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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.
Senator Chafee.

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.
Senator Bennett.


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 as appropriate involved with the Federal Home Loan Banks versus Fannie Mae versus Freddie Mac.

So there are certain elements that would apply. There are other elements that would not. But from the regulator's standpoint when you are dealing with mission, safety, and soundness, it seems to me there are a lot of common denominators, and there are synergies.

Senator BENNETT. I agree with that, and my time is up, but it just occurs to me that it may well be that if you put the Federal Home Loan Bank boards into this pot, you have to eliminate the joint and several liability arrangement that they currently have and thereby change the structure of them so they become more like the other entities that are in the pot.

Thank you, Mr. Chairman.
Chairman SHELBY. Thank you, Senator Bennett.

Mr. Walker, I have a couple of questions following up on Senator Bennett's questions for the record. One has to do with the organizational structure of the new GSE regulator, keeping in mind the differences among Fannie Mae, Freddie Mac, and as he has pointed out, the Federal Home Loan Banks and so forth.

The other question would relate to corporate governance and the Finance Board. We would like that answered for the record, and we will get this to you in a few minutes.

We have been talking about risk here and mission, safety and soundness. What we are trying to do as I understand it—and I have been on this Committee for 18 years; Senator Sarbanes dates me here but we both sat through the debacle of the thrifts. Senator Bennett came in the middle of it, I believe, on the Committee.

Senator SARBANES. And helped us to straighten it out.
Chairman SHELBY. Absolutely.

But at the same time, what we are trying to do is balance the mission of the GSE's, which we mostly agree is sound—that is, the housing policy for the United States of America and the people, and homeownership

and the safety and soundness of the GSE's as financial institutions.

Is that what we are trying to do?
Mr. WALKER. I agree, to balance those interests.
Chairman SHELBY. Absolutely.

And we have been talking a lot about failures here, but what we are really trying to get at if we create a powerful regulator is to preclude failure, to stay away from failure, in other words, to make sure that these institutions are going to be there for the future.

Is that a fair statement?

Mr. WALKER. That is correct, Senator. We want to prevent a failure, and we want to learn from the lessons of the past.

Chairman SHELBY. How important, Mr. Walker, is it for the regulator, whoever the regulator would be in the future, to know what the models are at Fannie Mae, Freddie Mac, or the Federal Home Loan Bank board—in other words, wouldn't they have to know what is going on there? It is a very complicated situation. They would have to have the personnel to know, and they would have to be hands-on, to know what was going on, so to speak.

One of the problems that I have gathered here is that it was PricewaterhouseCoopers, inside accountants, that brought the Freddie Mac situation to a head and not OFHÉO. I agree with Senator Sarbanes that the leadership at OFHEO since the revelations at Freddie Mac and Fannie Mae have been very diligent.

Go ahead.

Mr. WALKER. OFHEO has not historically had many people with expertise in accounting and reporting issues. They recognize the need to beef up in this area. They are taking steps to do that, and I think that that is appropriate that they do. In addition, in fairness to OFHEO, I will also note that one of the things I mentioned was about the need to have model corporate governance practices. OFHEO has taken steps to try to make sure that at least in the case of Freddie Mac, the CEO is separated from chairman of the board, which is a best practice in that regard, and they are trying to become more active there.

Senator SARBANES. May I

Chairman SHELBY. If I can finish up, Senator Sarbanes, of the securities that Freddie Mac, Fannie Mae, and the Federal Home Loan Bank Board, create and this is the securitization of the whole organization—who owns or buys most of those securities? Isn't it the banks? Don't a lot of the banks, as investors, invest in the GSE securities?

Mr. WALKER. That is my understanding, Senator.
Chairman SHELBY. Is that correct?

Mr. McCool. Yes. They are purchased by mutual funds, they are purchased by banks, but a lot of other entities purchase them.

Chairman SHELBY. Thank you.
Senator Sarbanes.

Senator SARBANES. Mr. Chairman, I just wanted to follow up on the other point.

An independent, assured source of funding for the regulator is a very important aspect of this, is it not? You were mentioning OFHEO's difficulties, but is not that one of them and something that needs to be addressed in any effort to strengthen the regulatory structure?

Mr. WALKER. It is important to assure that they have an adequate amount of resources in order to effectively do their job, and that is one consideration that I think you are going to have to give as to how should they be funded and the means by which they should be funded.

Senator SARBANES. Now, in your report, you point out that the FHFB just had 10 examiners as of about 18 months ago to examine the 12 Federal Home Loan Banks, and they have initiated a program to increase it up to 30. Of course, I think the Comptroller has 20 or 30 people at one or another of the major institutions that they are involved in as I understand it.

So it is really falling way short of what is needed, is it not?

Mr. WALKER. They are clearly going to have to take a look at what they need to get the job done versus the current resources they have, and they are likely to need additional resources.

Senator SARBANES. Do you have any perception that the Federal Housing Finance Board has actually been acting more as an advocate for increasing the powers of the bank system rather than its safety and soundness regulator?

Mr. WALKER. I do not.

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