and Freddie Mac are required to meet two capital standards, a minimum leverage ratio and a risk-based capital (RBC) standard.

FEDERAL HOME LOAN BANK SYSTEM

The FHLBank System was created by Congress in 1932 by the Federal Home Loan Bank Act. The Federal Housing Finance Board (Finance Board) is the FHLBank System's regulator. An independent agency, the Finance Board regulates both mission and financial safety and soundness. The FHLBanks are required to comply with both a leverage and a RBC capital requirement. The FHLBanks are also required by law to contribute a percentage of their net earnings each year to fund affordable housing programs.

Administration's Proposal

The Bush Administration proposes to create a new Federal agency within the Department of the Treasury (Treasury) to regulate and supervise the financial activities of Fannie Mae, Freddie Mac, and the FHLBank System. The new agency would have general regulatory, supervisory, and enforcement powers for GSE oversight, including the authority to establish, enforce, and revise capital standards. Oversight of Fannie Mae's and Freddie Mac's existing activities and approval of new activities would be shifted from HUD to the new Treasury agency. HUD would be left with minimal regulatory authority, limited to oversight of the annual affordable housing goals and a consultative role in program oversight. The Administration's proposal makes no specific recommendations for how the new regulatory agency would accommodate the inherent differences between Fannie Mae, Freddie Mac, and the FHLBank System. The Secretary of the Treasury would enforce policy accountability through review of the new agency's regulations, budget, and policy statements to the Congress. Importantly, the Administration does not recommend any changes in the GSES' agency status.

NAHB POSITION ON KEY ELEMENTS

Several elements of the Administration's proposal are antithetical to the core principles of GSE oversight. At the very least, the Administration's proposal would raise the costs of housing and stifle innovation. At worst, the proposal has the potential to undermine the entire housing finance system.

Much of the debate surrounding the GSE regulatory restructuring has focused on the treatment of Fannie Mae and Freddie Mac. Indeed, most of the key elements of the Administration's proposal relate exclusively to these two GSE's. Other reform proposals have proposed including the Federal Home Loan Banks under the new GSE regulatory framework, either within the Treasury safety and soundness regulator or through the establishment of an independent regulator for all the housing GSE's. NAHB's comments and recommendations on key elements of these various proposals are discussed below.

PROPOSED FANNIE MAE AND FREDDIE MAC REGULATORY FRAMEWORK

Location of Program Oversight

Under the Administration's proposal, Treasury would assume not only safety and soundness duties but also most mission-related oversight duties. For example, HUD's current authority to approve new programs would be transferred to Treasury under the premise that new program approval is a safety and soundness issue rather than a mission-oversight issue. HUD would have a consulting role.

NAHB maintains that the program approval activities that are currently conducted by HUD should not be transferred to the Treasury Department. HUD is the preeminent regulatory authority on housing-related issues. Treasury has virtually no experience or expertise in evaluating the effectiveness and appropriateness of housing policies, especially those pertaining to housing for working families. Treasury presently has oversight for two important housing tax programs, low-income housing tax credits and mortgage revenue bonds. Operation of these programs is left to the States and HUD to set program specifics. Outside of these tax programs, Treasury has little experience or expertise in evaluating the effectiveness and appropriateness of housing policies.

The ability of Fannie Mae and Freddie Mac to spur innovative solutions and to develop new products that increase homeownership and rental housing opportunities will be jeopardized if the mission of these corporations is regulated by Treasury. This stifling of innovation would reduce the capacity of Fannie Mae and Freddie Mac to provide the liquidity and stability needed to keep mortgage credit available at the lowest possible cost to homeowners and rental housing providers.

NAHB believes that Fannie Mae's and Freddie Mac's ability to spur innovative solutions and to develop new products that increase homeownership will continue

only if the mission of these corporations is regulated by an agency which also has a housing mission, that would, as a consequence, contain a thorough understanding of and extensive involvement in housing-related issues. The only Federal agency in existence now with sufficient housing mission orientation, experience, knowledge and focus is the Department of Housing and Urban Development. For this reason, NAHB recommends that HUD should retain its current status as the mission regulator for Fannie Mae and Freddie Mac, including approving new programs and establishing annual affordable housing goals.

The legislative history of program oversight provisions clearly indicates that the objective and focus of program oversight is not safety and soundness, it is mission compliance. The 1968 Fannie Mae Charter Act, which reconstituted Fannie Mae as a Government sponsored private corporation, granted HUD general regulatory power to ensure Fannie Mae's compliance with its housing mission as specified in the charter. In 1970, HUD was vested with prior approval of all new Fannie Mae programs through the Emergency Home Finance Act, which also created Freddie Mac. HUD was granted regulatory oversight of Freddie Mac in 1989 through the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), which transferred this authority to HUD from the Federal Home Loan Bank Board. Finally, the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the GSE Act) reaffirmed HUD as the program regulator of Fannie Mae and Freddie Mac and gave HUD the authority to establish, monitor and enforce affordable housing goals.

The legislative history reflects the recognition by Congress that program oversight is a function of mission regulation that must be conducted by an agency with a thorough understanding of and extensive involvement in housing-related issues. Indeed, during consideration of the 1992 GSE Act, Senate Banking Committee Chairman Riegle stated that "in order to properly coordinate national housing policy. regulations relating to the housing missions of Fannie Mae and Freddie Mac should be issued only with the review of the HUD Secretary."

HUD has proven itself to possess the capacity to adequately evaluate the potential benefits to housing from the GSEs' innovation and advancement in products and to ensure that the GSE's do not stray from their statutory mission. However, NAHB believes that HUD's program oversight could be strengthened through the establishment of an independently funded office within HUD. Having an office within HUD dedicated to mission oversight of Fannie and Freddie would be preferable to the current situation where GSE oversight is conducted through the Office of Housing with few dedicated staff and staff from other HUD offices are detailed on an ad hoc basis for GSE oversight duties. NAHB would support assessing Fannie Mae and Freddie Mac to fund the new HUD office.

Process of Program Approval

Under current law, Fannie Mae and Freddie Mac must submit a new program approval request to HUD if the initiative is "significantly different" from a program previously approved; is an activity in which the GSE had not engaged prior to passage of the 1992 GSE Act; or, represents an expansion in terms of dollar volume, number of mortgages or securities involved above limits expressly contained in any prior program approval. Further, if HUD believes an activity should be subject to prior approval, HUD may also request additional information or require a GSE to submit a program request. (Prior to 1 year after the effective date of the risk-based capital regulations, the GSE's were required to simultaneously submit new program requests to the Director of OFHEO. With the implementation of the RBC rule in September 2002, OFHEO now has a consulting role, at HUD's discretion, in the evaluation of new programs.) HUD is required to approve any new program request unless it is not authorized by the GSES' Charter Acts or is not in the public interest. The Administration proposes to significantly expand what would have to be approved, to include any activity or product that differs significantly from current activities. Fannie Mae and Freddie Mac introduce a myriad of new activities and products each year. Submitting each of these to the approval process envisioned by the Administration would severely inhibit or delay the development and implementation of valuable new mortgage products and technological innovations. The housing-related GSE's require a program approval process that provides adequate flexibility to respond promptly to market needs, while empowering their regulator to ensure ongoing charter compliance and to assess safety and soundness.

The existing program approval requirements and process have served the housing market well by ensuring effective regulatory oversight and encouraging product innovation to fulfill the GSEs' housing mission. This is particularly true in the affordable housing area where both GSE's have introduced products and services to expand homeownership opportunities for low- and moderate- (low/mod) income bor

rowers, renters and residents of areas underserved by the broader housing finance system. Technological innovations by the GSE's, such as their automated underwriting systems (AUS), also have contributed to their efforts to expand homeownership opportunities. In the affordable multifamily market, both GSE's have established forward commitment programs that support much-needed production of new units. Further, each has developed partnerships and alliances at the national and local levels to expand affordable housing opportunities.

While NAHB strongly supports the current process, we believe that the process could be improved in three areas: (1) the scope of review; (2) safety and soundness considerations, and (3) the mechanics of the review process.

Scope of review should facilitate innovation. A delicate balance is required between a careful examination of whether a new GSE program serves its important public mission and the need to not over-burden these organizations' innovative efforts to provide new lending opportunities in the most difficult to serve communities. There may be a need to improve the current approval process, NAHB urges Congress to proceed cautiously, and resist efforts to over-encumber this process.

The current process rightfully limits prior approval to new programs, which are defined as very broad undertakings unlike what is currently being done. The Administration proposes to significantly broaden what would have to be approved to include any new business activities. Submitting each new activity to the approval process envisioned by the Administration would result in such micromanagement of the GSES' innovations that they would be unable to respond to changing market conditions in a timely fashion. The result would be to stifle or severely inhibit development and implementation of valuable new mortgage products and technological innovations that have helped to dramatically expand homeownership in the country. The Administration asserts that their proposed new activity review would be the same model under which banks operate. A review of activity approval for banks and their financial subsidiaries indicates that this is not the case. Banks are not subject to an activity by activity review as envisioned by the Administration. They have wide latitude to engage in any activity enumerated in the National Bank Act. Banks also are permitted to conduct activities that are incidental to those enumerated.

There are no specific statutory or regulatory requirements for national banks to notify or seek OCC approval prior to engaging in a new business activity. However, banks often seek preliminary determinations from the OCC if an activity does not have a readily apparent nexus to an activity listed in the National Bank Act. Issues relating to new and ongoing activities are also addressed during the bank examination process.

Similarly, financial subsidiaries of national banks also have expansive latitude to engage in a wide range of statutorily enumerated activities without prior approval. Under the Gramm-Leach-Bliley (GLB) Act financial subsidiaries may engage in activities that are "financial in nature". The act provides a preliminary list of such activities and authorizes the list to be expanded by the Treasury Department in coordination with the Federal Reserve. If a bank wishes to engage in one of the enumerated new activities through a financial subsidiary, it must provide a notice to the OCC within 5 days before engaging in a new activity. The only prior approval notice added in the GLB Act is for activities not listed in the statute when the company is seeking the Treasury and Fed to authorize such activities.

Safety and soundness considerations should accompany, not dominate program approval decisions. The present program approval structure strikes an appropriate balance between mission and safety and soundness oversight. Safety and soundness are not criteria for new program approval. Indeed, the_Treasury Department reached the same conclusion in its 1990 study on the GSE's. Treasury stated,

"the regulatory authority which monitors a GSE's fulfillment of its Congressional mandate should be different from the entity implementing financial safety and soundness standards. Separating these two regulatory functions will remove risks to the taxpayers by removing a perceived conflict of interest [emphasis added]. . . . The Treasury recommends that the current program regulator continue to be responsible for ensuring that the GSE meets its Congressional mandate by effectively serving its intended beneficiaries." Report of the Secretary of the Treasury on Government Sponsored Enterprises, May 31, 1990.

It is interesting that the Administration now views program approval as a function of safety and soundness oversight to be overseen by the Treasury. As discussed above, NAHB believes Treasury is the wrong place to put program approval. Treasury lacks experience in and knowledge of housing.

This is not to say that safety and soundness should not be a consideration in new program review. NAHB believes that safety and soundness is one of the many ele

ments that should be evaluated during the new program approval process, but maintains it should not be the paramount consideration as the administration has proposed.

Reviewing new programs solely on the basis of safety and soundness would severely retard the development of programs needed by Fannie Mae and Freddie Mac to fulfill their housing mission. It will stifle innovation necessary to provide liquidity to the housing credit markets, particularly in areas that otherwise would not be adequately served. Such activities, by definition, involve higher risk and would be greatly constrained if program approval is solely a component and function of safety and soundness regulation.

The safety and soundness regulator should have a consultative role in program review, not the final decision. Some criteria that the safety and soundness regulator should consider are:

• Risk assessment: Does the new program pose undue risks to the Enterprise or the housing finance system generally?

• Risk management: Does the Enterprise have the expertise, resources, and programs in place to effectively manage the interest rate, credit, or other risks associated with the new program?

• Capital adequacy: Does the Enterprise have present or reasonably anticipated reserves to compensate for the risks involved?

Further, we note that the risks of new activities are accounted for in the riskbased capital model, which ensures that the GSE's have adequate reserves to cover the risks of new programs.

Program review process should be clarified with specific criteria. Presently, HUD has 45 days to review a new program request, with one 15 day extension. As noted, HUD is required to approve a new program request unless it is not in compliance with the GSES' Charter Acts or is not in the public interest. The present process is vague on the content of the application request and the criteria for approval. NAHB supports retention of the current timeframes for approval of new program requests and offers the following suggestions for application content and review criteria.

New Program Request Application Content:

Citation to the statutory, regulatory, or other legal authority;

Estimate of the anticipated dollar volume of the program (short- and long-term); Full description of proposed program, including: Purpose and operation; target market; delivery system; and effect of the activity on the housing market, broadly, and/or ability to meet affordable housing goals; and,

• Assessment of the risks associated with the activity, and a demonstration of the Enterprise's ability to manage those risks.

Review Criteria:

• Charter compliance: Is the program consistent with the Enterprise's charter and other relevant statutory and regulatory authority, and does the new program support the mission of the Enterprise?

• Public interest: Is the new program in the public interest? Does it support or help to fulfill an important housing-related objective?

• Innovation: Does the new program foster innovation in the availability or delivery of housing-related financial services?

• Risk Assessment: Must consult with and consider risk assessment by safety and soundness regulator.

Extent and Control of Fannie Mae and Freddie Mac Affordable Housing Goals

The current statute contains three specific goals that are intended to push Fannie Mae and Freddie Mac further into housing finance products and markets than they may otherwise go. HUD sets the specific levels of business they must achieve. HUĎ has steadily increased the levels and the GSE's have achieved them.

NAHB has always been a strong supporter of the affordable housing goals for Fannie Mae and Freddie Mac since HUD was granted this authority by the 1992 GSE Act. The housing goals establish percent of business purchase goals for three categories: Low- and moderate-income, underserved areas, and special affordable. The first set of goals was established by regulation in 1995, and was updated in 2000 to cover the years 2001-2003. Current goals levels, as a percent of annual purchases, are: 50 percent for low-mod; 31 percent for underserved areas; and, 20 percent for special affordable.

Both GSE's have consistently exceeded all of the housing goals since the initial goals were established in 1995. The goals have encouraged Fannie Mae and Freddie Mac to reach deeper into the affordable housing market with tangible benefits. The

GSE's financing of housing for low- and moderate-income families has increased from under 30 percent of their purchases in 1992 (prior to passage of the GSE Act) to over 51 percent in 2002.

The Administration is proposing to strengthen HUD's housing goals authority over Fannie Mae and Freddie Mac. As the HUD Secretary outlined in his October 16, 2003 testimony before this Committee, this will include the creation of a new GSE office within HUD, independently funded by the GSE's, to establish, maintain, and enforce housing goals. HUD would be granted new administrative authority to enforce housing goals, enhanced civil penalties for failure to meet the goals, and expanded authority to set housing goals and sub-goals beyond the three currently established. The President's proposed budget for fiscal year 2005 also calls for adding a new goal to promote affordable housing homeownership.

For the same reason that NAHB supports HUD as Fannie Mae's and Freddie Mac's mission regulator, NAHB supports HUD as the regulator for the GSEs' housing goals. We agree with the HUD Secretary that "HUD is the appropriate agency to develop and enforce housing goals. Institutionally, [HUD's] mission is devoted to furthering the goal of affordable housing and homeownership and HUD has the most expertise in this area." Indeed, NAHB believes housing goals authority is one of HUD's key functions as mission regulator for Fannie Mae and Freddie Mac.

NAHB also agrees that more needs to be done to encourage the GSE's to increase their activities in some market segments. However, we do not believe that adding additional goals or sub-goals, as the Administration has proposed, is the best way this could be accomplished. Fannie Mae and Freddie Mac were created to serve a broad range of housing needs and we would not want overly stringent or complex goals to impede that mission. Continual increases in the percentage targets will have diminishing returns and run the risk of adversely impacting other housing programs, such as FHA's single family program.

NAHB believes that a better way to encourage increased GSE activity in underserved markets is through bonus point incentives within the existing goals system. HUD's 2000 goals rule, which established goals for 2001-2003, also provided for bonus points during this period for units financed for GSE mortgage purchases in small (5–50 unit) multifamily properties and for units in 2- to 4-unit owner-occupied units. These units are key sources of affordable housing for large numbers of lowand moderate-income households, first-time homebuyers, and minorities. One-third of the rented homes are in buildings with 5 to 50 units and minority renters are more likely to be the occupant than are white residents. The bonus point system ended on December 31, 2003, when HUD chose not to extend it beyond the effective termination date.

NAHB is a strong supporter of the bonus points system as a flexible means to provide incentives for the GSE's to increase activity in targeted markets and we adamantly oppose HUD's decision to terminate the bonus points. The bonus points were an integral component of the current goals structure and they served their intended purpose as both Fannie Mae and Freddie Mac increased their purchases of bonus-related mortgages. For example, Fannie Mae's purchases of small multifamily (5-50) properties as a percentage of their total multifamily purchases more than doubled from 1.7 percent in 1997 to 4 percent in 2002. Similarly, Freddie Mac's purchases increased from 3 percent in 1997 to 6.5 percent in 2002.

NAHB is concerned that the elimination of the bonus points incentive will disrupt the progress that has been made in these markets as the GSE's focus on larger multifamily properties which are more "goals-rich" in order to meet their overall housing goals. More work remains to be done in the small multifamily market, especially in rural areas and urban infill locations that are part of community revitalization efforts.

As we have stated above, NAHB believes bonus points are a very effective tool for focusing GSE affordable housing efforts on areas of greatest need. NAHB urges this Committee to instruct HUD to reinstate the bonus points for small multifamily properties. We also recommend that bonus points for loans on small multifamily projects, rural homes and newly built homes be included in statutory provisions for affordable housing goals under any new GSE regulatory regime.

Finally, NAHB suggests that consideration should be given to the statutory factors HUD must consider in setting the housing goals. The 1992 GSE Act requires HUD to consider the following six factors in establishing the goals:

• national housing needs;

• economic, housing, and demographic conditions;

performance and effort of the GSE's toward achieving the goal in previous years; • size of the conventional mortgage market serving the targeted population or areas, relative to the size of the overall conventional market;