• ability of the GSE's to lead the industry in making mortgage credit available for the targeted population or areas; and,

⚫ the need to maintain the sound financial condition of the GSE's.

Of particular concern, is the requirement that the GSE's "lead the market" in reaching underserved populations. In evaluating this criterion, HUD includes markets in which the GSE's are unable to fully participate, such as manufactured housing loans and subprime loans. While NAHB does not dispute that the GSE's should be held accountable for their performance in these areas, NAHB believes that some allowances should be made for the fact that these markets are not readily available to them.

Safety and Soundness Regulator

NAHB supports strong and credible safety and soundness oversight for Fannie Mae and Freddie Mac. The purpose of safety and soundness regulation is to ensure that Fannie Mae and Freddie Mac are adequately capitalized for the mission-related programs they are operating, and appropriate governance structures and procedures are in place to operate those programs in a safe and sound manner. The safety and soundness of Fannie Mae and Freddie Mac should be ensured through rigorous examination, enforcement of capital standards and transparency, without unnecessarily impairing the ability of the GSE's to perform their housing mission. It is imperative that the safety and soundness functions be separate from mission regulation, specifically program oversight and housing goals. Safety and soundness regulation should not be a vehicle for disapproving programs so the enterprises undertake little or no risk.

As stated earlier, NAHB strongly disagrees with the position that the GSE safety and soundness regulator must have the primary role in approving new programs in order to adequately perform safety and soundness oversight. This argument is based on the assumption that the mission regulator would increase the riskiness of Fannie Mae's and Freddie Mac's operations by allowing them to expand into activities beyond the scope of their charters. As outlined above, charter compliance is a prerequisite for new program approval. NAHB supports a requirement that the mission regulator consult with the safety and soundness regulator during new program reviews. We also feel that the safety and soundness regulator should be empowered to prevent the GSE's from undertaking any new activity representing a threat to their ongoing viable operation. However, the focus of safety and soundness regulation and supervision should be on ensuring that Fannie Mae and Freddie Mac hold adequate capital in relation to the risk of the activities they are undertaking and that these enterprises have the appropriate staff, systems, and management controls in place to operate the programs in a safe and sound manner.

Safety and soundness oversight of Fannie Mae and Freddie Mac presently resides with OFHEO, an independent office within HUD. Recent events with respect to Freddie Mac's and Fannie Mae's accounting practices have led a number of observers to raise serious questions about OFHEO's ability to perform these regulatory functions. In light of these concerns, NAHB would support the transfer of safety and soundness oversight of Fannie Mae and Freddie Mac from OFHEO to another entity with greater capacity and resources, such as the Treasury Department. We recognize Treasury as the premier financial institution regulator because of its expertise and experience with financial issues. However, as explained above, the authority of the office must be limited primarily to safety and soundness functions only because Treasury is not equipped to handle mission oversight of the GSE's.

Capital

NAHB has consistently supported the establishment and enforcement of appropriate capital standards for Fannie Mae and Freddie Mac. Pursuant to the 1992 GSE Act, Fannie Mae and Freddie Mac are required to meet two capital standards, a minimum leverage ratio and a risk-based capital (RBC) standard. The minimum leverage ratio is 2.5 percent of assets plus 0.45 percent of adjusted off-balance sheet obligations. By law, the RBC standard, is based on a stress test which calculates the amount of capital that Fannie Mae and Freddie Mac must hold to maintain positive capital over a 10-year period of adverse credit and interest rate conditions, plus an additional 30 percent of this capital level to cover management and operations risk. The firms must meet both the RBC and minimum capital standards to be classified as adequately capitalized. Failure to meet the capital standards would trigger enforcement actions ranging from limits on growth and activities to conservatorship.

Fannie Mae and Freddie Mac have consistently met their capital standards and thus have been classified as adequately capitalized. Prior to the implementation of the RBC standard, the firms were required to meet the minimum leverage ratio.

The RBC standard became enforceable on September 13, 2002, after nearly 10 years of development. The RBC test is the first regulatory capital standard to be based on a stress test and has been hailed as the most dynamic and stringent capital standard for any financial institution.

The Administration proposes to provide the Treasury regulator greater flexibility in establishing the leverage and RBC requirements. However, in testimony before this Committee last year, Treasury Secretary Snow mentioned the need for stability in capital standards and suggested that capital standards should not be subject to frequent change. NAHB agrees with this perspective and applauds Secretary Snow's decision not to recommend any changes in the statute dictating the GSEs' minimum and RBC requirements. Given that the current RBC standards took 10 years to develop and have been in effect for only 1 year, we are pleased that the Treasury is willing to give the requirements a chance to work. NAHB recommends against any immediate changes in the GSEs' minimum capital standard as well. Longer-term, NAHB agrees the safety and soundness regulator should have the flexibility to adjust capital standards as necessary. However, NAHB cautions against significant changes in the GSE's RBC standard or any significant increase in the GSE's minimum capital standard. Overcapitalization of the GSE's, beyond the level of risk, is not economically efficient and could have unintended consequences for the housing markets, by reducing the level of capital for housing and increasing mortgage rates. NAHB would also oppose the imposition of bank-like capital standards for the GSE's as some have proposed. Congress rejected this notion and intentionally drafted a separate capital regime for Fannie Mae and Freddie Mac under the 1992 GSE Act. The present capital framework takes into account the unique nature of the GSE's business, that there are only two firms (as compared to thousands of banks) and they engage in a monoline business, focused on low-risk residential mortgages (unlike banks which engage in a wide range of activities). During the lengthy development process of the current RBC standard, OFHEO took great pains to ensure that the standard appropriately ties capital to risk. Bank regulators have recognized that bank capital standards do not tie capital to risk and are now engaged in a process to revise bank capital standards through the Basel II Accord. Independence of Regulator

OFHEO currently operates independently of the cabinet agency where it resides (HUD). Other banking regulators within Treasury also operate with independence. For example, regulations, agency guidance and testimony emanating from the Office of Thrift Supervision (OTS) or the Office of the Comptroller of the Currency (OCC) are not subject to a mandatory approval requirement by Treasury. The Federal Housing Finance Board is an independent, stand-alone regulatory agency.

The Administration proposal requires Treasury approval of testimony and regulations from the regulator within Treasury. NAHB strongly believes that safety and soundness regulators should be objective, nonpartisan, and protected from political interference. This is especially critical at times when regulators must make difficult and sometimes politically unpopular decisions. The primary responsibility of the regulator is to implement policy made by the Congress, and to do so in a safe and sound manner. NAHB strongly believes that a regulator lacking true independence may eventually find itself pursuing other agendas, not the will of Congress, nor what is demanded to assure safety and soundness.

Independent regulation also protects Congress' ability to receive the regulator's best judgment on regulatory matters unfiltered and without delay. With billions of dollars of potential taxpayer liability at stake, it is in everyone's interest that this important safeguard not be weakened. Therefore, NAHB believes if a new agency is created within Treasury, it should have autonomy in the following key areas:

• Testimony. Congress should be able to count on receiving the agency's unadulterated views on all issues it faces.

• Rulemaking. The agency's policy justification for issuing regulations should be devoid of interference from politically appointed officials.

Supervision and Examination. True safety and soundness cannot be attained without a strict separation between political appointees and supervisory and examination staff.

• Enforcement. The agency's enforcement actions must be unblemished by any extraneous influence.

INCLUSION OF THE FHLBANK SYSTEM

The Administration has called for placing Fannie Mae, Freddie Mac, and the FHLBanks under a single regulator. In fact, the President's proposed budget for fiscal year 2005 includes provisions for transferring oversight of the Federal Home Loan Banks from the Federal Housing Finance Board to the same new office at

Treasury that would regulate Fannie Mae and Freddie Mac. NAHB believes that it is Congress' responsibility to scrutinize the regulatory oversight of the housing GSE's, and to ensure that they provide the Nation's network of community-based financial institutions with the safest, soundest source of residential mortgage and community development credit possible. While all three GSE's have much in common, NAHB believes it is important to both recognize and preserve the unique nature of the FHLBanks. For example, unlike Fannie Mae and Freddie Mac, the FHLBank System is a cooperative owned by its member institutions. The FHLBanks' stock is not publicly traded and does not fluctuate in value. In addition, each of the FHLBanks is jointly and severally liable to all the others.

Each of the three GSE business models has their strengths. Any revised regulatory system should continue to respect those differences, while advancing the common goal-to maintain their financial safety and soundness.

FUNDING OF REGULATOR

President Bush's fiscal year 2005 budget proposes to increase the amount of resources allocated to regulating the housing-related GSE's. The proposed budget earmarks $83 million to establish a new office within Treasury. The budget also anticipates that HUD will incur approximately $6.25 million in the establishment and enforcement of affordable housing goals, ensuring GSE compliance with fair housing laws, and providing consultation to the safety and soundness regulator on new activities. The activities of the safety and soundness regulator would be funded through mandatory assessments on all of the GSE's; the mission oversight costs at HUD would be assessed on Fannie Mae and Freddie Mac.

NAHB believes that those who supervise and regulate the GSE's should possess adequate authority and resources. The housing-related GSE's are engaged in a myriad of complex financial transactions. It is crucial for the regulator to possess a high degree of experience, knowledge, and familiarity with current accounting, risk-management and housing-related issues so that they are credible, confident, and capable. Furthermore, NAHB believes that it is entirely reasonable for the GSE's to fund the responsibilities of their regulator.

INDEPENDENT REGULATORY BODY

The idea of a stand-alone independent regulator has been floated as a compromise to break the current impasse among policymakers on the key issues of program oversight and political independence of the regulator. It is argued that a stand-alone agency would resolve concerns about independence of the regulator from Treasury, as well as Treasury's oversight of new programs. It might also ease concerns about including the FHLBanks in the new system since a merged agency would avoid a perception that any of these Government Sponsored Enterprises are subject to more effective regulation than any of the others.

While not our first preference, NAHB would be open to exploring the concept of a new independent regulator for all three housing GSE's outside the Treasury Department, depending on how key details are implemented. NAHB's primary concern in either regulatory scenario is that the mission regulator must have a housing focus and expertise and the safety and soundness regulator must have sufficient respect and authority to satisfy Congress and the capital markets.

In addition to the funding and political independence issues addressed in other sections of this testimony, NAHB notes that other preliminary characteristics to consider are the corporate structure of the agency, and how its managers will be selected. Given the diversity and complexity of supervisory issues the agency will address, NAHB initially recommends the agency be structured as a board of directors rather than a single agency head. In this scenario, NAHB suggests that a HUD representative should serve on the board in order to ensure that it possesses a housing-oriented focus and experience. NAHB also suggests that the board comprise stakeholders from various industry sectors. As mentioned above, it is imperative to recognize the differences between Fannie Mae, Freddie Mac, and the FHLBanks. This could be effectuated by establishing two divisions and maintaining separate funding for the costs of regulation.

Conclusion

NAHB appreciates the opportunity to share our views on the regulatory framework for Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System. The critical supports provided by these housing Government Sponsored Enterprises (GSE's) were an essential component to the recent success of the housing market in sustaining the Nation's economy. NAHB appreciates the Committee's efforts to assess and seek improvements to the regulatory framework of these GSE's. We look forward to working with the Committee as you progress toward fashioning a narrow regulatory solution to the oversight of these important housing institutions.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED

FROM ALAN L. BELLER

At our October 23, 2003 hearing, Federal House Finance Board (FHFB) Chairman Korsmo testified that he recommended to Congress that all 12 Federal Home Loan Banks (FHLB's) comply with the Securities Exchange Act of 1934. However, some of the 12 FHLB's have argued that, due to the unique nature of the System, disclosure registrations as required under the Securities Exchange Act of 1934 are difficult to implement, and would prevent the FHLB's from efficiently offering securities to the market. Only the Cincinnati FHLB has voted to implement the disclosure registrations of the Securities Exchange Act of 1934.

Q.1.a. What is your reaction to that argument? Do you foresee any major impediments to Securities Exchange Act of 1934 compliance for the FHLB's? Why or why not?

A.1.a. We do not foresee any major impediments. We have met with representatives of many of the Banks and with staff of the Federal Housing Finance Board to discuss a number of aspects of the requirements and timing of registration under the Securities Exchange Act of 1934. In particular, we have addressed what have been identified as four threshold accounting issues. As noted in my testimony, we have resolved those issues.

In addition, Commission staff members have worked with representatives of a number of the Banks to discuss accommodations the staff will make to address concerns the Banks have raised. The Commission staff has clearly indicated that it will provide "no-action," interpretive or other relief, to accommodate each Bank's preference to register a class of its capital stock rather than a class of debt. We believe that the investors in the publicly issued debt of the Banks are entitled to the same level of information as that provided to investors in debt securities of other public companies. However, if the Banks register a class of their capital stock with the SEC, they would be subject to certain disclosure and other requirements beyond those to which companies that have registered only their debt securities with us, and not their common stock or other equity securities, are subject. In our discussions with the representatives of the Banks and the Finance Board, the Commission staff has agreed to provide relief from provisions of the securities laws that would make the requirements to which they are subject consistent with those of companies who have registered only their debt securities with us.

The Federal Home Loan Banks, although federally chartered entities, have many of the same disclosure issues faced by any financial institutions whose securities are issued to, and held by, the public. The Federal Home Loan Bank System is one of the largest issuers of debt securities in the world. The debt of the Banks does not carry the full faith and credit backing of the United States and investors in the Banks' debt must, therefore, look only to the Banks for repayment of the debt. Therefore, disclosures by the Banks should give the holders of their debt a materially complete and accurate picture of the Banks' financial and operational situation to provide investors in their debt with sufficient information on which to evaluate an investment. As noted above, we believe that the holders of debt issued by the Office of Finance, for which the 12

Banks are jointly and severally liable, are entitled to the same type of information that is provided to investors in other public debt securities. We believe that the Commission's detailed disclosure rules and filing requirements and the staff review and comment process provide the best framework for disclosing information to which investors are entitled. In addition, we have a long history of reviewing complex entities that comply with the disclosure requirements of the Exchange Act and other Federal securities laws.

Q.1.b. Would registration prevent the FHLB's from efficiently offering securities to the market?

A.1.b. No. Under the Securities Exchange Act of 1934, publicly reporting companies are required to file periodic and current reports. Registration under the Securities Exchange Act of 1934 is not tied to the timing of offerings as it is under the Securities Act of 1933. There would, therefore, be no impact on a Bank's timing or other aspects of offering securities as a result of Exchange Act registration. Some Banks have expressed concern that staff review of a Bank's Exchange Act reports might require a Bank to cease selling its securities. However, the staff does not advise or instruct a publicly reporting company to stop selling securities based on its comments on the company's Exchange Act filings. As is the case now, if a Bank uncovers a disclosure issue the Bank itself must determine whether or not it should continue to sell securities in the public markets. While registration under the Exchange Act may cause the Commission staff to raise a comment which could alert a Bank to a particular issue, it would, as now, be up to the Bank to determine whether the issue was significant enough to temporarily curtail securities offerings until the appropriate disclosure was provided to the public. This would be the case whether the issue was identified by the Bank itself or by the Commission staff in a comment letter.

Fannie and Freddie have argued that due to the nature of the mortgage-backed securities market structure, the fees associated with the Securities Act of 1933 disclosure would be onerous, seriously slowing the offering of mortgage-backed securities to the "To Be Announced" (TBA) market, as well as being unfairly costly. They also claim the volume of the securities they offer also makes such registrations difficult for the SEC to handle expeditiously. Q.2.a. What is your reaction to that argument? In your opinion, can the SEC handle such registrations? Would it be too difficult to implement or too costly?

A.2.a. We have a long history of overseeing the disclosure and offerings of companies in many diverse industries including financial companies that perpetually offer securities to the market. The current registration fee is $126.70 for each $1,000,000 of securities offered. Since Fannie and Freddie issue a large volume of securities, the fees they would pay for registering the offer and sale of securities under the Securities Act of 1933 could be large. We have no reason to believe that subjecting Fannie and Freddie to the same fees, disclosure, and review as other companies that offer mortgage-backed securities to the market would be unfairly costly to Fannie or Freddie or present any difficulties for the SEC. However, as noted below, we do not know whether or how requiring registra