. It is important when you are dealing with an entity that is Government sponsored, of which there is a public purpose, that they be allowed reasonable flexibility to engage in certain types of investments and investment strategies, but hopefully, those are designed to moderate and mitigate risk rather than to enhance short-term earnings.

Senator HAGEL. Thank you. With regard to financial transparency—and we have dealt with that this morning in some detail, and there will be more of that exchange—what are your views as to mandatory compliance with prevailing SEC regulations?

Mr. WALKER. My understanding is at least some of the entitiesI think it is Fannie Mae, if I am not mistaken-are voluntarily complying with—Fannie is voluntarily complying with some of the SEC requirements, and Freddie Mac is considering it, if I am not mistaken. These are public companies with significant shareholders with important public purposes, and I clearly believe that the concepts behind increased transparency are ones that these entities need to follow. Whether or not that means that they have to be subject to the same requirements under the 1933 and 1934 Act, there could be some issues with the 1933 Act, which I think the SEC representative can talk about, I think in substance they need to conform with the requirements. Whether or not it is by statute, that is up to the Congress.

Senator HAGEL. So you would say that they really should be mandatory?

Mr. WALKER. I would say they need to enhance their transparency, and one of the ways to do that is to subject them to these Acts.

We have not taken a formal position on this in the past time? I think they need enhanced transparency, and I will not go as far as saying that they should be subject to the Act. That is for Congress to decide.

Senator HAGEL. Would then fair value disclosure be useful?
Mr. WALKER. Yes.
Senator HAGEL. Thank you.
Chairman SHELBY. Senator Carper.

STATEMENT OF SENATOR THOMAS R. CARPER Senator CARPER. Thanks, Mr. Chairman.

Welcome, General Walker. Good morning. Let me see if I understand what you said with respect to how you think the regulatory structure should be organized. Do I understand you believe that

there should be an independent regulator, single independent regulator?

Mr. WALKER. That is correct, Senator.

Senator CARPER. Do you believe that a regulator should be housed within Treasury?

Mr. WALKER. It can either be within Treasury. There is some incremental synergy that could be attained that way, or independently, but we are not taking a position on that.

Senator CARPER. How would you recommend that we go about making that decision? What should we keep in mind as we try to decide?

Mr. WALKER. My personal view is the issues that are the most important are pulling together one single regulator that has responsibility for mission and safety and soundness, making sure that they have the appropriate amount of authorities, the appropriate capabilities in order to get the job done, and I think you can look to other models that are out there as to ones that have been totally independent in how they have worked, versus ones that have been within departments and agencies, and make a judgment based upon that.

My view is, is that the issue that I think most people have talked about is how do you deal with balancing the mission and the safety and soundness issues. The reason that I threw out the idea of the possibility of a board structure is I think that is a good way to do that, and that could be accomplished whether it is within the Treasury Department or not. For example, the Pension Benefit Guaranty Corporation has a board of directors that I think could be built upon, and technically the Pension Benefit Guaranty Corporation is deemed to be within the Labor Department. It has separate facilities. It is within their budget, but in many ways it operates very independently. So look at past experience is what I would say, and what has worked and what has not worked.

Senator CARPER. I want you to talk with us—and you may have already done this, and if you have, I am going to beg your indulgence—but I would like to just pick your brain a little bit if I could with respect to who should be setting minimum capital levels? Should it be a regulator? Should it be something that Congress does through legislation? Talk to us about the pros and cons of doing either.

Mr. WALKER. One of the things we talked about earlier, Senator, is that the regulator needs to have the flexibility to be able to

Senator CARPER. Wait a minute. Before you do that, just preface your response to my question by talking about the importance of the minimum capital levels. Why is it important?

Mr. WALKER. Minimum capital requirements are obviously very important in order to assure safety and soundness. It is one of the most fundamental elements to try to assure safety and soundness. In that regard, one of the things that we had talked about a little bit earlier was the possibility of Congress considering providing minimum requirements. In other words, setting the floor but not the ceiling, providing some guidance that the regulator would use, but allowing the regulator some flexibility to be able to employ risk-based concepts dealing with different entities to determine

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