need for support-would give the agency reason to consult and cooperate with the Treasury even if the agency did not need formal Treasury clearance of regulations and testimony.

Requiring Treasury clearance of the new agency's Congressional testimony could cause delay, as Treasury officials who might otherwise have little interest in the Agency's work scrutinized the testimony to make sure it would not embarrass the Treasury Secretary or the Administration. One persistently tardy participant in a clearance process can make testimony persistently late despite the other participants' best efforts. Note, moreover, that if the Secretary cannot control the agency's testimony, then it is harder (although not impossible) to blame the Secretary for that testimony.

A stronger case exists for Treasury clearance of the new agency's regulations (although I do not regard such clearance as essential). Such clearance would help guard against capture. It need not cause delay, as regulation-writing takes time and rarely has the short deadlines typical in preparing Congressional testimony.

In any event, Treasury clearance of regulations should not derail GSE reform legislation. Congress can develop middle-ground options, such as (1) setting a time limit on Treasury review, or (2) permitting the new agency to proceed with a proposed regulation unless the Treasury expressly disapproves the regulation within a specified time period and publishes specific written reasons for its disapproval. Such an intermediate option would make Treasury review of the Agency's regulations more than merely advisory, while providing safeguards against delay or unreasoned disapproval.

RESOURCES

Like the OCC and OTS, OFHEO pays its expenses using fees collected from the firms it regulates; it receives no general tax money. But unlike the OCC and OTS, OFHEO needs an annual appropriation to set and collect such fees. Fannie and Freddie have used the appropriations process both to pressure OFHEO (just as thrifts used the process to pressure the old Federal Home Loan Bank Board) and to limit OFHEO's capacity to undertake more rigorous scrutiny of the GSE's. To reinforce the new agency's independence from the firms it regulates, Congress should end this reliance on appropriations.

LEGAL AUTHORITY

Capital, Enforcement, and Prompt Corrective Action

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 drew on banking law to strengthen the safety and soundness regulation of Fannie and Freddie. The 1992 Act required new capital standards. It included Prompt Corrective Action provisions to encourage the GSE's to correct capital deficiencies. It authorized OFHEO to take administrative enforcement action against unsafe practices. But at the insistence of Fannie and Freddie, the 1992 Act unwisely tended to deny OFHEO authority possessed by bank regulators. As a result, OFHEO has (in Tom Stanton's phrase) "a parody of the authority of the Federal bank regulators." The limits on OFHEO's authority contrast sharply with the goal of creating "a strong, world-class regulatory agency" with powers "comparable in scope and force to those of other world-class financial regulators."

Bank regulators have broad authority to prescribe capital standards, including authority to impose new standards or toughen existing standards. 12 U.S.C. §§ 18310(c)(1), 3907(a). OFHEO, by contrast, faces major constraints on the form and content of capital standards, including an extraordinarily complex Congressionally dictated stress test. §§ 4611-4612. The new regulator needs authority to raise capital standards in light of experience.

OFHEO has much weaker enforcement authority (§§ 4631-4636) than Federal bank regulators (§ 1818), as shown in the table following this page. For example, bank regulators can issue a cease-and-desist order against any "unsafe and unsound practice." OFHEO can issue such an order only if the conduct jeopardizes a GSE's capital. Bank regulators can bar any officer, director, or employee of an FDIC-insured institution from working at that or any other Federally insured institution if the individual committed misconduct (for example, breaking the law) that (1) enriched the individual or caused loss to the institution, and (2) involved personal dishonesty or demonstrated willful or continuing disregard for institution's safety and soundness. OFHEO has no such authority. Bank regulators can impose civil money penalties of up to $25,000 per day for lawbreaking that enriches the violator or breaches the violator's fiduciary duties. OFHEO cannot impose civil money penalties on these grounds. Bank regulators can impose civil money penalties of up to $1 million per day for (1) knowingly breaking the law or breaching fiduciary duty, and

Fannie and Freddie face Prompt Corrective Action rules (§§ 4614-4619, 4622) conspicuously weaker than those governing FDIC-insured depository institutions (§ 18310). For example, an undercapitalized bank cannot increase its total assets unless (1) the bank has an acceptable capital restoration plan, (2) the asset growth comports with the plan, and (3) the bank's capital ratio increases at a rate sufficient to enable the bank to become adequately capitalized within a reasonable time. § 18310(e)(3). Yet no statute bars Fannie and Freddie from continuing to grow while undercapitalized, even if they have no capital restoration plan or if the growth conflicts with such a plan (§4615). The Prompt Corrective Action_statute authorizes growth restrictions only against a significantly or critically undercapitalized GSE, and makes such sanctions purely discretionary. §§ 4616(b)(2), 4617(b), (c)(2). Similarly, a bank cannot pay dividends if the bank is or would become undercapitalized, whereas even an undercapitalized GSE may be able to pay dividends as long as the dividends are not so large as to render the GSE significantly undercapitalized. §§ 18310(d)(1)(A), 4515(a)(2).

The GSE enforcement and Prompt Corrective Action rules should be strengthened in line with their banking counterparts.

Receivership

There are two basic ways to deal with a firm if its liabilities exceed its assets and it cannot pay its debts as they become due: Liquidation and reorganization. Liquidation involves selling the firm's assets and using the proceeds to pay creditors. Reorganization involves scaling back the firm's liabilities, such as by turning some of the firm's debt into equity.

Liquidation or reorganization mechanisms exist for most firms. A court can liquidate a business corporation under Chapter 7 of the Bankruptcy Code or (with enough creditors' approval) reorganize the corporation under Chapter 11. The FDIC can liquidate or reorganize an insolvent FDIC-insured bank or thrift. The Federal Housing Finance Board can liquidate or reorganize a Federal Home Loan Bank.

But in the case of Fannie and Freddie, no adequate legal mechanism exists for dealing with a GSE if its liabilities exceed its assets. The Bankruptcy Code does not apply. Although OFHEO can appoint a "conservator" to take control of the GSE, the conservator cannot require creditors to exchange debt for equity or to accept less than full payment of their claims.6 Thus if the GSE's assets fall short of its liabilities, the conservator has no power to resolve the shortfall. The insolvent GSE would remain adrift in legal uncertainty until Congress enacted special legislation. This lack of an orderly "receivership" mechanism-that is, mechanism for using the insolvent GSE's assets to satisfy the GSE's creditors-is a serious gap in current law, with potentially serious consequences for financial markets. So long as the gap remains, the GSE regulator will not truly have powers "comparable in scope and force to those of other world-class financial supervisors, fully sufficient to carry out the agency's mandate."

Congress can fill the gap in at least two ways: (1) by authorizing the GSE regulator to commence a bankruptcy proceeding against an insolvent GSE; or (2) by authorizing the regulator to appoint a receiver to deal with the GSE under a specialized set of rules such as those applicable to failed banks. Either approach can do the job.

Regulating GSE's but having no receivership mechanism is like investing in an elaborate fireprotection system-complete with firewalls, smoke detectors, heat sensors, alarm bells, and sprinklers-but failing to mount a crucial fire door on its

5 Specifically, the Bankruptcy Code does not permit Fannie or Freddie to become a debtor in a bankruptcy proceeding, whether voluntarily or involuntarily. As Federal instrumentalities, Fannie and Freddie are "governmental units" under § 101(27) of the Bankruptcy Code and thus under § 101(41) are not a "person." Under § 109(a) only a "person" can become a "debtor" in a bankruptcy proceeding. See 11 U.S.C. §§ 101(27), (41), 109(a).

6 Under 12 U.S.C. §4620(a), a conservator generally "shall have all the powers of the shareholders, directors, and officers of the Enterprise under conservatorship and may operate the Enterprise in the name of the Enterprise." But a firm's shareholders and managers have no power to require creditors to exchange debt for equity or to accept only partial payment of their claims. Nor does §4620(f) authorize OFHEO to write down creditors' claims. Under §4620(f) OFHEO "may require a conservator to set aside and make available for payment to creditors any amounts that the Director determines may safely be used for such purpose." Using this authority, OFHEO could require a conservator to make larger or earlier payments to creditors than the conservator might otherwise make. But the statute in no way suggests that by accepting such payments creditors would waive their right to eventual payment in full.

7A conservator might, in theory, attempt to get all of the GSE's creditors to agree to scale back their claims. But obtaining the creditors' unanimous consent would be impracticable given the large number of creditors and the incentive for some creditors to threaten to veto the deal unless they received favored treatment.

hinges. Like firesafety measures, GSE safety and soundness regulation serves dual purposes. Firesafety measures protect a building by preventing and extinguishing fires there; they also protect other buildings by inhibiting the spread of fire. Similarly, GSE regulation seeks not only to keep the GSE's themselves safe but also to protect the financial and housing sectors from damage that might result from a GSE's failure. Bank regulation serves similar purposes and did so even before Federal deposit insurance: Seeking both to protect banks' depositors and other creditors and to prevent bank failures from causing broader economic harm. A receivership mechanism, by providing an orderly means for dealing with a failed GSE's obligations, would help limit and contain the harm resulting from a GSE's failure. The GSES' Double Game

IN GENERAL

In managing their relationship to the Federal Government, the GSE's play an extraordinarily successful double game: They deny that they have any formal, legally enforceable Government backing, even as they work to reinforce the market perception of implicit Government backing. Let us look more closely at the two parts of the double game.

First, the GSE's emphatically deny that they have any formal, legally enforceable Government backing-in itself, a valid point. But the GSE's make this point in ways designed to convince the uninitiated that the GSE's enjoy no Government backing at all (an implication directly conflicting with the second part of the double game). The GSE's stress that "Every one of our debt securities clearly states, in plain English, it is not backed by the full faith and credit of the Government."8 They argue that they operate "with entirely private capital" and that their activities "are entirely supported by [their] revenue and the capital of private investors and are not in any way guaranteed by the Federal Government.

Second, the GSE's work to reinforce the perception of implicit Government backing. Consider three examples involving Fannie. In the first example, Fannie sought legislative history stating that Fannie and Freddie "are implicitly backed by the full faith and credit of the U.S. Government." 10 In the second example, Fannie attacked Treasury Under Secretary Gensler as "irresponsible" and "unprofessional" when he testified before a House Subcommittee on March 22, 2000, that "the Government does not guarantee [GSEs'] securities." 11

In the third example, Fannie argued in a 1998 letter to the Office of the Comptroller of the Currency that "all GSE issued securities merit" more favorable treatment under the Federal banking agencies' risk-based capital standards than all "AAA-rated [non-GSE] asset-backed securities." Thus the mere fact that a GSE issues a security makes that security more creditworthy than any non-GSE security. An IOU issued by a financially troubled GSE (such as the Farm Credit System before its 1987 bailout) would, under Fannie's reasoning, still be more creditworthy than a top-tier asset-backed security guaranteed by the Nation's healthiest fully private corporation. Fannie based this argument squarely on what it calls "the implied Government backing of Fannie Mae":

GSE issues generically, and Fannie Mae-guaranteed MBS in particular, are viewed by the capital markets as near proxies for Treasury securities in terms of credit worthiness.

Fannie Mae standard domestic obligations, like Treasuries, typically receive no rating on an issue-by-issue basis, because investors and the rating agencies view the implied government backing of Fannie Mae as a sufficient indication of the investment quality of Fannie Mae obligations. . . .12

Thus Fannie contended that in assessing credit quality, investors and rating agencies do not (and presumably need not) look beyond "the implied Government backing of Fannie Mae," which in Fannie's view renders Fannie's securities "near proxies for Treasuries." These assertions are all the more remarkable in that Fannie made

8 Franklin D. Raines, Remarks at Conference on Money Markets and the News: Press Coverage of the Modern Revolution in Financial Services, March 19, 1999.

9 Fannie Mae, FM Watch Observer: Glossary of Terms, www.fmwatch-observer.com/glossary.html (emphasis added).

10 When I worked for this Committee on a Glass-Steagall repeal bill in 1987-88, Fannie asked that I include such language (emphasis added) in a draft section-by-section analysis, which I declined to do.

11K Day, Remarks Put Pressure on Fannie, Freddie Bonds, Washington Post, Mar. 24, 2000, at E1; J. Kosterlitz, Siblings Fat and Sassy, 32 National Journal 1498 (2000).

12 Letter from Anthony F. Marra to OCC, Feb. 3, 1998 (emphasis added).