risks. Although the federal government explicitly does not guarantee the obligations of the GSES, it is generally assumed on Wall Street that assistance would be provided in a financial emergency. In fact, during the 1980s the federal government provided financial assistance to both Fannie Mac and FCS when they experienced difficulties due to sharply rising interest rates and declining agricultural land values, respectively. The potential exists that Congress and the Executive Branch would determine that such assistance was again necessary in the event that one or more of the GSES experienced severe financial difficulties. Because the markets perceive that there is an implied federal guarantee on the GSEs' obligations, the GSEs are able to borrow af interest rates below that of private corporations, which as I discussed carlier allows them to extend credit to financial institutions at favorable rates. The GSES also pose potential risks to the stability of the U.S. financial system. In particular, if Fannie Mae, Freddie Mac, or the FHLBank System were unable to meet their financial obligations, other financial market participants depending on payments from these GSEs, may in turn become unable to meet their financial obligations. This risk, called systemic risk, is often associated with the housing GSES because of the sheer size of their financial obligations. For example, as discussed in OFHEO's 2003 report on systemic risk, if either Fannie Mae or Freddie Mac were to become insolvent, financial institutions holding the enterprise's MBS could be put into a situation where they could no longer rely on those securities as a ready source of liquidity. Depending on the response of the federal government, the financial health of the banking segment of the financial services industry could decline rapidly, possibly leading to a decline in economic activity. As another example, derivatives counterparties holding contracts with a financially troubled GSE could realize large losses if the GSE were no longer able to meet its obligations. If such a hypothetical event were to occur, widespread defaults could occur in derivatives markets. How Can GSE Risks Be The GSES Should Lead by To prevent the need for the federal government ever to have to provide I would now like to offer, on the basis of both my own experience and past Not only should GSES be sensitive to good governance but it is all the The GSES Require a Strong, achievements related to the company's long-term strategic objectives and less on short-term accomplishments such as quarterly or annual earnings. Further, it is not just the total amount of compensation but the form and structure of executive compensation arrangements that is important as well. Finally, transparency through timely and reliable financial and performance information and reasonable disclosures is necessary to enable capital markets and investors to understand related values and risks associated with the GSEs. Market discipline works best when firms fully and publicly disclose their financial obligations and activities. A regulatory system of GSE oversight must have the necessary strength, Further, a single regulator would be better positioned to consider potential trade-offs between mission requirements and safety and soundness considerations, because such a regulator would develop a fuller understanding of the operations of these large and complex financial institutions. Some critics of combining safety and soundness and mission have voiced concerns that doing so could create regulatory conflict for the regulator. However, we believe that a healthy tension would be created that could lead to improved oversight. The trade-offs between safety and *See U.S. General Accounting Office, Government-Sponsored Enterprises: Advantages and Page 8 GAO-04-269T Measures Must Be Established soundness and compliance with mission requirements could be best understood and accounted for by having a single regulator that has complete knowledge of the GSES' financial condition, regulates the mission goals Congress sets, and assesses efforts to fulfill them. To be effective, the single regulator must have all the powers, authorities, and technical expertise necessary to oversee the GSES' operations and compliance with their missions. Without clearly defined measures of the GSES' benefits, it is not possible for Congress, accountability organizations, and the public to determine whether the federal government should be subject to the financial risks associated with the GSEs' activities. I acknowledge that developing such measures may prove challenging for several reasons. First, isolating the GSES' effects on mortgage and agricultural credit markets is a complex and technical undertaking. Second, the GSEs' financial activities have evolved over the years and become increasingly sophisticated, which further complicates any analysis of the GSEs' benefits and costs. Third, in some cases, there is a lack of measurable mission-related criteria that would allow for a meaningful assessment of the GSEs' mission achievement or whether the GSES' activities are consistent with their charters. Nevertheless, past actions by Congress and regulators demonstrate that developing such quantifiable measures is possible. For example, in 1992, Congress required HUD to set numeric housing goals for Fannie Mae and Freddie Mac to help ensure that their mortgage purchases served the needs of low-income households as well as other targeted groups. The GSES' Corporate Compliance Reporting Now that I have laid out the risks associated with the GSEs and principles for effective governance and oversight, I would like to turn my attention to how the current system compares with those principles. While there is some positive information to report, about the GSES, there are also weaknesses in the areas of corporate governance, regulatory oversight, and mission compliance reporting. In cach of these areas, there are stops we believe Congress, the regulators, or GSES can take to address weaknesses in GSE governance and oversight that we have identified. |