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Highlights

Highlights of SAC)-04-2697, a testimony before the Committee on Banking. Housing, and Urban Affairs, US. Sonato

Tuesday, February 10, 2004

GOVERNMENT-SPONSORED

ENTERPRISES

A Framework for Strengthening GSE
Governance and Oversight

Why GAO Did This Study
Congress established government
sponsored enterprises (GSE)
Such as Faunie Mac, Frertdie Mac
the FILBank System, and the Fam
Credit System to facilitate the
development of mortgage and
agricultural ending in the bed.
States, Although the federal
government does not explicitly
guarantee the GSES approximately
$4.4 trillion in financial obligations,
the potential exists that the
government would provide
financial assistance in ant
emergency as it this done in the
past. Recent financial reporting
profleras at Freddie Mac have.
raised concerns about the qualty
of the GSES corporate govenance
and resudatory oversight

What GAO Found

GSES should lead by example in connection with governance, accountability,
integrity, and public trust issues. GSEs should strive to achieve model
corporate governance structure, provide reasonable transparency of
financial and performance activities, and adopt compensation arrangements
that focus on both long-term and short-term results. However, GSE
corporate governance has not always reflected best practices. For example,
currently, the Chief Executive Officers (CEO) of Freddie Mac and Fannie
Mac also serve as the chairmen of their respective GSE boards, which is not
consistent with model governance standards that call for officers to work for
an independent board. GAO notes that as part of its regulatory agreement,
Freddie Mac has agreed to separate the position of CEO and the position of
chairman within a reasonable period of time. However, Fannie Mac has yet
to take this step. With respect to compensation arrangements, Freddic
Mac's focus on short-term financial results as performance largets appears
to have contributed to the GSE's recent financial reporting problems.

GSE regulators must be capable, credible, strong, and independent.
However, the regulatory structure for the housing GSES-Fannic Mac,
Freddie Mac, and the FIILBank System—is fragmented with safety and
soundness and mission oversight responsibilities divided among three
regulators. A single housing GSE regulator offers many advantages over this
fragmented structure including prominence in government, the sharing of
technical expertise, and the ability to assess trade-offs between safety and
soundness considerations and certain mission compliance activities, such as
affordable housing initiatives. Although there are advantages of a single
director model for the new housing GSE regulator, GAO believes on balance
that a board or a hybrid board and director might make the most sense to
oversee the GSEs' safety and soundness and mission oversight. To be
effective, the single GSE regulator must also have all the regulatory
oversight and enforcement powers necessary to carry out its critical
responsibilities.

Because of a lack of clear measures, it is difficult for Congress, accountability organizations, and the public to determine whether the benefits provided by the GSEs' activities are in the public interest and outweigh their financial risks. Available evidence and data indicate that the housing GSES have made, in some cases, progress in benefiting homebuyers. For example, it is generally agreed that Fannic Mac and Freddie Mac's activities have lowered mortgage interest rates, although there is debate over the degree of these benefits. However, it is not clear that the housing GSEs' large holdings of mortgage-backed securities benefit borrowers. There is also limited information as to the extent to which the FIILBank System's more than $500 billion in outstanding loans to financial institutions have facilitated mortgage lending.

United States General Accounting Office

Mr. Chairman, Mr. Ranking Member, and Members of the Committee:

I appreciate the opportunity to participate in today's hearing to discuss oversight of the government-sponsored enterprises (GSE), namely Fannie Mac, Freddie Mac, the Federal Home Loan Banks (FHLBanks), the Farm Credit System (FCS), and the Federal Agricultural Mortgage Corporation (Farmer Mac). I note that the GSEs had combined obligations, including mortgage-backed securities (MBS) and other debt obligations, of $4.4 trillion as of September 30, 2003, and, as I will explain in detail later, the potential exists that the federal government may choose to provide financial assistance to the GSEs in an emergency. Accounting and financial reporting problems related to earnings disclosed by Freddie Mac last year have raised several concerns about the company's management. and board of directors as well as the effectiveness of regulatory oversight. that is designed to protect taxpayers from the risks associated with the GSES. Recently reported investment losses at the FHLBanks have also served to raise public concerns regarding the well-being of GSEs. These events prompted Congress to consider the need for meaningful reforms to help strengthen the oversight of GSES. In my view, our past experience in the savings and loan industry, the recent accountability breakdowns in the private sector, and the importance of gaining public trust for regulatory agencies that oversee our financial institutions and our capital markets is directly relevant to the ongoing debate on appropriate regulatory oversight. of GSES.

It is clear that many parties have different views on what needs to be fixed and how to do it. My comments today are intended to frame GSE oversight. issues broadly and provide our views on some of the questions and options that must be addressed to better oversee the GSEs going forward. Although my comments will largely focus on the housing GSES-Fannie Mae, Freddie Mac, and the FHLBank System-given the themes of our discussion today, I will also use examples from the other GSEs to illustrate my points. We look forward to working with Congress to provide assistance in defining these issues, exploring various options, and identifying their implications in order to address any weaknesses that could serve to threaten confidence in our financial markets and that inhibit improvements in the current regulatory structure.

will provide our views regarding the extent to which GSE governance and oversight structures are consistent with these important principles.

In summary, to ensure that the GSES operate in a safe and sound manner, it is essential that effective governance, reasonable transparency, and effective oversight systems are established and maintained. In particular, the GSES should lead by example in the area of corporate governance; GSE regulators must be strong, independent, and have necessary expertise; and GSE mission definitions and benefit measures need to be established. However, our work found that GSE corporate governance does not always reflect best practices; for example, Fannie Mae's Chief Executive Officer (CEO) serves as chairman and its Chief Operating Officer (COO) and Chief Financial Officer (CFO) both serve as vice chairmen of the board, which is not consistent with model governance theory that calls for an independent board and chair. I note that Freddie Mac's CEO is also the chairman of that company's board but Freddie Mac has agreed to split these functions in the future. Furthermore, the regulatory structure for the housing GSEs is fragmented and serious questions exist as to the capacity of GSE regulators to fulfill their responsibilities. In each of these areas, I will summarize steps that Congress, GSES, and regulators can take to improve GSE governance and oversight. In particular, I believe that Congress should establish a single housing GSE regulator that would be governed by a board or a hybrid board and director and provided with the authorities necessary to carry out its mission.

To prepare for this testimony, we relied heavily on a substantial amount of work that we had done on GSEs and their regulatory oversight in the past, but we also reviewed our historical positions in light of the current regulatory structure and GSE activities. The attachment lists reports representing this body of work. In addition to reviewing our past work, we solicited views of officials from the Office of Federal Housing Enterprises Oversight (OFHEO), the Department of Housing and Urban Development (HUD), and the Federal Housing Finance Board (FHFB). We also reviewed financial data on the GSES, best practices standards for corporate governance, and regulatory reports on such issues as the GSES' effects on financial market stability. We conducted our work in Washington, D.C., between November 2003 and January 2001 in accordance with generally accepted government auditing standards.

Overview of GSES,
Their Risks, and
Principles for

Effective Governance
and Oversight

What are the GSES and
How Do They Carry Out
Their Missions?

I would like to begin by summarizing the roles and responsibilities of the GSES, describing their potential risks to taxpayers and the financial markets, and offering certain principles on governance and oversight to help ensure that the GSEs' activities are safe, sound, and consistent with their public missions.

Over the past century. Congress established GSES to address concerns
that private financial institutions were not adequately meeting the credit
needs of homebuyers and agricultural interests (see table 1). The GSEs are
government-sponsored, privately owned and operated corporations whose
public missions are to enhance the availability of mortgage and
agricultural credit across the United States. It is also generally understood
that the housing GSEs' public missions include the obligation to meet the
needs of targeted groups of borrowers. The GSEs generally carry out their
missions by (1) borrowing funds in the capital markets and purchasing
assets from financial institutions or making loans to the institutions or (2)
securitizing assets and providing a credit guarantee to security holders.
These activities may provide mortgage or real estate credit to homebuyers,
businesses, or farmers at rates or conditions more favorable than those
that would be available in the absence of these GSEs. It is important to
note that the GSES' debt and security offerings are not explicitly
guaranteed or insured by the U.S. government.

Fannie Mae and Freddie Mac's mission is to enhance the availability of mortgage credit across the nation during both good and bad economic times by purchasing mortgages from lenders (banks, thrifts, and mortgage lenders) that use the proceeds to make additional mortgages available to homebuyers. Most mortgages purchased by Fannie Mae and Freddie Mac are conventional mortgages, which have no federal insurance or guarantee. The companies' mortgage purchases are subject to a conforming loan limit that currently stands at $333,700 for a single-family home in most states. Although Fannie Mae and Freddie Mac hold some mortgages in their portfolios that they purchased, most