Chairman GREENSPAN. This is the reason why I think this is a very sensitive question and the reason why it is an issue that I perceive to be necessary to be resolved in the longer-run. As I indicated early on, Senator, I think at the moment there is no evidence that there is any imminent systemic risk here, and that is precisely the reason why I think this is the time that you start to think about making certain it does not occur in the future. In the process of defining how this is done, remember, as you point out, that under existing statute, there is a conservatorship, not a receivership, which essentially says for all practical reasons that the Congress will bail out the GSE's in the event of a crisis. Chairman SHELBY. It is another implied guarantee; is that right? Chairman GREENSPAN. Under existing rules, if there is a crisis, it is going to be very difficult for the Federal Government not to guarantee these assets. If that is not the decision of the Congress, something different has got to be done, and all I will say to you, as you very well understand, Mr. Chairman, this is a very difficult situation because we have extraordinarily viable GSE's. Chairman SHELBY. That is right. Chairman GREENSPAN. Fannie and Freddie-I may criticize the issue of the subsidy, and that is basically because it is so starkly different for me in the sense that without the subsidy, as I have told my friends in both of these institutions, I think they would be far better off privatized, and one of the reasons is I think they are very well run. But if in the process of resolving this issue, we undercut these institutions, I think we will be doing the Nation a great disservice. So it is not a simple process as I see it. Chairman SHELBY. Mr. Chairman, could we have a statement of public policy that we are very interested in-and we know why, for economic reasons, social reasons, and so forth-on private housing ownership in this country and at the same time state we are interested in sound financial institutions to help bring this about? Couldn't we do both, or can we? Chairman GREENSPAN. Mr. Chairman, I think we have to do both. Chairman SHELBY. We have to do both. Okay. Fannie and Freddie are subject, as I understand it, to a 30 percent risk-based capital add-on for operational risk. Is this sufficient to guard against operational risk? Chairman GREENSPAN. I do not know the answer to that. Chairman SHELBY. Okay. Would you get back with us on that, maybe? Chairman GREENSPAN. I will get back to you, but I have a suspicion that it is a difficult question to answer unless you get involved Chairman SHELBY. Very complicated. Chairman GREENSPAN. —into the detail of what their potential operational risks could be. Chairman SHELBY. Okay. Chairman GREENSPAN. But I will check and see if I can find somebody to address that. Chairman SHELBY. Okay. Mr. Chairman, do you believe, or could you say that the GSE's now hold sufficiently diverse assets to pro Wouldn't those be good qualities to have as a board member exercising fiduciary responsibility and oversight of such an important part of our financial system? Chairman GREENSPAN. Senator, it would if it were not for the fact that we have a potential large conflict of interest. On the one hand, we are involved in being the lender of last resort and the institution which has been required by the Congress to try to maintain systemic stability. If we were involved, I am fearful that we Iwould have on the one hand the desire to make sure that the GSE's were whole the way all regulators do and we do for commercial banks, but we would clearly be concerned if we thought there were systemic risks involved in the process. So, I would say we would probably be uncomfortable in that particular role and hope that we are not asked to do so. Senator SUNUNU. Thank you, Mr. Chairman. Chairman SHELBY. Thank you. Chairman Greenspan, you have touched on a number of things here today, and I might go over a few that you have already talked about a little bit. We do have that ambiguous relationship-that is, the Federal Government-with the GSE's. How do we actually get rid of that ambiguity is a complicated, tricky thing. I do not know how we do it. You have alluded to it a little bit, but how do we define the relationship is important, is it not? Chairman GREENSPAN. Yes. Of all the issues that have been discussed today, I think that is the most difficult one, because you cannot have in a rational government or a rational society two fundamentally different views as to what will happen under a certain event, because that invites crisis and it invites instability, and invites a conclusion that the Congress will not be able to control unless it moves in advance and defines exactly how this issue will be resolved. One possibility-and as I said, it is difficult to know exactly how to construct this-is to define what would happen in the event of some form of crisis where you can define the nature of a receivership and who gets what under certain conditions. That would be a difficult thing to do. It would clarify the issue and perhaps clarify enough to remove the ambiguity going forward. Chairman SHELBY. But there is a heck of a lot of difference between a conservatorship and a receivership. The banking system that we deal with up here every day, they are subject, at least technically, to a receivership. Is that correct? Chairman GREENSPAN. Correct. Chairman SHELBY. Now, if we were to create some type of receivership in legislation, you could not just unwind overnightChairman GREENSPAN. No. The problem here Chairman SHELBY. It is very complicated. Chairman GREENSPAN. It is very complicated, and you have to be very careful not to undermine the GSE's in the process. Chairman SHELBY. Because if you did, you could undermine some of the banking system Chairman GREENSPAN. Absolutely. Chairman SHELBY. -because the banking system are big investors here; is that right? Chairman GREENSPAN. This is the reason why I think this is a very sensitive question and the reason why it is an issue that I perceive to be necessary to be resolved in the longer-run. As I indicated early on, Senator, I think at the moment there is no evidence that there is any imminent systemic risk here, and that is precisely the reason why I think this is the time that you start to think about making certain it does not occur in the future. In the process of defining how this is done, remember, as you point out, that under existing statute, there is a conservatorship, not a receivership, which essentially says for all practical reasons that the Congress will bail out the GSE's in the event of a crisis. Chairman SHELBY. It is another implied guarantee; is that right? Chairman GREENSPAN. Under existing rules, if there is a crisis, it is going to be very difficult for the Federal Government not to guarantee these assets. If that is not the decision of the Congress, something different has got to be done, and all I will say to you, as you very well understand, Mr. Chairman, this is a very difficult situation because we have extraordinarily viable GSE's. Chairman SHELBY. That is right. Chairman GREENSPAN. Fannie and Freddie-I may criticize the issue of the subsidy, and that is basically because it is so starkly different for me in the sense that without the subsidy, as I have told my friends in both of these institutions, I think they would be far better off privatized, and one of the reasons is I think they are very well run. But if in the process of resolving this issue, we undercut these institutions, I think we will be doing the Nation a great disservice. So it is not a simple process as I see it. Chairman SHELBY. Mr. Chairman, could we have a statement of public policy that we are very interested in-and we know why, for economic reasons, social reasons, and so forth-on private housing ownership in this country and at the same time state we are interested in sound financial institutions to help bring this about? Couldn't we do both, or can we? Chairman GREENSPAN. Mr. Chairman, I think we have to do both. Chairman SHELBY. We have to do both. Okay. Fannie and Freddie are subject, as I understand it, to a 30 percent risk-based capital add-on for operational risk. Is this sufficient to guard against operational risk? Chairman GREENSPAN. I do not know the answer to that. Chairman SHELBY. Okay. Would you get back with us on that, maybe? Chairman GREENSPAN. I will get back to you, but I have a suspicion that it is a difficult question to answer unless you get involved Chairman SHELBY. Very complicated. Chairman GREENSPAN. -into the detail of what their potential operational risks could be. Chairman SHELBY. Okay. Chairman GREENSPAN. But I will check and see if I can find somebody to address that. Chairman SHELBY. Okay. Mr. Chairman, do you believe, or could you say that the GSE's now hold sufficiently diverse assets to pro tect against liquidity risk? You said you believe they are pretty well-managed. Chairman GREENSPAN. I would say generally they have quite adequate liquidity. Chairman SHELBY. Mr. Chairman, we have had one hearing on Basel II here, and there has been some skepticism, as you know, from some of your regulator contemporaries expressed on some of the models that Basel II's framework would come about. You note in your testimony, "In order to manage risk with little capital requires a conceptually sophisticated hedging framework" and that these are your words "in essence, the current system depends on the risk managers at Fannie and Freddie to do everything just right.” If this is the case for Freddie and Fannie, who tout their risk management practices, shouldn't we have similar concerns with the reliance that Basel II would similarly place on such models, because they would change the whole capital structure as we know it, at least from up here? Chairman GREENSPAN. Yes. Fannie and Freddie are special cases which are quite different from the institutions that Basel II is directed at. In other words, this is a special case of highly leveraged, low credit risk, high interest rate institutions. I do not want to say they are unique, but they are close to that. The type of risk-based capital procedures that are involved in Basel II are far less complex types of issues than arise here, and also, it is a different type of risk management. Chairman SHELBY. Okay. Mr. Chairman, one last question. You assert in your testimony that "Fannie and Freddie's purchases of their own or each other's securities or their debt do not appear needed to supply mortgage market liquidity or to enhance capital markets in the United States." Those are your words. You suggest-and these are your words again-"deep and liquid markets that are provided by MBS's held by private investors." What effect if any would we see on liquidity in the mortgage market where the GSE is prevented from holding these securities in their own portfolio? Chairman GREENSPAN. I do not think there should be a prohibition. I just think the size is what the issue is all about. In other words, to the extent that you need to hold securities for various different operations which facilitate the securitization operations of the GSE's, that is perfectly sensible. Chairman SHELBY. Is that generally temporary, though? Chairman GREENSPAN. Well, the issue is not the temporary; it is a question that is a very small part of the portfolio they hold. Chairman SHELBY. Senator Sarbanes. Senator SARBANES. Thank you, Mr. Chairman. Let me just follow up on the question that the Chairman just put, because I think it is interesting. Some have argued that the GSE's provide important stability in the mortgage markets during periods of economic instability, and they cite, for example, the Asian debt crisis in 1998 or the business and bank recession of 1990-1992, and argue that the mortgage rates would have increased dramatically at that time-as in fact they did in the jumbo mortgage market and in other credit markets-but that the GSES' ability to continue buying mortgages and mortgage-backed securities made a difference so that they helped play an important stabilizing role. What is your response to that? Chairman GREENSPAN. First of all, the reason that there were fairly significant purchases at that time is that during that crisis you had a flight to quality which pushed long-term Treasury rates down, and because the presumption was that the GSE debt was comparable to Treasury, its rates went down, and as a consequence of that, the margins opened up, and it became quite profitable to go in and purchase mortgages and mortgage-backed securities. So that the issue was not an endeavor to do something for the markets per se; it was a very sensible business decision. Senator SARBANES. But did that endeavor contribute to stability? Chairman GREENSPAN. I think it did in part, yes; I said I think it did in part. Senator SARBANES. Okay. Now, I was struck by your response to Senator Stabenow earlier on the effect of GSE's on mortgage rates in which you said, well, if it is 7 basis points, citing the Passmore study, and then you said, well, maybe it is 10 or maybe it is 12, and that was the range of your example. But are you familiar with the CBO study in 2001 that said the effect of GSE's on mortgage rates was 25 basis points? Chairman GREENSPAN. I am, Senator. Senator SARBANES. And are you familiar with the CBO study in 1996 that said the effect of GSE's on mortgage rates was 35 basis points? Chairman GREENSPAN. I am, Senator. Senator SARBANES. I am interested why your range of example seemed to fall so significantly short of these other studies excepting, at least in part, the argument that we have all these different studies, and we do not really know, which I think was the thrust of your argument, but then the range you gave really fell well short of these CBO studies. Chairman GREENSPAN. Well, I think you have to remember that as these studies progress, we are learning things, and each analyst has the ability to learn from previous estimates. The early estimates, as best I can judge, were much simpler in structure and in evaluation than those that have occurred more recently. Remember that Wayne Passmore and his colleagues who worked on this study were fully familiar with those previous studies and clearly, they had the choice of saying, well, they are right, or we can improve on them; and in the process, as best I can judge looking at the different techniques that are employed, the most recent study by Passmore and his colleagues is by far the most sophisticated and the one most likely to be accurate. Senator SARBANES. There is considerable controversy over that. Chairman GREENSPAN. And I might say that the one thing that I am quite pleased about, Senator, is that we are finally coming to grips with this issue, and I hope that a good deal of resources, private and otherwise, are applied in this direction. And as we said |