Q.6. Do you believe the fact that current law gives authority to oversee new GSE programs and activities to HUD, and safety and soundness oversight to the Office of Federal Housing Enterprise Oversight (OFHEO), have undermined OFHEO's ability to oversee the safety and soundness of Fannie and Freddie? Why or why not? A.6. Under current law, the Federal Reserve Board serves as the safety and soundness supervisor for bank holding companies and also has primary responsibility for reviewing and approving (or disapproving) proposals by bank holding companies to engage in new activities. (In some instances, the Board must coordinate its review of new activities with the Treasury Department.) Importantly, this authority permits the Board to review the potential risks involved with a proposed new activity, and the systems and procedures a bank holding company will use to monitor and control these risks, before the activity is commenced by a bank holding company. This authority also provides the Board with the ability to prevent bank holding companies from commencing any new activity that would present unacceptable risks to the safety and soundness of the banking organization or that is not authorized by applicable law.

As I mentioned in my testimony, I believe the GSE regulator should have authority similar to that of the banking regulators. This would include the authority to review and approve (or deny) proposals by a GSE to engage in new business activities, to place conditions on any such approvals to ensure that any new business activity commenced by a GSE is conducted in a safe and sound manner and is consistent with applicable law, and to enforce these prior approval requirements and any decisions made by the GSE regulator under this authority.

Q.7. In your testimony, you reiterated your support for privatization of the housing GSE's. However, in response to a question from Senator Sarbanes, you also appeared to disavow one of your previous recommendations advocating for redirecting capital away from housing and toward other, more "productive" uses. In a May 19, 2000 letter to Representative Baker, you said, “. these orga

nizations alter the housing finance markets only to the degree that they pass through to homebuyers part of their Government subsidy. They accomplish this by diverting real resources from other market-determined uses." Later in that letter, you stated, "Subsidies accorded to the GSE's are, of necessity, at the expense of other Federal or private sector initiatives." In a subsequent August 25, 2000 letter to Representative Baker, you said, "If the lower costs associated with these implicitly subsidized funds are passed through to the mortgage market in the form of lower mortgage rates, then housing will expand relative to nonhousing investment, including private sector initiatives such as investment in productivity-enhancing plant and equipment." If the GSE's were privatized, wouldn't it result in capital being redirected away from housing toward other sectors of the economy, reducing liquidity in the secondary market, and thus resulting in higher mortgage rates for homebuyers? Why or why not?

A.7. In recent years, I have become impressed with how important wide homeownership has been to a general acceptance of property rights as a pillar of our society. This is not an issue I had given

adequate thought to previously. Hence, although subsidizing of homeownership does divert capital from more "productive" uses, it is, in my judgment, a small price to pay for the benefits.

Subsidizing homeownership, as I indicated earlier, is far more ef ficiently implemented by on-budget programs. Too large a part of subsidies granted implicitly to GSE's is diverted to shareholders. None is diverted from on-budget subsidies.

Whether or not privatization of the GSE would raise mortgage rates or reduce liquidity in the secondary market depends on how much the GSEs' status as Government Sponsored Enterprises, and the implied subsidy that flows from this status, actually influences mortgage rates or provides liquidity. The evidence to date is that their influence on mortgage rates is small. The consequences of privatization do not seem to be significant except to the extent that it may cause Fannie Mae's and Freddie Mac's portfolio growth rates to lessen, thus reducing the systemic risk associated with such portfolios. As I indicated during my testimony, even after any privatization, it is likely Fannie Mae and Freddie Mac would continue to play important roles in the housing and mortgage markets.

RESPONSSE TO WRITTEN QUESTIONS OF SENATOR DOLE

FROM ALAN GREENSPAN

Q.1. In your testimony you state "GSE's need to be limited in the issuance of GSE debt and in the purchase of assets, both mortgages and nonmortgages." You explain earlier in your testimony that these mortgage investments ". ... concentrate interest rate and prepayment risks at these two institutions." Some have argued that these mortgage investments help Fannie and Freddie to fulfill their mission. What are your thoughts on that?

A.1. Federal Reserve staff is not aware of any evidence that convincingly shows that channeling GSE activity toward mortgage securitization and away from holding mortgage-backed securities in portfolio would negatively impact liquidity in mortgage markets. Whatever liquidity or other benefits the GSE's bring to the markets, if any, likely can be supported by GSE's with a greater emphasis on mortgage securitization and with less emphasis on enhancing their subsidy by holding their own MBS. Moreover, as I noted in my testimony, any proposal to direct the flow of Fannie Mae's and Freddie Mac's activities toward mortgage securitization would still leave the GSE's among the largest financial institutions in the United States and would allow them to grow with the mortgage markets.

Q.2. Chairman Greenspan, the General Accounting Office has warned us that the incentives to use the benefits of Government sponsorship to increase shareholder value could, over time, erode the public mission. Do you agree with that warning?

A.2. Given the large nonmortgage portfolios held by the GSE's, I can understand GAO's concern.

Q.3. In your testimony you state: ". .. if the regulation of the GSE's is strengthened, the market may view them even more as extensions of the Government and view their debt as Government debt." Do you believe there is any practical way of strengthening

their regulation without expanding the misperception of an implicit subsidy?

A.3. The practical way is to create GSE receivership provisions and make the method by which creditors of the GSE's can take losses clear and credible to the investing community.

PROPOSALS FOR IMPROVING

THE REGULATION OF THE HOUSING GOVERNMENT SPONSORED ENTERPRISES

WEDNESDAY, FEBRUARY 25, 2004

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, DC.

The Committee met at 2:34 p.m., in room SD-538, Dirksen Senate Office Building, Senator Richard C. Shelby (Chairman of the Committee) presiding.

OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY Chairman SHELBY. The hearing will come to order.

This afternoon, the Committee holds its fifth hearing on needed improvements to the regulation of Government Sponsored Enterprises. The Committee will hear from Mr. Franklin D. Raines, Chairman and Chief Executive Officer, Fannie Mae; Mr. Richard F. Syron, Chairman and Chief Executive Officer, Freddie Mac; and Mr. Norman B. Rice, President and Chief Executive Officer of the Federal Home Loan Bank of Seattle.

It is my intention that today's hearing will be the final session in our series of hearings. After today's hearing, we will have heard from a wide variety of witnesses, and we will have an extensive record to review in our deliberations. Several Members of this Committee introduced their own proposals to reform GSE regulation, and I want to commend Senators Hagel, Dole, Sununu, and Corzine for their hard work in this regard and their ideas and their approach, and also for their participation in the hearing process. They have been very involved.

It is time for the process to move forward. The Committee will be working over the next several weeks to assemble a legislative package. I know that all of the Members of this Committee share a goal of putting in place a strong, credible regulator that will ultimately benefit the GSE's, protect taxpayers, and preserve the prominent role of housing in our economy, which we all support. I want to thank all the witnesses for appearing here today, and we look forward to your testimony and also the question period. Senator Johnson, do you have an opening statement?

STATEMENT OF SENATOR TIM JOHNSON

Senator JOHNSON. Yes, a brief statement. Thank you, Mr. Chairman, for calling today's hearing, another in a series to determine the best way to improve the regulatory framework for the housing

GSE's. I look forward to hearing this distinguished panel. Following Chairman Greenspan's testimony yesterday, I think it is timely and important that we carefully consider the testimony of today's witnesses on the important mission our housing GSE's carry out every day to help advance the dream of homeownership for millions of low- and middle-income American families.

I simply do not agree with Chairman Greenspan's view that housing GSE's should be privatized. I am also growing increasingly concerned that officials of the Bush Administration, most recently Gregory Mankiw, Chairman of the Council of Economic Advisers, have called into question the real and perceived benefits Fannie and Freddie receive because of their Congressional charter. These benefits the Administration continues to attack come with critically important public policy responsibilities and mandates from Congress, including requiring Fannie and Freddie to meet affordable housing goals and targeted minority homeownership goals.

Congress provided these tools to the GSE's to help low- and middle-income Americans realize the dream of homeownership, and they are also restricted from participating in the marketplace for higher-end homes. There are important policy reasons that we need to address in considering regulatory reform, including whether to include the Federal Home Loan Bank in a new regulatory entity, appropriate minimum capital standards, receivership, and program approval authority.

I intend to work with my colleagues to reach a consensus on these and other issues, and I continue to believe that changes are needed to ensure the integrity of the system. However, I have to caution that continued statements by the Administration questioning the need for a Federal-private partnership through the Government Sponsored Enterprises makes reaching agreement on reforming the regulatory structure of these entities all the more difficult. The goalposts keep shifting, and I find this troubling.

In my home State of South Dakota, many community financial institutions rely heavily on products offered by Fannie Mae, Freddie Mac, and the Federal Home Loan Bank of Des Moines to help finance quality, affordable housing in small rural communities. Without the important private-public partnership demonstrated by our housing GSE's, I have to wonder how many of my low- and middle-income constituents in rural South Dakota would be significantly hindered in becoming homeowners.

The Administration, in the name of economic efficiency, has tried to convince us that exporting jobs is good, and now we are urged to leave our housing needs to the marketplace and hope for the best. As we move forward on regulatory reform of the housing GSE's, we have got to keep in mind the fundamental role that these institutions play and ensure that whatever changes we make to the regulatory structure, whether in the areas of minimum capital, receivership, or other issues, we do not inadvertently harm the housing mission of the GSE's.

As the creator of these important institutions, we in Congress have a special obligation to ensure that the GSE's are meeting their unique role while at the same time ensuring that the regulatory structure for the GSE's is strong, independent, and credible.