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 entities— I 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? 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 toSenator 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 what the appropriate capital requirement should be, given the risk involved. Senator CARPER. Do you see that as a compromise between one or the other? Is that a reasonable compromise? Mr. WALKER. I see it as a reasonable and prudent course because the fact of the matter is, Congress may want to provide minimums. Congress may want to provide criteria or standards that the regulator must consider. Congress may want to assure that there is a regulatory process with appropriate transparency that the regulator must follow in setting these capital requirements. But I believe that the regulator is in the best position to make informed judgments, including exercising tradeoff considerations between mission goals and safety and soundness considerations. Senator CARPER. Obviously, the Fannie Mae and Freddie Mac are a different breed of animal than the Federal Home Loan Banks, and with that in mind, how should we and how should this independent_regulator approach the regulation of the Federal Home Loan Banks? Mr. WALKER. Presumably, this single regulator would be responsible for overseeing all of these entities. It would be Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Presumably they would all be subject to a minimum capital requirement, but that the regulator would, based on facts and circumstances basis, be able to decide what the appropriate capital requirement would be for each type of entity. Tom, I would ask if you want to comment. Mr. MCCOOL. Again, the point would be that you would set capital requirements that were based on different types of risks and we know that the Federal Home Loan Banks have different types of risk than Fannie and Freddie, but they also have similar types of risks; it depends on the activity. Some of the banks do different things than other banks, and so even within this system, the Federal Home Loan Bank System, there are different types of activities that would require different capital depending on the risk level. The same principles would apply across the Federal Home Loan Banks and Fannie and Freddie. Senator CARPER. Thank you very much. Chairman SHELBY. Thank you, Senator Carper. STATEMENT OF SENATOR LINCOLN D. CHAFFEE Senator CHAFEE. Thank you, Mr. Chairman. Mr. Walker, you have testified that there should be some kind of hybrid oversight, and in the second panel, Mr. Rayburn is going to testify that he believes that the Department of Housing and Urban Development is the appropriate agency to regulate the mission of Fannie Mae and Freddie Mac. What is the best argument you could use to convince Mr. Rayburn that it is better to have a hybrid? Mr. WALKER. My view is that the Department of Housing and Urban Development clearly has a stake, and they clearly need to be involved. I believe that the hybrid option is one way to help assure that they will be involved, that they will have a seat at the table, and at the same point in time, recognizing that one has to balance the mission with the safety and soundness issues, and that is the way to get it done. That is my personal view. Senator CHAFEE. Thank you. My other questions have been asked already, and that is the only one I had, Mr. Chairman. Thank you. Chairman SHELBY. Thank you, Senator Chafee. STATEMENT OF SENATOR ROBERT F. BENNETT Senator BENNETT. Thank you, Mr. Chairman. As we go through these hearings, the issues become clearer, and I congratulate you for your usual job of being very thorough in this but moving toward a goal. And I think it is pretty well summarized, General Walker, by your comment that we have the mission issue, and we have the safety and soundness issue. We want to be sure that the regulator keeps everything safe and sound, but not in such a way as gets in the way of the mission. Senator Sarbanes talked about how successful we have been-the most successful of any nation on Earth in stimulating homeownership by virtue of this structure we have built-and we do not want to damage that. Senator Sununu made reference to the savings and loan crisis. I came to the Senate in the midst of that crisis and had some period of time outside the Senate where I watched the regulators close down sound S&L's as well as failed S&L's in their zeal to make sure that everything was safe. And there were shareholders who lost their life savings and viable businesses that were shut down in the zeal of the Federal regulators to make sure there were not anymore loan losses. And we saw an example of that at the back end, which I saw when I came to the Senate in two waysnumber one, when they started liquidating all of the things that they took over, they found that a lot of them were worth a whole lot more than they had thought, and therefore, the Government got a lot back-the shareholders were out and injured, but the Government seized these things-"seized" is not the proper legal word, but it is in effect what happened-in an effort to get safety and soundness, shutting down, and then having good assets as they came around to liquidate them, and the S&L final bill was not as big as projected because the Government had all those assets. And then, the other aspect of it was financial institutions in that period, when I was just coming on the Banking Committee, were reluctant to loan because they saw how badly beat up people were when they took any kind of risk-in the name of safety and soundness you cannot do that—and we had problems where we were saying you have to get some liquidity into the economy to get it going. And it took a year or more before banks began to raise their heads enough to say, "We will start to make some loans again, but we are fearful from the reaction of the regulators." I give you that history because that is basically what you are talking about. If we decide that safety and soundness is the holy grail, we can tighten this thing down to the point that no more loans are made, and yes, your money is safe-it is all sitting there in Government securities rather than in loans-it is safe, but we are not fulfilling the mission. So as we hold these multiple hearings, we come more and more to that point-how can we assure safety and soundness without being so paranoid on that subject that we shut down the mission and ultimately damage the benefit to society that these groups are doing. There are a number of issues here, and you have talked about that one, but I want to introduce two more and just get your reaction. You say these are public companies, which in the case of Fannie and Freddie, they are. The Federal Home Loan Banks are not. So that becomes an additional wrinkle that a regulator has to deal with. Furthermore, the Federal Home Loan Banks are so structured that there is a joint and several liability situation built in. All of the focus has been on the implied Government guarantee. I still do not understand what that is. It is either a guarantee or it is not, and if there is an implied guarantee, where do I go to collect the implied guarantee on an investment that I have that went bad. To which window do I show up and get cashed in if I have an implied guarantee that my investment is okay, but there is nothing in writing? But okay, are we talking about the implied guarantee for Fannie and Freddie, but you have joint and several liability, which is in stone for the Federal Home Loan Banks? The SEC obviously has a role to play in a publicly traded company like Fannie and Freddie, but what does the SEC have to do here when you bunch in the Federal Home Loan Banks? Talk about that mix for a little while. Mr. WALKER. First, the implied guarantee. Let me start with that, since you mention it. There are a lot of entities that the Federal Government is involved with that do not have express guarantees by the Federal Government. They are not backed by the full faith and credit of the U.S. Government. One example is the GSE's. Another example is the PBGC, the Pension Benefit Guaranty Corporation. Its insurance system is not backed by the full faith and credit of the U.S. Government. Implied guarantees I think presume something that Senator Hagel talked about, this "too big to fail" concept, that whether there is a legal commitment or not, from a practical standpoint, many people speculate, maybe rightly, maybe wrongly, they speculate that if something really bad happens, that politically, there would be a move to step in and that therefore, that is the "implied guarantee." It is not expressed, it is not a legal commitment. Senator BENNETT. The mix of the GSE's, Freddie, Federal Home Loan Bank, joint and several liability, SEC, public company, nonpublic. How does that all work out? Mr. WALKER. Thank you, Senator, for refreshing my memory. I think we have to look at each based on the facts and circumstances. You are right that the Federal Home Loan Banks are cooperatives. They are not public companies. So therefore, I think having them subject to SEC regulation is obviously not the issue. On the other hand, as it deals with mission, safety, and soundness, it seems that there are a lot of common denominators that a single, integrated regulator would be able to consider and apply |